When you earn money, you have a few different choices about what to do with that money. Suppose you’ve paid all your bills and have some funds left over. You can spend it, save it, or invest it.
If you spend your money on a weekend trip, a fancy date night, or new clothes, you’ll certainly enjoy yourself in the moment. But, setting aside funds for investing can help you enjoy the future as well.
Maybe you’re interested in the thought of investing but aren’t sure where to start. Well, let’s break down the basics of investing so you can begin building your portfolio.
Types of Investment Vehicles
The first thing to consider about investing is that there are a few different types of investments. Since they have different purposes, let’s take a moment to discuss some of the most common types of investment vehicles.
Certificate of Deposit
A Certificate of Deposit, or as it’s more commonly known — a CD, is generally available through any retail banking institution, including online accounts. Certificates have a preset rate of return that is locked in over a specific period.
Certificates range from very short term to fairly long term. Most banks offer CDs ranging from three to six months, and sometimes all the way up to ten years.
Certificates of Deposit are helpful for new and seasoned investors who want their bank to choose when and how to invest money on their behalf. These are hands-off investments.
Investors set up the account either online or in-person and then watch their statements until the end of the contract term. At the time of account maturity, the investor can decide whether to cash out or reinvest their funds.
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A traditional brokerage account will not have a preset rate of return, and the investment balance will fluctuate based on the underlying investments. We will discuss some of those investments in the next section.
Brokerage accounts are more actively managed than a Certificate of Deposit. In this type of account, an investor chooses when, where, and how to invest their money.
The term derived from the common use of stockbrokers, who are still licensed representatives prepared to assist investors with making trades. Communities, corporations, and wealthy individuals used to hire brokers to facilitate trades on their behalf.
Thanks to significant technological advances, there are several different ways to learn about stock market activity. Today, individuals can place trades electronically and do not have to rely on a stockbroker.
Whether you prefer to learn independently or from a live instructor, you can choose a brokerage account that works for you. Of course, you owe it to yourself and your portfolio to carefully review potential investments before deciding.
You can use brokerage accounts for short term and long term savings goals, including retirement. As with any investment, the investor should consider what they expect to accomplish before purchasing.
Personal financial advisors work with their clients virtually and in-person to discuss their investment style. This includes reviewing important criteria such as:
- Initial Investment Amount
- Investment Timeline
- Overall Investment Goals
- Risk Tolerance
Regardless of the type of investment vehicle you choose, these factors are important to explore and understand. They are imperative when you are considering a brokerage account and working without the benefit of professional expertise.
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Individual Retirement Account
An IRA is an investment account dedicated for retirement savings. This type of investment is considered an individual account because it cannot have a joint owner.
A beneficiary can, and should be, designated if an IRA owner passes away before the account has been depleted. There are a few different types of Individual Retirement Accounts, each with its benefits and potential drawbacks.
For example, a self-managed IRA allows the investor to choose the underlying investment options. Investors who like the hands-on approach may opt for a brokerage IRA and select their stocks.
Employer-Sponsored Retirement Plan
With the inevitable decline of the current Social Security Administration benefit payments, workers are encouraged to have their own retirement investment strategy. Employer-sponsored plans are an easy and beneficial way to save for retirement.
One reason employer-sponsored plans are so popular is that they come with income tax incentives. In fact, they are frequently named after the relevant Internal Revenue Code they represent: 401(k), 403(b), 457, etc.
There is another significant benefit to participating in an employer-sponsored plan. In addition to the potential tax savings, many employees can also take advantage of an employer match contribution.
Most employers offer at least some incentive, such as a 50% match of every dollar an employee contributes. There are even some employers that place such a high priority on retirement planning that they contribute to each employee’s retirement savings plan whether the employee contributes or not.
Types of Underlying Investments
Now that we have discussed different investment vehicles, we can quickly peek at some of the underlying investments found in each one.
Keep in mind that some of these investment options are more suitable for one investment vehicle over another. For example, high-risk brokerage accounts that specialize in growth funds may not be recommended for a retirement savings plan.
When an investor buys stock, they are actually buying shares of a particular company. Each share represents one portion of the overall outstanding shares available for purchase.
Some shares of stock have special privileges, such as voting rights. These stocks may have a different name or symbol to help differential them from regular company stock.
Generally speaking, individual company stocks are often considered the highest risk investment because investments in a single company can only perform as well as that particular company. Diversifying your portfolio by adding a few different types of investments will help offset higher-risk options.
One final note about company stock as it relates to employer-sponsored plans. Companies that are publicly traded may offer shares of their stock for sale through an employee stock option plan (ESOP).
An ESOP is different than an employee profit-sharing plan (EPSP or PSP). Under a traditional profit-sharing plan, the company provides payouts to employees without the employee making any contributions toward the company stock.
Bonds operate a little differently than company stock. Basically, an investor pays to be part of a company when they buy stock, and they get paid to be part of a company or project when they buy bonds.
When a company or government entity wants to increase revenue for a specific project, they may appeal to the public. A bond issue is a fundraiser of sorts, and proceeds must be used for a particular event or project.
An infrastructure-repair project is an excellent example of when bonds could be issued by a municipality, city, or state. Bonds for this project will be issued with a specific interest rate designated to be paid out at the end of a specific term.
Buyers do not have to hold bonds until their maturity date. Bonds can be traded privately or on the public markets at any time, depending on supply and demand.
As you may have guessed, several different types of bonds are available for investors to purchase. Some bonds are rated higher than others, and a AAA bond label indicates a very low risk of default.
Some bonds are actually considered high risk, or junk bonds. The rate of bond interest scheduled to be paid is higher based on the risk assessment, so investors should carefully choose their bond selections.
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A mutual fund account combines traits of individual company stocks and other investment options. One mutual fund is made up of several different company stocks, which reduces the risk associated with investing in a single company.
Mutual funds are actively managed and may follow a specific trend, industry, or company size. They give investors a way to combine resources with other investors and fractionally invest in up to a few hundred companies at one time.
Depending on the underlying stocks in a mutual fund account, the risk associated varies between low to high. Mutual funds are generally considered a moderate risk investment because there are enough companies to balance and minimize principal-investment loss.
Trading in foreign currency is among the newest investment option for individual investors. Cryptocurrency is loosely a form of foreign currency and allows investors a new way to trade actively.
Cryptocurrency and other forms of currency trading are highly volatile and involve greater risk than some other investment strategies. Currency trades are driven by supply and demand but are also subject to political and economic factors.
New investors should research carefully before considering cryptocurrencies. There is a higher potential for loss, and novice investors may not have fully developed instincts for this trading style.
This high-level overview of investing introduced some new vocabulary and has hopefully given you some food for thought. Investing is not inherently good, bad, risky, or safe.
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