Investing 101 - How to Overcome the Fear of Investing
It’s easy to fear something you either don’t fully understand, or know how it works.
Investing may sound like a scary or unstable use of your money, but understanding your options can help ease the fear of taking the first step. So what is investing and how do you get started?
What is Investing?
Investing is the act of placing money in financial vehicles with the goal of it growing over time and eventually producing a profit. There’s a number of ways to accomplish building wealth, whether you’re investing in endeavors, or purchasing assets to sell later for a higher price.
Have you heard the phrase “high risk equals high reward”? In investing, risk and reward are two sides of the same coin. Low risk generally gives a low return, and higher risk can potentially yield more profitable returns.
Types of Investments
There are many different types of investments to choose from, making it easier to find one that will fit your unique needs. As mentioned previously, the level of return can depend on the risk involved with your investment. Depending on your comfort level with risk, you can evaluate which investment makes sense for you.
On the lower end of risk are basic investments such as Certificates of Deposit (CDs). Going higher on the risk scale are products like bonds or fixed-income instruments, and generally considered more risky are stocks or equities. Commodities and derivatives are usually considered among the riskiest investments. Outside of intangible investments, are more physical items such as land or real estate, or even fine art and antiques.
The type of return you receive depends on the asset – many stocks pay quarterly dividends, while bonds can pay interest every quarter. Also, keep in mind different types of income are taxed at different rates. In addition to the dividend or interest you earn, consider your investment’s price appreciation. Price appreciation is the increased value of an asset over time. Your total return on an investment includes the sum of income and capital appreciation. Many different types of investments exist, and most fall within cash, bonds, real estate, and stocks. An asset is something valuable that increases your net worth.
First things first – before investing, be sure you have enough in your emergency funds to cover three to six months’ worth of living expenses. Also, evaluate your current debt-to-income ratio. While some debt is good and can help increase your wealth over time, like a mortgage, some debt is bad and can grow quickly, like high-interest rate credit cards. Consider paying down outstanding debts that won’t benefit your financial outcome. It’s important to make sure you have enough liquid money to cover any unexpected emergencies, which will help give you peace of mind as you begin investing.
Keeping your cash in a checking, savings, or money market account is a low-risk and low-return way to secure your money. Typically, these types of accounts don’t keep up with inflation. Inflation is how life gets more expensive over time, like how the cost of a new car was around $7,000 in 1980, and is $40,000 in 2021.
Certificates of Deposit (CDs) are an account you put your money in for a set amount of time, and it will earn a certain amount of interest. CDs usually have lower interest rates, and may not give you a high return, but they are generally considered a safe investment.
A bond is an agreement between the borrower and the investor. The borrower is typically the government or a corporation, and you are the investor.
There are three kinds of bonds:
Government– the U.S. Treasury department backs these bonds, which supports government spending and obligations. Government bonds can pay periodic interest payments, and are considered low-risk since the government backs them.
Municipal– is a debt security issued by a state, municipal, or county for financing its capital expenditures. This includes infrastructure projects like construction of highways, bridges, or schools. Municipal bonds are usually exempt from federal taxes and most state and local taxes. These are typically more attractive to people in higher tax brackets.
Corporate– is a type of debt security issued by a firm and sold to investors. The company receives the money it needs, and in return, pays the investor a predetermined number of interest payments. These interest payments can have fixed rates or variable rates. When the bond expires, the interest payments end, and they return the money to the investor.
In general, bonds can be safe and reliable. However, their value can fluctuate similar to stocks, and they do come with their own set of risks. A few primary risks include:
Reinvestment risk– means a borrower will need to reinvest a bond or cash flow into a security with a lower return.
Call risk– callable bonds come with the authority to allow the issuer to purchase the bond back from the investor, and close the bond.
Default risk– occurs when a bond issuer is unable to pay the agreed-upon interest or principal to the investor, either in a timely manner, or not at all.
Inflation risk– as mentioned in the above example about inflation, this risk happens when the rate of price increases in the economy, and deteriorates the returns associated with the bond.
Real estate is land, and anything you decide to build on it. Types of real estate investments include houses, apartments, retail space, or commercial buildings. Typically, investors regard real estate as a smart investment because it appreciates value. If you own your home, you’re already investing in real estate! Sometimes people purchase an additional home to rent out, for generating income. Real estate is a demanding investment, and requires your time and effort to maintain. Also, consider purchasing real estate properties with cash to avoid unnecessary risk, and you won’t have to purchase with a loan, which increases your debt.
Stocks represent a small piece, or share, of a company. When a company goes public, they sell small shares to people to help fund its growth. There are two types of stocks:
Single Stocks– means purchasing stocks in a specific company. There are two main ways to make money on single stocks:
Dividends– Companies may pay stockholders a regular share of its earnings.
Selling your stocks for profit– as the company earns more money, the value of its stock increases. If you decide to sell when your share is worth more, you could earn more profit.
However, success with single stocks is contingent on the success of the company. When determining if you want to invest in a single stock, consider factors like the amount of time you have for investing, tax planning needs, and your experience with investing. Here are a few pros and cons of single stocks:
Pros– reduced fees, understanding your taxes owed and paid, and the ability to get to know the company in which you’re invested.
Cons– potential difficulty with diversifying your portfolio, need for more time in your portfolio, and a greater responsibility to avoid emotional buying and selling as the market fluctuates.
Mutual Funds– are created when a group of people put their money together to buy stocks in different companies. Mutual funds allow you to diversify your portfolio – one of the most important principals of investing. Diversifying essentially means, “don’t put all your eggs in one basket.” The idea is you want your money to work across different kinds of stocks, with different levels of risk. Here are four main types of mutual funds:
Growth and Income funds– These are typically the most predictable funds when it comes to their market performance.
