Important Factors to Consider Before You Begin Investing

Important Factors to Consider Before You Begin Investing

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When you’re new to investing, the concept can feel both risky and intimidating. It’s more comprehensive than simply saving money in a bank account. Saving does not protect against inflation, which reduces the value of money over time. Investing, on the other hand, is a smart way to leverage money and earn higher returns in order to build wealth. It’s a vital aspect of financial planning and maintaining financial stability.

Before diving into investing, it’s important to consider some key points, like understanding your financial standing, establishing a budget, and assessing your comfort with risk.

What to know before investing

With a little bit of effort and a whole lot of reading, you can become comfortable and confident in making informed investment decisions. Here’s what you should know before putting your money on the line:

1. All investments have some element of risk involved.

Can you afford to lose your money? Every investment carries risk, some greater than others. Unlike saving, which safeguards funds, investing provides the opportunity for higher returns but also the potential to lose part or all of the initial investment. Taking on risk can be unnerving, especially in a volatile market. Determining your risk tolerance, or your ability to endure uncertainty and potential loss in an investment, is crucial for managing your overall investment strategy.

2. Prioritize your financial responsibilities.

Housing, utilities, groceries, debt repayment, and other necessities should be budgeted for prior to committing to any investment opportunities. Once essentials are covered, it’s important to allocate money towards an emergency fund to ensure a safety net for unexpected circumstances.

After an emergency fund is established, you can redirect your focus to prioritizing general savings. After all, in order to have funds to invest, it is necessary to prioritize saving over wasteful spending.

3. You don’t need a lot of money to invest.

There’s often a misconception that investing requires thousands of dollars to get started. In reality, though, zero-fee brokerages, low-to-no minimums, and fractional shares make it simpler than ever to begin investing with small dollar amounts.

With consistency and commitment, even investing $50 a month will eventually lead to growth, thanks to the power of compound interest.

4. Diversify your investments to account for your financial goals.

Factor in your financial goals, like retirement or funding your children’s education, when deciding how to invest. These long-term goals can help you determine where to invest to maintain your wealth while also weathering market fluctuations.

Diversify investments to account for financial goals.

Alternatively, if you’re solely interested in experimenting with some extra cash and are looking to potentially earn substantial returns with no concern about losing your investment, then jumping into high-risk investments could pay off in a big way. Putting your money in volatile stocks or even cryptocurrency could result in significant gains (or losses!). You may find certain types of investments more favorable based on your personal preferences and financial goals.

Ultimately, diversification of investments is highly recommended to mitigate risk, ensure a balanced investment portfolio, and increase the stability of your overall investment strategy.

Certificate of Deposits and High Yield Savings Accounts

Certificate of Deposits (CDs) and high yield savings accounts (HYSAs) are considered low-risk investments that are intended for short-term goals, such as a house fund or emergency fund. They are safer and more conservative than investing in the stock market, but they offer lower opportunities for growth. While a HYSA allows for immediate access to funds, a CD requires a set deposit amount and term length, restricting access until the maturity date.

Stocks

A stock represents a share of ownership in a company. Investing in individual stocks carries great risk due to their exposure to both market fluctuations and company-specific challenges that could lead to loss. While it’s important to research all investments before making a purchase, it’s especially critical to examine a company’s financial data and overall performance history when investing in a stock.

Bonds

Bonds are more conservative than stocks and earn lower long-term returns. A bond is a debt security, or a loan made to a company or government for a specific period of time, in exchange for interest payments and the original value once it reaches the date of maturity.

Mutual funds

Mutual funds offer a diversified option. Instead of selecting individual stocks, an investor could purchase a collection of investments, including stocks, bonds, and other commodities, through a mutual fund. It makes them less risky than buying individual stocks. Some mutual funds are actively managed by professional money managers and incur higher fees than a more passive approach to investing, such as index funds or exchange-traded funds (ETFs). Index funds track and mirror a specific market index, like the S&P 500, which follows the stock performance of 500 large public U.S. companies.

5. Take advantage of free money from your employer.

If you’re lucky enough to have an employer-sponsored retirement plan with an employer match, you should contribute at least enough to receive the full match. Don’t leave free money on the table! Take advantage of this benefit to maximize your retirement savings potential.

6. Max out your tax-advantaged accounts first.

To simplify and reduce your tax liability, focus on contributing to your tax-advantaged accounts first. These accounts include individual retirement accounts (IRAs), 401(k) plans, 529 college savings plans, and health savings accounts (HSAs). Contributions made to tax-advantaged accounts are commonly tax-deductible, tax-deferred, and may even qualify for tax exemption.

7. Invest in what you know.

Billionaire investor Warren Buffett famously advised to “never invest in a business you cannot understand.” While it’s not necessary to be an expert in the company you are interested in, it’s best to have a certain level of familiarity and understanding of the industry and the company’s business model to make informed investment decisions.

8. Pay attention to the fees.

Be mindful of investment fees, as they can significantly reduce your returns over time. As previously mentioned, actively managed mutual funds charge higher management and transaction fees than passive index funds. In addition to these fees, you may also encounter trade commissions, expense ratios, sales loads, 401(k) fees, and other management fees.

Fee-conscious investors should consider index funds and robo-advisors as low-cost investment options. While robo-advisors are more costly than taking care of investments yourself, they are more affordable than hiring financial advisors. Financial advisors can help create a personalized financial plan for a premium fee, often ranging from 0.5% to 2% annually of the assets they manage. As you can imagine, this fee adds up considerably over time, particularly when factoring in returns and compound interest.

Personal finance enthusiast Alex Rae offers a useful breakdown of fee examples:

Start as early as possible

The best time to start is today! Of course, that’s if you’re able to comfortably and responsibly invest a few dollars in the market. Getting started doesn’t require a large sum of money, and the sooner you begin, the more you can benefit from compound interest!

As the old adage goes, “Time in the market beats timing the market.” The more time your money has to grow, the more you can potentially earn in the long run. Consistently investing small amounts over time can lead to healthy returns in the future. So, if you’re able to, consider investing today with whatever amount you can afford and watch your money grow.

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