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. Granted, 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!
And, 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.
For 2019, these accounts have a limit of $19,000 each. If your employer offers more than one, you can actually put up to that $19,000 in each.
All of these accounts all 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.
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. The reality is that 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 more in bonds, 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 don’t have employer matching, but they still have tax advantages.
One advantage IRAs actually have over employer plans is flexibility. While employer plans typically only have certain funds you can choose, with an IRA you can pick your own funds.
Keep in mind that VTSAX has a $3,000 minimum investment. FZROX has no minimum.
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:
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!
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? The truth is that this question also doesn’t have a definitive answer.
Generally, you will 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.
The idea here is still (relatively) simple. Instead of putting all of your money in the US stock market, you’ll allocate it to three assets:
- 64% total stock market (i.e. VTSAX)
- 16% total international stock market (i.e. VTIAX)
- 20% total bond market (i.e. VBTLX)
If you have a relatively long time horizon (20+ years) but don’t want an overly risk portfolio, this is a great start.
Note that the three-fund portfolio link also covers several major investment firms as well. If you don’t have Vanguard available, be sure to check that link.
How To Invest Money In Savings
It’s also a good idea to have money that is a little more secure than stocks. If an emergency arises, you don’t want to be unsure how much money you have readily available.
Some people leave this money sitting in a checking account or in traditional savings. Don’t do this! There are much better places to keep your cash.
One of the best places to keep your money that you don’t want to keep in the market is high-interest savings. Why? Because, as the name implies, these savings accounts have much higher interest rates than traditional savings.
Despite these higher interest rates, they aren’t subject to market forces. In addition, they will generally be FDIC-insured.
I have an Ally Bank online savings account. As of this writing, these accounts have 2.20% annual APY. They are also insured for $250,000 per depositor.
Ally isn’t the only high-interest savings account, however. Doctor of Credit has a great list of high-interest savings accounts. Some of them have very particular rules and limitations, but in some cases, you can see up to 5%.