Growth funds– Are fairly stable funds in growing companies, and provide an equal risk to reward ratio.
Aggressive growth funds– You can’t be entirely sure what these funds will do, which makes them high-risk = high-reward investments.
International funds– These funds invest in companies across the globe.
You may have heard the term “cap” associated with some of these funds. “Cap” is short for capitalization, which is how much a company is worth. Here’s how companies are classified:
Small-cap– Valued less than $2 billion.
Mid-cap– Valued between $2-10 billion.
Large-cap– Valued more than $10 billion.
A mutual fund will contain a bunch of different investments, with either the market index, particular asset class, or specific sector, in common. By spreading out your investments across a variety of mutual funds and company sizes, you can balance high-risk investments, with steady and predictable funds.
The secret to investing success? Compounding interest. Compound interest is when you invest your money in an interest-bearing account, and the interest you earn, begins to earn interest. You’ll see your account balance grow more quickly with the accounts that pay interest more frequently.
Patience and time are key to seeing the benefits of compounding interest.
How to Start Investing
Now that you know the basics, where do you go from here? You have a few options to get started. If your workplace offers a retirement program, that’s an easy way to start building your portfolio. Otherwise, you have the option to invest through a bank or brokerage firm.
If your workplace offers a Retirement Account Match, be sure you’re contributing the company match (at a minimum!). Employer Matches are essentially free money.
For example, if your employer will match up to 4% of your total gross income, and if you make $40,000 annually and invest 4%, you’re earning a $1,600 match. Over 20 years, a 4% match alone earns you more than $100,000 at a 10% rate of return.
There may be several options for investing with your work, but a few good suggestions to consider are a 401(k) or 403(b). Both of these accounts allow you to invest dollars pre-tax in mutual funds.
Fun fact: The title “401(k)” is named after the section of the tax code: page 401, section “k,” pretty cool, right?
Diversify Your Investments
As mentioned earlier, spreading out your investments between different mutual funds can give you a good risk to reward ratio. Consider automating your investments and contributions. You can decide to contribute a fixed amount or percentage each paycheck. Putting your money from your paycheck directly into your 401(k) automates the process, and makes building your wealth easier.
IRA stands for Individual Retirement Account, and is a way for you to open a retirement account if your employer doesn’t offer one, or you’re self-employed. You can open these types of accounts at a bank or brokerage firm. Even if you have a traditional IRA through your work, consider opening a Roth IRA. Roth means “tax free,” and by investing your after-tax dollars now, your investments will grow tax-free, and withdrawals at age 59 ½ are tax-free!
How Much Should You Invest?
Some financial experts suggest investing 15% of your gross income into retirement, if you’re debt-free (aside from a mortgage) and in a position to invest. It’s important to remember to leave your investments alone, especially when the market slumps. Investing in the stock market is similar to riding a bull – there’s ups and downs, and you certainly don’t want to get off at the wrong time!
Do I Need a Financial Advisor?
If you’re new to investing, or you’re a seasoned pro, it’s wise to have a comprehensive evaluation of your total economic condition created. An advisor will guide you through the steps of creating a personal financial plan, help you strategize your portfolio, evaluate your specific needs and goals, and offer educated advice and direction to help you achieve your goals.
The first step toward reaching your goals is finding the right advisor to help get you there. That’s why we offer no-obligation initial consultations. These meetings provide an opportunity for you to get to know the person who will be advising you, and just as importantly, for us to get to know you.
Investing 101: How to Start Investing, Chris Hogan
Investing 101: A Guide to Investing for Retirement, Nerd Wallet
1980's Collector Cars including Prices, The People History
Average New-Vehicle Prices Continue to Surpass $40,000, Kelley Blue Book
Government Bond, Investopedia
Municipal Bond, Investopedia
What Are the Risks of Investing in a Bond?, Investopedia
Single Stocks in Your Portfolio: Pros and Cons, Investopedia
Investing involves risk including the potential loss of principal. There is no guarantee that a diversified portfolio will outperform a non-diversified portfolio: it is a method used to help manage portfolio volatility. The prices of small and mid-cap stocks are generally more volatile than large cap stocks. There are no guarantees that dividend-paying stocks will continue to pay dividends. Companies may reduce or eliminate the payment of dividends at any given time. In addition, dividend-paying stocks may not experience the same capital appreciation potential as non-dividend-paying stocks.
CDs are FDIC insured to specific limits and offer a fixed rate of return if held to maturity.
In general, the bond market is volatile as prices rise when interest rates fall and vice versa. This effect is usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss. An issuer may default on payment of the principal or interest of a bond. Bonds are also subject to other types of risks such as call, credit, liquidity, interest rate, and general market risks. Treasuries are debt securities issued by the United States government and secured by its full faith and credit. Income from treasury securities is exempt from local and state taxes. Municipal bond offerings subject to availability and change in price. Municipal bonds are federally tax-free but other state and local taxes may apply. If sold prior to maturity, capital gains tax could apply.
The fast price swings in commodities will result in significant volatility in an investor’s holdings. Commodities include increased risks, such as political, economic, and currency instability, and may not be suitable for all investors.
A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRA penalty tax. Limitations and restrictions may apply.
The information provided in these articles is intended for informational purposes only. It is not to be construed as the opinion of Central Bancompany, Inc., and/or its subsidiaries and does not imply endorsement or support of any of the mentioned information, products, services, or providers. All information presented is without any representation, guaranty, or warranty regarding the accuracy, relevance, or completeness of the information.