Saving? Investments? The future??! Yeah, not high on your list of priorities at the moment, I get it. The last thing you’re worried about is retirement. Problem is, it really shouldn’t be. I realize this is something that is currently decades away for you and there are far more pressing concerns that require your undivided attention at the moment. But putting aside a little money now could prove to be one of the smartest decisions you’ve ever made later on.
Investing may seem daunting and just a little more than intimidating with all of the strange acronyms and weird lingo, and the fact of the matter is that, yes it can be a little confusing at times. And dry. I mean, you try reading one of these investment guides from some of the big Wall Street experts and yawn. You’ll wonder how they managed to make money, something that we all find extremely exciting, so boring. IRA, 401K, ETF, vesting, penalties, rollover. Yeah, rollover and go to sleep.
But here’s the thing, investing doesn’t have to be scary or boring, because once you know the basics and understand how some of it works, it’s actually pretty engaging. It’s all about making smart decisions, finding the right investment opportunity for your situation and eventual goals, and being dedicated. You may not even know what your goals are yet, and that’s fine, you’re still going to want plenty of money to live comfortably when you are your Grandpa’s age.
Take a look at our beginner’s guide to investing money for the future, we’re going to break it down for you in easy to understand language.
First things first, come up with some ideas. Think about why you’re investing your money. I know we’ve been discussing retirement, but there are all kinds of reasons to start putting some money aside now. Maybe you want to buy a home in the near future or start saving for college tuition, your goals don’t have to be set in stone for the rest of your life now. Perhaps you don’t know what you want yet, but you want the money to be there down the line. Great, good enough. That’s a start, because the reason you’re making this plan is to determine how long you want to invest.
If this is money you can sack away and not have to worry about any time soon, then the stock market is the right move. Investing in the market is a long-term commitment. But if you’ll need to access that cash in a few years, then there are other investment methods you should consider instead. The stock market holds no guarantees that your money will be available to you when you need it.
Determining your long term plans is one part, but before you are ready to invest your money, you should also consider your risk tolerance. There are many opportunities and channels to invest your money for future returns and how much exposure you can tolerate to risk will be a major factor in where you put your money. You can consider the stock market, real estate holdings, mutual funds, and other investment strategies. Just remember, investments with higher risk also come with greater reward than their safer counterparts.
This planning stage can help you define your investment goals and how much money you should then put aside to begin saving. It’s easy to break it down if you just look at it like a formula: think about how much money you will need to get that home or retire and when you will need that money, this will help you determine how much you should set aside and the kind of return on investment (ROI) you’ll want to target.
No Time Like the Present
You may be young and not ready to think about saving money just yet, you’re more concerned with things like paying rent and partying. But the earlier you start saving money, the more your eventual nest egg will grow. This all sounds great but nebulous, so here are some hard numbers.
Let’s say you’re in your 20s right now and making around $35,000-40,000 a year at your current job. If your employer offers a 401(k) with a matching contribution of 3% and you take advantage of it by depositing 10% of your income into that 401(k), you could have somewhere in the neighborhood of $1.5 million dollars in there by the time you’re 65 years old. A million bucks, just for putting in a little bit starting now. Not bad, right?
Let’s stop a second. How much of that was confusing to you? You may not know what a “matching contribution” is or what a “401(k)” means. If you don’t, let’s not lose you right from the get-go.
Learn the Lingo
There is a lot of it, that’s for sure. But let’s go over some of the basics you need to know off the bat and then you can continue your research by seeking out more comprehensive explanations and descriptions of the myriad of investment opportunities and financial instruments that are available.
A 401(k) is a method for saving (usually for retirement) which is funded by payroll deductions at your place of work. That money is tax-free (which is a good thing, obviously) but you will have to pay taxes if you withdraw any of the money from that account (which isn’t so great, so best to keep it in there for now). Many employers who offer 401(k)s to their employees will provide a “matching contribution” up to a certain percentage, which means they will match any deposit you make with a limit on that contribution. In simple terms, it’s free money! If you put $20 into your 401(k), your employer will also put $20 into your 401(k). Now that’s a pretty terrific deal.
