Investing: Why it’s important and how to get started
You’ve paid the bills and put aside the usual amount in your savings account, and you still have some money to spare. While you could simply add that cash to your savings for short-term goals, now may be the time to consider investing for longer-term goals by buying individual stocks or bonds, shares of a mutual fund or other investments.
As important as it is to save, adding investments to your financial strategy (above and beyond your retirement accounts) could help you pursue an important future goal such as buying a house, paying for your kids’ education or taking time off to travel. Investing may help you get to your longer-term goals, yet many people are hesitant to begin.
It’s okay to start small
Perhaps you assume that investing requires lots of money, and you have other important financial priorities such as maintaining those retirement contributions and creating an emergency fund that can cover at least three months of living expenses. Other needs include a plan to pay off balances on credit cards and buying life insurance, especially if you provide most of the financial support for your household.
Still, holding off on investing for longer-term goals until these needs are fully met could be counterproductive. “If you delay working toward longer-term goals until you have your entire emergency fund or you’ve paid off all of your high-interest debt, you could miss out on important opportunities for potential growth,” says Chris Vale, senior vice president of products and solutions at Merrill.
Most people have the potential to pursue multiple goals at once, which means you don’t have to choose between saving and investing. Understand the difference between them and use them as they are appropriate to your needs. If progress toward your short-term financial goals permits, you may be able to invest a small amount—as little as $25 to $50 a month.
A potential for your money to grow
One key goal of investing is to provide the potential to keep up with the cost of living. If you’re too protective of your cash, you might not earn enough to keep up with inflation, or the increase in prices over time.
Say, for instance, you stashed $1,000 in a savings account. After 10 years, with a 1 percent interest rate, you’ll have about $1,105. However, if annual inflation averages 2.5 percent, as it has recently, you would need at least $1,280 after 10 years just to keep pace with rising prices.
Investing your $1,000 instead could potentially lead to a better result. It’s important to know that different types of investments carry different risks. For example, stocks are generally considered riskier than bonds but have historically earned greater returns (though past performance is not a guarantee of future results). Investing for 10 years or more gives you some time to potentially recover from any downturns, so you may feel comfortable with a fund that invests in stocks. If you put your $1,000 into a fund that seeks to track the performance of the stock market, and you hypothetically get a 7 percent annual return, you could have the potential to nearly double your money in a decade, ending up with $1,967.
Of course, there is no assurance you will earn this or any return on your investments. This is a hypothetical example. While most savings accounts are insured by the FDIC up to a certain amount, there is no such insurance for investments, and you can lose your investing principal. You should consider all the possibilities before deciding to invest.
What’s holding you back?
“Many people opt not to invest because they overestimate the amount of money they think they need to get started,” says Vale. “They may also be concerned about market risk.”
Investing can feel intimidating, and there are certain risks. Many conditions can negatively affect the value of your stocks or bonds, such as an unpredictable economy and financial markets. You should also consider your own personal reactions when investments rise or fall in value. You may be able to address the risk by mixing, or diversifying, investment types in your portfolio, but there’s no guarantee against losses. That’s why it’s important to understand your tolerance for risk, time horizon and liquidity needs before you make investment decisions.
Once you’re ready to begin investing, the next step is choosing how to do it. Today there are more ways to invest than ever before, and you can have as much—or as little—involvement in the process as you’d like. Consider these approaches:
- Make your own trades. This may be the most direct approach with the lowest fees, although it requires more time to research, monitor and rebalance your investments. Many brokerage firms offer free trades if you invest on your own, but make sure you understand whether you are being charged a commission or fee before placing a trade. A few brokerage firms offer free trades if you maintain a certain balance, but normally you’re charged a specified fee or commission on each transaction. For all of the convenience, making your own investment choices may be confusing, especially when you’re starting out.
- Take advantage of online guidance. If you’d like more help in finding the proper mix of investments for you, you may want to consider an online investing program designed to match your investments to your personal needs and situation. Here, too, there are a range of offerings that greatly simplify things. In most cases, you provide information about your age, how much you have to invest, when you need the money and how much risk you can tolerate. Then computer algorithms (also known as robo-advisors) or human portfolio managers create a portfolio tailored to your goals, typically for a fee. Beyond choosing your initial investments, these programs can also help you rebalance your portfolio as market conditions and your needs change.
- Work with an advisor. Some investors choose to work with personal financial advisors who help them select investments that fit their needs. Yet most advisors require a higher level of assets than you’re likely to have when you’re just starting out and will generally charge more in fees than an online program, so this may be an option for later, as your portfolio grows.
Whichever approach you choose, what really matters is understanding how investing could potentially help you put some of your money to work toward reaching larger, longer-term goals. If you have a clear idea of your objectives, timetable and ability to tolerate risk, you can decide whether investing could be a core part of your overall financial strategy.