Want to travel the world, buy your ideal home, or enjoy a worry-free retirement? Investing can help you achieve your financial dreams. You don’t need to be ultra-wealthy, a finance expert, or have tons of time to research and manage investments—you just need to begin. Follow these steps to embrace the promise of compound growth—your future self will be grateful.
Step 1: Identify your investment goals
Investing without a goal is like driving a car without a destination. Investment goals should be specific and quantifiable; you’ll want to set clear, time-bound, and achievable objectives.
For example, if your goal is to retire comfortably, you need to clarify what age you want to retire. Then, identify how much money you need by that age to ensure a lifestyle that aligns with your values.
Investment goals can be anything you want them to be, like paying for your grandkid’s college education or buying your first home. You can work toward multiple investment goals at the same time.
Your time horizon, the period you expect to hold an investment, dictates your strategy. The longer your time horizon, the better equipped you’ll be to benefit from compounding growth and ride out any potential volatile market fluctuations, like a recession.
An investment calculator can come in handy here. You can input critical data like your initial investment and time horizon to determine your potential earnings.
Take a closer look at the differences between short- and long-term investments.
Short-term investments
Short-term investments are savings you expect to use for a goal—like an emergency or wedding fund—that’s typically less than five years away. These lower-risk investments are characterized by stable yet low growth and high liquidity, so you can quickly convert them into cash in your pocket. Ideally, you’ll hold these assets in short-term investment vehicles rather than something like a checking account. Think high-yield savings accounts, certificate of deposit accounts (CDs), or money market accounts.
Long-term investments
Long-term investments, like stocks, bonds, and real estate investments, are assets you intend to hold for an extended time horizon, ideally more than five years. Long-term investments are helpful for goals like saving for retirement, a down payment for a home, or general wealth-building. Compared with short-term investments, long-term investments require a higher risk tolerance, but often result in higher returns.
The magic of long-term investments lies in compounding growth. To better visualize this concept, imagine a snowball rolling down a hill. The longer the snowball rolls, the more snow it gathers and the larger it grows. Similarly, the money you invest increases over time thanks to compound interest. For example, if you invest $200 monthly for 25 years at a 7% rate of return, you'll make $151,798. If you invest the same amount at the same rate of return for 35 years, you'll earn $331,769.
Step 2: Choose from different types of investment accounts
An investment account is a platform to buy, sell, or hold securities (stocks, bonds, mutual funds, etc.). It's possible to diversify your investments across various accounts—just be sure to consider any fees and costs associated with the accounts and the reputation of the financial institution you choose to invest with.
Your goals help you determine which account is best. Investment accounts include retirement, individual investment, taxable, and educational savings accounts. There are pros and cons to each.
401(k)
401(k) retirement accounts are long-term investment vehicles employers sponsor to incentivize their employees to save for retirement. They’re great for beginner investors because employers can walk you through the process. They also have excellent tax benefits, and frequently, your employer will match a percentage of the cash you contribute. But they also have limitations.
Pros
- Tax-advantaged: If you select a pre-tax 401(k) option, you can defer paying taxes on contributions until you decide to withdraw. As a result, you have more money in your account to invest for retirement.
- Employer contributions: Your employer may match every dollar or partial dollar of your contributions up to a percentage of your salary. In other words, signing up for a 401(k) equals free money.
- Automatic deductions: You can have money from your paycheck automatically deducted and transferred into your retirement fund, which is convenient and keeps you contributing consistently.
Cons
- Early withdrawal penalties: If you cash out your investments before 59½, you'll incur a 10% penalty tax.
- Limited investment options: You can't select individual investments like stocks and bonds. You must choose from pre-set portfolios your employer offers.
- Fees and expenses: These will vary based on your employer’s plan, but 401(k) retirement accounts can incur administrative and management fees. Additionally, the government caps the amount you can invest per year. Contribute more than that annual limit, and you’ll be penalized.
A 401(k) is often composed of pre-tax contributions; you pay income taxes when you withdraw money after retirement. However, more and more employers today offer a Roth 401(k) option. The difference is the way the contributions are taxed—you fund a Roth 401(k) with money you’ve already paid taxes on. 401(k)s aren’t the only accounts with traditional and Roth offerings.
Get complimentary financial guidance that’s focused on your goals and how to reach them.
IRA
An individual retirement account (IRA) is a tax-advantaged plan to support your retirement goals. Like 401(k)s, there are two types of IRAs: a Traditional IRA and a Roth IRA. A Traditional IRA allows you to delay taxes until you retire so your savings grow tax-deferred. A Roth IRA requires you to pay taxes upfront. While a Traditional IRA offers immediate tax deductions, Roth IRAs give you certainty over your tax treatment.
IRAs are suitable if you don’t have the option for an employee-sponsored retirement plan, or you want to roll over and combine 401(k) cash from previous employers.
Pros
- Tax-advantaged: You can choose to have your account grow tax-deferred or tax-free.
- Control over investments: You can customize your portfolio to align with your risk tolerance and goals.
- Portability: Unlike a 401(k)—where your employer chooses the bank where your money lives—with an IRA, you can change financial institutions to your liking without penalty.
Cons
- Contribution limits: IRAs enforce limits on the amount you can invest. Anyone can contribute to a pre-tax IRA up to the annual limit—those above a certain income threshold can’t contribute to Roth IRAs without penalty.