If you’ve decided that the money you are setting aside is going to be for your retirement, then a 401(k) is a smart way to go. This is particularly true if your employer is ready to match your contributions. But there’s a catch, that money does come with some strings attached. That’s where the term “vested” comes in, which means you have to work at the company for a minimum amount of time – usually at least a few years – before the matching contributions that your employer makes into your 401(k) are yours to keep.
For instance, let’s say your employer has imposed a vesting schedule of five years on their contributions into your 401(k). That means you get a portion of the money, in this case 20%, for every year you work there. After those five years pass, the money’s all yours, but if you leave the company before those five years are up, the unvested portion is forfeited and you don’t receive it, even though the money has been invested in your account. So if you bail out after the third year, you’ll keep 60% and the rest you’ll lose when you withdraw or rollover the money in your 401(k).
Therefore, it makes sense to stick it out all the way through the vesting period to ensure you get all of that money. If you’re thinking of changing jobs, maybe you want to wait just a little bit longer at the company giving you free cash for your retirement, no matter how annoying Carol in accounting can be.
What’s a Rollover?
Let’s say you’re leaving that job anyway (either before or after the vesting period, don’t worry about that for the moment), your 401(k) remains in place until you decide what it is you want to do with it. But decide quickly, because your employer may just cash it out for you, particularly if it isn’t a lot of money, which then means you will pay penalties and taxes on that sum.
What you really want to do (and you should figure this all out when you decide to change jobs) is roll it over into one of two types of investments, either a 401(k) offered by your new employer or an Investment Retirement Account (IRA). A rollover is pretty simple to initiate and you do not have to pay any fees, penalties, or taxes on the money.
Why is that? Because you’re not withdrawing it and it’s not officially income on your part yet. It’s still a tax-free investment. You haven’t taken possession of the funds in that account, you’re just moving that money from the old 401(k) at your former employer into the new one at your new employer. This method basically changes nothing from your previous situation, it’s pretty much as if you didn’t even change jobs (unless, of course, your new employer doesn’t offer a matching contribution with the same limits or any contribution at all). However, your other option is to rollover to an IRA. The IRA offers a lot of benefits that a 401(k) doesn’t necessarily afford you and the distinctions between the two are important to consider.
So we’re talking about something called an IRA now and there are many reasons why you may want to move the money from your old 401(k) into one of these accounts instead. First and foremost, an IRA affords you more control over your money.
Let’s stop a second and discuss how a 401(k) actually works first. It’s an account into which you deposit money to save it for many, many years from now. But that money is actually working for you through a number of available investment plans that are offered by way of your 401(k). These investments are typically mutual funds, which are investments in stocks, bonds, and other various securities that bring a pool of money together from a collection of investors to purchase. That collection of investors is made up of you and the many employees who work at your company which is sponsoring these 401(k)’s.
The problem with a 401(k) is that you are often limited by the investment strategies in which your money can be invested. You only have so many options available to you. However, with an IRA, you have a whole range of choices in which your money can be invested. IRA’s offer you the chance to put your contributions into just about anything including mutual funds but also cash, stocks, index funds, bonds, you name it. You’re the one in control of managing your investments and diversifying your portfolio. You may not want that kind of autonomy now, but it’s always there if you decide you want to take a more proactive approach to your investing strategies some time in the future.
That’s just one of the many advantages to going with an IRA as opposed to a new 401(k). There are others, from brokerage companies waiving minimum deposits on their IRA accounts to online trading opportunities so you can manage your money whenever you want, wherever you want. Perhaps the best advantage of all is the freedom you have with respect to withdrawing that money from your account. But wait a minute — I just said you don’t want to withdraw any money from your retirement savings or else you’ll be subject to potential fees and penalties. It’s true.
With an IRA, similar to a 401(k), if you withdraw any cash from it before you turn 60, you’ll pay a hefty 10% penalty along with applicable federal taxes on that money. However, there are some exceptions to the penalty which could prove extremely beneficial to you depending on your long-term goals. The government will not penalize you if you withdraw money from your IRA to pay for tuition costs so you can attend college. There are some specific qualifications that must be met but if you are eligible, you can use some of your IRA money to pay for school. The other exception provides for a maximum withdrawal of $10,000 to put towards the purchase of your first home. Now maybe saving money for retirement doesn’t sound like such a bad idea after all and going with an IRA might just be the way to do it.
