When people want to know how to invest money, I often see people asking if now is the “right time” to invest. As humans, it’s natural for us to do this because we want to have an active role in our finances.
We want to feel like we’re in control because we believe that will be better than leaving things alone. But if you want to know how to invest money the right way, having an active role might be the worst thing you can do.
So if you want to know the best ways to invest money, let’s take a look at how we can get started.
How to Invest Money in Your Employer’s Retirement Plan
For most of us, this should be the first step in your investment strategy. The reason for this is rather simple: tax advantages. Taxes themselves can be a bit complicated. What isn’t complicated is that avoiding them is always good.
In addition to tax advantages, most employers have at least one plan that includes matching. This means they will match your contributions dollar-for-dollar. This is free money so you should definitely take advantage of it!
Depending upon your employer, it’s likely you will have one or more tax-advantaged plans available to you. This could be, for example, a 401k, 401a, 403b, or 457b.
The 401k contribution limit for 2019 is $19,000. If your employer offers more than one, you can actually put up to that $19,000 in each.
The same applies to 401, 403b, and most 457 plans.
All of these accounts allow you to invest money on a pre-tax basis. Growth on them is also tax-free. Given that tax brackets go up to 37%, avoiding tax can make a huge difference in the long run.
Note that you cannot withdraw early from any of these accounts – except the 457b – without a penalty. Money withdrawn from the others will incur a 10% penalty if you withdraw before age 59 & 1/2.
Keep in mind that some employers offer a Roth account such as Roth 401k. The key difference between a Roth 401k vs. a traditional 401k is when you pay taxes.
With a Roth 401k, you pay taxes upfront and no taxes on withdrawals. With a traditional 401k, it works the opposite. Growth on both is tax-free.
So, how do you decide which is “better?” The truth is that there is no absolute answer to that question.
Simply put, if you believe your annual withdrawals from your 401k will be more than the amount you currently earn per year, then a Roth 401k makes sense.
How to Invest Money in the Right Retirement Fund
Now that you’ve identified the plans your employer offers and invested in them, you might think you’re done. But not so fast!
A lot of employer plans retirement plans that are not the best. This is a big money maker for investment firms, so you need to actually take a look at how your money is being invested.
Your employer may put you in a target date fund (TDF) for example. Target date funds do have strengths. They simplify the investing process, adjusting automatically to reduce risk later in your career.
Often, these plans will put you in index funds, giving you broad exposure to the stock market. Depending on your specified retirement year, they may also add some bonds to reduce risk.
However, these funds may have higher fees than other funds. In addition, investors with a higher risk tolerance may not want their portfolios being adjusted, which TDFs often do.
IRA vs Roth IRA
If you have maxed out your employer plan contribution limits, the next step is to invest in an IRA. These plans usually don’t have employer matching, but they still have tax advantages.
One advantage IRAs have over employer plans is flexibility. While employer plans typically only have certain funds you can choose, with an IRA, you pick your own funds.
Keep in mind that VTSAX has a $3,000 minimum investment. FZROX has no minimum.
Health Savings Account (HSA)
Another account in which you may consider investing is an HSA.
What is an HSA?A health savings account, or HSA, is an account that lets you set aside money to cover medical expenses. But the crazy thing about an HSA is this money can be invested just like an IRA.
This money can be invested tax free, grows tax free, and can be withdrawn TAX FREE!
A single person can invest up to $3,500 in an HSA while the limit for families is $7,000. Also note that in order to be eligible for an HSA, you must be enrolled in a high-deductible health plan (HDHP).
How to Start Investing in Stocks
When many people start investing in stocks, some believe they should have an active hand. They want to be able to strike when the iron is hot. I often see people in Facebook groups asking if “now is the right time to buy.”
But the reality is that this way of thinking is misguided. One of my favorite quotes about investing goes something like this:"The best time to start investing is 20 years ago. The second best time is today." Click To Tweet
I couldn’t find the exact quote, but this is the general idea. You may watch the market and see it go up and down. You may think you can time it. Forget all of that. What’s important is not when you invest, it’s how long you invest.