- No employer match: IRAs aren't employer-sponsored, so you must manage and fund the account independently.
Early withdrawal penalties: Withdrawals before 59½ are subject to income taxes and a 10% early withdrawal penalty.
Taxable account
A taxable account, also called a brokerage account, lets you buy and sell securities (stocks, bonds, mutual funds, etc.). Unlike a retirement plan, a taxable account doesn't receive special tax treatment. However, due to its accessibility and customizability, it's a suitable option for short- and long-term goals.
Pros
- No early withdrawal penalties: Cash out whenever you want without paying a penalty.
- No contribution limits: Invest as much as you want and increase your growth potential.
- Control over your investments: You can customize your portfolio with investments aligned to your risk tolerance, goals, and values.
Cons
- No tax advantages: Taxable accounts don't offer tax-deferred or tax-free growth on your earnings. You must pay capital gains taxes on earnings, interest, and dividends the year you sell your investments.
- Potentially higher taxes: If you sell an investment held for less than a year and profit, you must pay short-term capital gains taxes. These tax rates are typically higher than long-term capital gains.
- Emotional investing: While taxable accounts offer control over your portfolio, they may also lead to impulsive investing. Investing decisions based on short-term fluctuations can derail your long-term investment goals.
529 plan
A 529 savings plan is for educational expenses like tuition, housing, and supplies. This plan is great for parents, guardians, and relatives of young children and anyone who has several years before they need to pay for education.
Pros
- Tax-free growth: This account grows with after-tax dollars. You don't pay taxes on investment earnings.
- Funds are transferable: You can pass unused funds to a qualified relative.
- No income restrictions: Unlike other education-related tax benefits, your income won't prevent you from investing in a 529 plan.
Cons
- Exclusive for education: If you use your 529 plan for non-qualified educational expenses, you'll incur a 10% penalty tax.
- Limited control: You're limited to pre-set portfolio options offered by the plan administrator, which limits the types of investments you can choose.
- Impact on financial aid eligibility: A sizable 529 plan can impact a student's eligibility for need-based aid.
Step 3: Pick from different types of investments
Make sure you’re crystal clear on the differences between an investment and an investment account. An investment account (401(k), IRA, and brokerage) holds the investments (stocks, bonds, real estate, and mutual funds) you purchase with the expectation of generating wealth over time. You don’t have to invest in just one type. To reduce your risk while still having the potential to get great returns, spread your money across multiple asset classes. That’s called diversification. Understand the distinctions between these popular investments, and you’ll be on your way to building a well-balanced portfolio.
Stocks
When you buy a stock, you own a portion of a company. You can purchase stocks individually, or in mutual and retirement funds. Stocks are known for high returns. They yield an average return of 10%, while bonds have an average return of 5%. However, stocks are riskier investments than bonds due to their volatility.
Bonds
A bond is an investment backed by debt. When you purchase a bond, you’re lending money to the bond issuer, who pays it back with interest. Bonds are less risky than stocks. You’ll get back your money with regular interest payments eventually. However, bonds don’t garner returns as high as stocks.
The beauty of investing is that you can buy stocks and bonds together. Stocks provide more growth opportunities, and bonds offer stable returns that offset the risk. A simple way to include both stocks and bonds in your investment strategy is to invest in mutual funds.
Mutual funds
A mutual fund is a collective investment. Many people pool their money together, and then a professional manager buys a mix of stocks and bonds. If you’re risk-averse, buying into a mutual fund is a great way to diversify your portfolio. The risks are much lower than if you were to purchase single stocks or bond securities. However, you won’t be able to dictate where your money goes.
Real estate
A common way to invest in real estate is to buy a physical property. The property appreciates, which means its value increases over time. You turn a profit by selling the appreciated property at a higher price than what you paid for it. You can also rent your property for an additional income stream.
Buying a home requires significant upfront money and time. If you don't have the capital, you can invest in real estate investment trusts (REITs), which are like mutual funds for properties, or crowdfund projects.
Should I use a financial advisor or do it myself?
You can absolutely start investing on your own without the help of a financial advisor. Investing involves a little upfront effort and ongoing maintenance despite being largely passive, but nothing you can’t handle.
Plan to check in with your investments annually and rebalance as needed. A well-diversified portfolio has an asset allocation that aligns with your risk tolerance and timeline. Asset allocation refers to the distribution of money across different investments, usually represented by percentages. If you’re the hands-off type, there are options. For retirement, you can invest in a target-date fund—a mutual fund structured to automatically become more conservative as you approach retirement.
Once you put your money to work, avoid cashing out before you need to. Your investments won’t benefit from compound growth, and you'll likely need to pay hefty withdrawal taxes.
Finally, fund your portfolio regularly, even if you can only contribute a little each month. It will add up. Consider automatic contributions to keep yourself on track.
If you're an investor with specific or complex goals, a financial advisor can develop a custom investment strategy for your needs. A financial advisor can also step in if you're a new investor and want expert advice. The right financial advisor can address your financial needs and offer relevant services.
Author Details
Alani Asis is a freelance content marketing writer who has written for esteemed brands like AARP, Forbes, and Prudential. She excels at breaking down complex topics like taxes, investing, and insurance into digestible and actionable tips.
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