Investing in the Stock Market
If you do end up putting your money into an IRA, then you can create some shrewd investment strategies to diversify your portfolio. The many options available give you some opportunities to play the stock market. Up until now, your 401(k) has limited your exposure to the stock market, but with an IRA you have more leeway to devise a game plan for investment that may be better tailored for your long-term goals.
But before you dive in head first, we need to talk about the many perils and profits that are inherent with investing in the market. The most important thing you need to know about the stock market is how it really works. It can be extremely volatile: One day you’re up, the next you’re down, the day after that you’re down even more. Over time, you can rally back and you’re ahead of the game on your ROI once more. Maybe.
These fluctuations come as a result of investors feeling positive or negative about a certain stock and the reasons behind that feeling are myriad; the company posts earnings higher or lower than expected, their personnel changes, there’s a controversy surrounding a company’s product, a war breaks out in the Middle East, or the stock simply isn’t performing the way investors have expected it for whatever reason. A stock price rises or falls based upon the collective emotions of the investment community at large and those emotions are spurred by any combination of the determining factors I just listed.
The important thing for you to remember is to invest with your head and not your heart. Keep emotions out of it and you’re bound to succeed to far greater heights than if you let things like worry and panic set in. You need to keep a level head when you invest in the stock market.
Like anything else, if you go into investing without a solid game plan, you’re likely to lose more than win. Defining the parameters for your investments ahead of time will prevent you from making those mistakes that come solely from emotion. As you sink considerable amounts of your hard-earned money into securities you’re naturally going to feel many things, and none of them will be confidence at first. With stock prices almost constantly fluctuating, the tendency will be to second guess yourself and the whole idea of investing in the market in the first place.
But remember, a bad day today can lead to a good day tomorrow. You just need to enter into this exercise with the proper mindset, a long-term outlook, and that means developing a fully researched approach to your investment plan. When you select certain stocks to purchase, think hard about the reason why you’re choosing that particular stock. Your reasoning will dictate your strategy on buying or selling the stock eventually.
It’s likely that you are buying that stock because the price is right and you have a credible expectation of which way the price will go in the future. If the stock performs as expected, then you are faced with some decisions. If it doesn’t, you have even more choices to address. Naturally, if the stock performs well and the price rises, you have to consider whether or not to hold firm in case it moves even higher or sell for a profit and get out before it drops.
Every stock performs differently and, again, there are all those internal and external influences that can affect the price in the minds of the investment community. Conversely, the price dropping can make you sick to your stomach and prone to knee-jerk reactions to prevent from losing any more of your money. For the beginner, either of these scenarios may grip you with fear and tension. Panic sets in and you’re likely to make a snap decision, even after you’ve ruminated upon all of the pros and cons and worst-case scenarios that flood into your mind.
Here’s a word of advice: Stop. Just stop and step back. Take emotion out of the equation and, while I realize this is one of those easier-said-than-done situations, it does get easier as you become more experienced in the routines and cycles of the market. The best way to do all of this is actually pretty simple: create that game plan first. This entails selecting the stocks you like by deciding what it is you really like about them and basing your purchases on that research. Then set the parameters by which you will take action on the stock should the price rise or if it falls.
By establishing solid ground rules ahead of time, you eliminate the possibility of letting your emotions rule your decision-making process. These parameters should be carefully considered and thought out, of course, but once you have formed your action plan on the stock price you can then sit back and wait to see what happens. These exit strategies for success, or lack thereof, enable you to think clearly and invest more wisely, resulting in a higher return on your money.
Our Final Thoughts
We’ve only just scratched the surface with this beginner’s guide for investing. Take this information as a good foundation for expanding your knowledge of the many investment opportunities and processes that exist and educate yourself further to get the maximum benefits for your money. But remember, a good investment strategy requires a lot of patience, some luck, and a considerable amount of risk.
Just because you’re investing money into stocks and other securities does not mean you will always see a high return or any return at all. You can lose money, millions have over the long history of stocks and bonds. It helps to contact a good brokerage house or financial consultant before you make any major investing decisions at first. However, if you keep at it and do the necessary due diligence you can find success over the long-term. Good luck!