The stock market has returned about 10 percent annually over the past 40 years. If you started from zero and were able to invest $500 monthly, after 30 years you would have had $986,964.14!
No, 10% is not a typical growth rate, nor is it a rate on which we can depend. But we also have little reason to believe the market will stop growing.
How to Invest Money in the Stock Market
Now that we know time is the most important aspect of investing, how do we invest our money? Unfortunately, that question also doesn’t have a definitive answer.
Generally, you should invest the largest portion of your money in what’s known as a brokerage account. In these accounts, you invest after-tax dollars in stocks. This money can be withdrawn at any time with no penalty.
There are a lot of ways to invest in stocks, and I can only give my best recommendation. Along the same lines as timing the market, many people have complex portfolios.
While you may be able to see a marginally better rate of return this way, it’s also overly complicated. Not only that but it will make rebalancing much more difficult than it needs to be.
Personally, I prefer a simple portfolio. Typically, that portfolio will be heavily invested in one of the funds mentioned above – VTSAX or FZROX.
Both of these funds are total-market funds. This means you’re buying a piece of every publicly-traded company on the market.
Some actually choose to invest their entire portfolio in one of these funds. Other investment firms such as Charles Schwab have comparable funds as well.
But what if you still aren’t comfortable putting all your money in the US stock market?
The Three-Fund Portfolio
While simply putting your money in a total-market fund is the ultra-simple approach, you can reduce risk somewhat without making things overly complicated.
- US Stock Market
- International Stock Market
- US Bond Fund
To get an idea of what this actually looks like, Bogleheads provides several examples. I tend to be a little more aggressive; their most aggressive three-fund portfolio is:
- 64% total stock market (i.e. VTSAX)
- 16% total international stock market (i.e. VTIAX)
- 20% total bond market (i.e. VBTLX)
Despite these higher interest rates, they aren’t subject to market forces. In addition, they will generally be FDIC-insured.
One thing you should be aware of is that if you transfer money into or out of your savings, the transaction typically takes 2-3 business days. So while the money is technically liquid, it won’t be available instantly.
Money Market Accounts
One possible alternative to high-interest savings is to invest money is a money market account. These rates are actually fairly close to those seen in high-interest savings accounts.
At the time of writing, Fidelity Investments offers 2.07% APY on their government money market accounts.
What is a Money Market Account?
If you aren’t familiar with money market accounts, the idea is pretty straightforward. When you transfer money into a brokerage account, it will go into a money market account before you buy stocks.
Similarly, if you choose to sell stocks, the sale will fund a money market account.
If you simply leave money in your money market account, it will continue to accrue interest.
Of course, this interest is much less than the potential of the stock market, but it also is not subject to volatility. This can make it a nice place to cash you need readily available.
How to Invest Money in a Certificate of Deposit (CD)
Another way to invest money without it being subject to market volatility is with a CD. You may have heard of these, but how do they actually work?
A certificate of deposit is a savings certificate with a fixed maturity date and interest rate. While it is possible to withdraw from them before the maturity date, this will usually result in a penalty.
This makes them similar to retirement accounts, with a couple of key differences. With a CD, you have control over the maturity date. Unlike a retirement account, this does not have to be age 59 & 1/2.
In addition, the interest rate is fixed. Plus, the longer the CD takes to mature, the higher the interest rate usually is.
This can make it very useful to help you save for a house or other large purchase. Or, if you simply want money you can’t touch, this is one possibility.
Wrapping it Up
This may sound like a lot. And to a certain extent, that’s true. However, this can actually be made fairly simple.
For example, these are all the accounts I typically have:
- Retirement (401k, 457b, etc.)
It really doesn’t need to be more complicated than that. And I don’t even recommend funding an IRA until your retirement accounts are fully funded.
If you aren’t at that point, that’s okay! I would just recommend also having some extra cash in savings.
While you may also choose to have money in a CD or money market account, those are less critical.
Using this strategy, you’re on your way to being a succesful investor!