What to Know Before You Invest

What to Know Before You Invest

Many people believe that you need thousands of dollars to invest. This is simply not true. You can invest with as little as a few dollars if you really wanted to. Ideally, I would suggest waiting until you have more than that, though.

Before investing, there are a few things to consider. First, I would make sure you have paid off all high interest debt (i.e. credit card debt). The reason for this is you want your rate of return on your investments to outweigh the interest rate on your debt, or else you net out paying more money than you are making. Second, you want to make sure you have enough liquid assets for emergency purposes, such as money set aside if something happens to your car or something breaks in your house.

Once you feel comfortable financially, I would suggest saving up a minimum of $1,000 before investing your money. If you are comfortable saving $1,000 without defaulting on paying any bills or everyday expenses, this is a good indicator this money can be tied up in investments.

Once you’ve saved up the money, you are ready to determine what kind of investment account you would like to open. You can open a brokerage account, retirement account, or custodial/guardian account.

Brokerage accounts can be individual or joint accounts. It is a standard investing account in which there is no defined purpose for the use of funds and, therefore, no real restrictions on withdrawals or use of the funds once deposited into the account (unlike retirement or custodial accounts). These accounts can be used to buy or sell stocks, options, mutual funds and more.

Retirement accounts for an individual investor, rather than employee-sponsored or self-employment, come in the form of a traditional IRA or Roth IRA. A traditional IRA is a retirement savings account that provides tax-deferred growth and potentially tax-deductible contributions. These accounts are great for those looking to build their retirement nest egg. The main benefit of a traditional IRA account is that the gains grow tax free, this includes capital appreciation gains and dividends received.  Contributions are also tax deductible if your income is below the threshold determined by the IRS (see table below for 2016 thresholds).The downfall to the traditional IRA is that funds are taxable when withdrawn, after the individual reaches age 59 ½.   A Roth IRA is a retirement savings account that is not tax-deductible and is not taxable if withdrawn after the individual reaches the age of 59 ½. The main benefit and distinction here is that gains grow tax free and the withdrawals are also tax free. So while the investor may not receive a taxable deduction upfront like on a traditional IRA, they are able to withdraw the funds tax free once over the age of 59 ½.

Source: IRS

 

Custodial/guardian accounts are managed by one individual for the benefit of another. A regular custodial account is managed for the benefit of a minor and is terminated once that individual reaches a certain age. Another popular custodial/guardian account is the Coverdell Education Savings Account (ESA). An ESA allows the contributor to make contributions until the beneficiary reaches the age of 18. These contributions are not tax-deductible and are not taxable as long as the funds are used for qualified educational expenses.

For beginner investors looking to enter the market, you may want to consider an index fund. An index fund is a type of mutual fund with a portfolio constructed to match or track the components of a market index, such as the Standard & Poor’s 500 Index (see below for an example). An index mutual fund is said to provide broad market exposure, low operating expenses and low portfolio turnover which is why it’s great for the beginner investor. If you are beginning with $1,000 to invest, the index fund allows you to diversify your funds across a large number of stocks which reduces the risk and exposure to any one company.

Source: MorningStar

Before making an investment it is crucial to do your own research in order to understand what you are buying and how it works. Think about your investment choices similar to other purchases. There are countless sources providing research on investments, such as the brokerage providers, Yahoo Finance, MorningStar, various financial blogs and more. Nowadays, people won’t even make simple purchases online without reading up about an item, so there is no excuse not to do your research on your investments.

9 thoughts on “What to Know Before You Invest

  1. Interesting post. Do you have any thoughts on the type and amount of research one should do before investing ?

    1. Great question. I think it really differs depending on an individual’s specific situation. Different types of investment accounts work for different people, as everyone has different goals. Age can also be a factor because the younger an individual is, the more open they are to risk; however, some people may want to be more conservative if they don’t want to risk losing any of their money.

      I think the first step is determining why you want to invest and what your goal is with the money. This will help you choose what type of account is best for you and what kind of risk you are open to. Index funds, as mentioned, are a good way to create a diverse portfolio that tracks similar to the market. If you are more comfortable with investing and want to choose individual stocks yourself, I would suggest choosing something you are interested in. I personally find Yahoo Finance very user friendly and I also like TD Ameritrade’s resources.

      As far as the amount of research, you want to do enough to feel comfortable with and knowledgeable about what you are investing it.

  2. Great article. Agree with the thought on the index fund as it gives the beginner investor exposure to the markets return without having to research individual stocks. Obviously there a many investment decisions and options available to the more experience investor, but index funds are a great way to enter the market which has historically returned around 7% since inception. Clearly better than any CD or savings account rate currently available.

    Keep up the great work!

    1. Thanks! I definitely agree. Index funds are generally a safe, less-risky option that will still give you a decent return on investment. Obviously, individual stocks can do this too, but they are less predictable.

      1. Hey great article! Incredibly organized which I think is key for reducing the fear of getting involved in the process.
        Question:
        How long do new young investors hold onto index funds? Are these intended to be long term alongside riskier investments and the other account types you mentioned? Or is there a rough timeline as to when an individual should get involved in each one of these account types?

        1. Great question, Kevin!

          I’d suggest holding onto an index fund longer term. It’s a good start for investing and generally a safer investment, so as you said I’d keep it alongside some riskier investments. The idea with keeping the index fund long term is that the earnings will compound each year. For example, if you earn 6% on $1,000 the first year, you will then earn another 6% on top of that $1,060 the following year and so on. The index fund is just something to get people comfortable with the idea of investing, while generating fairly stable earnings. Many 401k and other retirement plans offered at work include index funds or some other type of mutual fund investment. In the end, it’s truly all about what each individual investor is comfortable with.

        2. I agree with Courtney’s response. Index funds are a great way for the beginner investor to enter the market. These types of investments can be held for the long term and are often referred to as passive investments. Meaning that an individual usually invests money in these funds and allows the company that runs the fund to manage that money. Index funds are great because they charge a very low fee to manage that money for you with the goal of generating a return comparable to the index benchmarked by the fund. While there is overall market risk associated with these funds, there is minimal company risk, which makes them safer than investing outright in an individual company’s stock or bond offering.

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