Investing is the second pillar to building wealth and achieving financial freedom, but putting your hard-earned savings back out into the world is a scary prospect. Investing is inherently risky, since any asset bought for cash can rise in value as easily as it can fall.
The last twenty years saw one of the strongest bull runs in the history of the stock market, with new financial products that made it easier than ever to participate. However, these days, world events and weakening economic conditions have put a damper on that easy flow of money. Investors who jumped in at the peak of the cryptocurrency craze have lost life savings, and retirees have had to reconsider their retirement plans as high inflation and negative returns eat into their livelihoods.
Investing is risky.
But keeping your emotions in check and investing when the market falls is exactly what the rich do. In the 2021 World Wealth Report, Capgemini reports that the world’s high-net-worth individuals allocated between 21-28% of their assets to cash in crisis years during the past two decades. When the economy heats up again, these cash reserves help investors buy cheap homes, stocks and other assets. Here’s how to invest like the pros.
Enroll in an employer-sponsored retirement plan
First and foremost, make sure you are enrolled in your employer-sponsored retirement plan and taking advantage of any contribution matches offered. Direct contribution plans like your 401(k) or 403(b) offer special tax advantages, such as allowing you to increase your investment returns tax free until retirement.
Investing in a tax-efficient manner can retain as much as 2% more in gains every year, according to research by investment firm Fidelity. Over 30 years, that could add up to nearly a 30% difference in account value, just from paying annual taxes on your investment gains. That’s why experts recommend utilizing different tax strategies to optimize your gains, and that’s why enrolling in an employer-sponsored retirement plan is a solid place to start. Employer matches are free money for you, so take advantage and contribute.
Open a no-minimum taxable brokerage account
Direct contribution plans have legal limits on how much you can contribute – $20,500 per year in 2022 for a 401(k). But even if you don’t reach that maximum, you still need to consider that these plans are retirement plans, which is to say, you can’t tap those funds until retirement without paying a heavy penalty. Another option for investing is to open a no-minimum taxable brokerage account, i.e. a normal investment account.
The benefits to opening a taxable brokerage account include more freedom to choose investments and the ability to buy and sell investments to optimize your tax bill. You could also potentially view your brokerage account as a long-term savings vehicle that you could access in case of emergency or financial need. Because a normal investment account is only limited by your knowledge and funds, opening a regular investing account can also help you increase your knowledge about specific stocks, industries and other financial assets.
In a survey of over 100 under-40 millionaires, these savvy investors generally saved 20% of their salaries, directing 10% to retirement accounts and the other 10% to taxable brokerage accounts. Investment giant Charles Schwab estimates that utilizing both a tax-advantaged account and a taxable brokerage account can help you maximize your investment gains.
For example, tax-advantaged accounts like your retirement accounts are ideal for stocks and active funds that may generate a higher short-term tax bill. On the other hand, taxable brokerage accounts are ideal for long-term individual stocks, exchange-traded funds, funds that pay dividends and bonds. This is because taxes on longer-term assets are significantly lower.
Basically, opening a taxable brokerage account offers you more investment freedom and the opportunity to optimize your taxes, potentially saving you more over time. Furthermore, many major brokerage firms offer no-minimum accounts with extensive education centers to help you dig deeper into the subjects that interest you.
Consider a robo-advisor account
If, however, you’re more of a hands-off type of investor, consider opening an automated investment account, also known as a robo-advisor account. These are accounts that substitute a human portfolio manager with an AI-powered advisory service. You answer a questionnaire that determines your level of risk tolerance, time horizon and investment goals, and the robo-advisor will return investment options that should suit your profile. These robo-advisors generally follow an asset allocation strategy that diversifies your money among different asset funds.
Advantages to robo-advisor accounts include: low fees, investment algorithms based on Nobel-prize-winning models and wide accessibility given their low account minimums. Of course, many of these services are not wholly personalized to your situation and preferences, and robo-advisor accounts don’t usually support investing in options, futures or alternative investments. Nevertheless, as the technology evolves, these may prove a comfortable option for hands-off, DIY investors.
Consider fractional investing
Even if you open a normal investment account, individual stocks can be expensive. Large, well-established companies are often valued at dollar amounts that seem impossible, and the more famous it is, the more likely the company’s stock is worth a lot. These large companies are considered less risky than their smaller counterparts, since their business is often very stable and less likely to fail during rocky economic times.
Even so, when you’re just starting out as an investor, putting all your money into one stock may not be easy or wise. Remember, investing is a risky activity, and if you ever need to pull that money for unexpected situations, you may be selling your shares at a loss. That’s why financial experts recommend diversifying your funds depending on how much risk you can tolerate. If you’re not willing to potentially lose that money, you should follow an investment strategy that reduces your exposure to the daily ups and downs of the stock market.
When you have only a little money to invest, you’re more exposed to these minute movements in the market. Other than buying cheaper stocks (and possibly exposing yourself to more risk), you could buy fractional shares.
Fractional share investing is exactly how it sounds: investing in fractions of stocks that have a high price per share. On platforms where fractional investing is offered – notable platforms include Robinhood, Fidelity Investments and Charles Schwab – instead of buying a whole share, you can buy a portion of a share. This can be especially helpful for investors new to investing, who might not have the cash available for whole shares or who prefer to diversify their limited funds among different stocks.
For example, before splitting their stocks, Alphabet, the parent company for Google, hit $2,200 per share and Apple was worth $400 a share. In July 2020, Apple announced a 4-to-1 stock split, which meant every share was divided into four, bringing its per-share price to a more manageable $130. Alphabet, on the other hand, announced a whopping 20-to-1 stock split in July 2022, which brought its per-share price from over $2k a share to a more accessible $110. If those companies hadn’t decided to split their stocks, only investors with a lot of cash would be able to invest in them. Or fractional investors, who bought a fraction of a share.
Research low- and no-cost investment funds
Not even five years ago, buying and selling stocks carried a fee. This commission was deducted every time you conducted a transaction, meaning you had better earn more than the commission each time you bought and sold a share or you’d actually be losing money.
Now, with the advent of low- and no-cost stock trades, many brokerage platforms like Robinhood, ETrade, Charles Schwab and Fidelity essentially make the buying and selling process free. While most firms still charge fees for trading derivatives and bonds, buying individual stocks is far more accessible these days. Which means investors looking to build long-term wealth can start investing with less money than ever before.
Pooled investments like exchange-traded funds and mutual funds, can also be very low cost, which make them very effective choices for longer-term investing. The advantage to buying shares of these funds is that they are professionally managed, which means that the management team of that fund is frequently tracking and adjusting its performance.
There are funds for nearly every financial asset in existence, so it’s important to learn a little about the industry and sector before purchasing. Learn how to research funds here.
Bottom line
Investing is inherently risky, but with risk comes the potential for reward. Never jump on the bandwagon of a meme stock or internet-recommended investment without solid research and understanding of the financial asset you’re considering. Investing is an important facet of building your wealth, as it allows your money to grow with little input on your part. So start early if you can and try to think of investing as a long-term activity. There are many investment options out there, with varying degrees of risk, and there’s certain to be something that will catch your interest.
