First of all, congratulations! Investing your money is the most reliable way to build wealth over time. If you’re a first-time investor, we’re here to help you get started. It’s time for your money to work for you.
Before you put your hard-earned cash into an investment vehicle, you’ll need a basic understanding of how to properly invest your money. Here are some of the best ways to invest money:
However, there is no one-size-fits-all answer here. The best way to invest your money is whatever works best for you. To understand that, you have to consider:
- your style
- Your budget
- Your risk tolerance.
1. Your Style – How much time do you want to invest your money?
There are two main camps in the investing world when it comes to ways to invest money: active investing and passive investing. We believe both styles have merit, as long as you focus on the long term and are not just looking for short-term gains. But your lifestyle, budget, risk tolerance and interests may give you a preference for one type.
Active investing means taking the time to research investments and build and maintain your portfolio yourself. If you plan to buy and sell individual stocks through an online broker, you are planning to become an active investor. To become a successful active investor, you need three things:
- Time: Active investing requires a lot of homework. You’ll need to research investment opportunities, do some fundamental analysis, and follow through with your investments after they’ve been purchased.
- Knowledge: All the time in the world won’t help if you don’t know how to analyze investments and research stocks properly. You should at least be familiar with some basics of how to analyze stocks before you invest in them.
- Willingness: Many people don’t want to spend hours on their investment . And since passive investments have historically produced strong returns, there’s absolutely nothing wrong with this approach. Active investing certainly has the best return potential, but you have to spend time getting it right.
Passive investing, on the other hand, is the equivalent of putting the airplane on autopilot versus flying it manually. You will still get good results in the long run, and the effort required is much less. In short, passive investing involves putting your money to work in investment vehicles where someone else does the hard work — mutual fund investing is an example of this strategy. Or you can use a hybrid approach. For example, you can hire a financial or investment advisor — or use a robo-advisor to create and execute investment strategies on your behalf.
2. Your budget – how much money do you want to invest?
You may think you need a large amount of money to start a portfolio, but you can start investing with $100. We also have great ideas for investing $1,000. The most important thing isn’t how much money you’re starting with — it’s making sure you’re financially prepared to invest and that you’re investing money over time.
An important step to take before investing is to establish an emergency fund. This is cash set aside in a form that makes it available for quick withdrawal. All investments, whether stocks, mutual funds, or real estate, carry some level of risk, and you never want to be forced to divest (or sell) these investments in times of need. An emergency fund is your safety net to avoid this.
Most financial planners suggest that the ideal amount for an emergency fund is enough to cover six months of expenses. While this is certainly a good goal, you don’t need to set aside that much before you invest — the point is that you don’t want to sell your investment every time you get a flat tire or something else. Unexpected expenses pop up.
It’s also a smart idea to get rid of any high-interest debt (like credit cards) before starting to invest. Think of it this way – the stock market has historically returned 9%-10% annually over the long term. If you invest your money in these types of returns while paying your creditors 16%, 18% or higher APR, you are putting yourself in a position to lose money in the long run.
3. Your Risk Tolerance – How much financial risk are you willing to take?
Not all investments succeed. Every type of investment has its own level of risk — but this risk is often associated with a return. It is important to find a balance between maximizing the return on your money and finding a level of risk that you are comfortable with. For example, bonds offer predictable returns with very little risk, but they also offer returns as low as around 2-3%. In contrast, stock returns can vary widely depending on the company and time frame, but the overall stock market returns an average of about 10% per year.
Even within broad categories of stocks and bonds, there can be large differences in risk. For example, Treasury bonds or AAA-rated corporate bonds are much less risky investments, but they will likely have lower interest rates. Savings accounts represent much less risk, but offer less reward. On the other hand, high-yield bonds can generate more income but will come with a higher risk of default. In the world of stocks, the difference in risk between blue-chip stocks like Apple ( NASDAQ:AAPL ) and penny stocks is huge.
A good solution for beginners is to use a robo-advisor to create an investment plan that meets your risk tolerance and financial goals. In short, a robo-advisor is a service offered by a brokerage that will create and maintain a portfolio of stock- and bond-based index funds designed to maximize your return potential and keep your level of risk appropriate for your needs.
What should you invest your money in?
Here’s a tough question, and unfortunately there isn’t a perfect answer. The best type of investment depends on your investment goals. But based on the guidelines discussed above, you should be in a better position to decide what you should invest in.
For example, if you have a relatively high risk tolerance, as well as the time and willingness to research individual stocks (and to learn how to do it properly), it may be the best route. If you have a low risk tolerance but want a higher return than you’d get from a savings account, bond investments (or bond funds) may be a better fit.
If you’re like most Americans and don’t want to spend hours of your time in your portfolio, putting your money into passive investments like index funds or mutual funds can be a smart choice. And if you want to take a really hands-off approach, a robo-advisor might be right for you.