Best Ways To Invest Money

Everyone has a unique financial situation. The best way to invest depends on your personal preferences along with your current and future financial circumstances. It’s important to have a detailed understanding of your income and expenses, assets and liabilities, responsibilities and goals when building a sound investing plan.

Here’s a five-step process that can help you figure out how to invest your money right now:

  1. Identify your financial goals, timeframe and feelings about risk.
  2. Decide whether you want to take a “do-it-yourself” or “manage it for me” approach.
  3. Pick the type of investment account you’ll use (401(k), IRA, taxable brokerage account, education investment account).
  4. Open an account.
  5. Choose what investments match your risk tolerance (stocks, bonds, mutual funds, real estate).

And here are the details on how to put your cash to work in the right way, right away.

1. Give your money a goal

Figuring out how to invest money starts with determining your investing goals, when you need or want to achieve them and your comfort level with risk for each goal.

  • Long-term goals: The universal goal is often retirement, but you may have others as well: Do you want a down payment on a house or college tuition? To purchase your dream vacation home or go on an anniversary trip in 10 years?
  • Short-term goals: This is next year’s vacation, a house you want to buy next year, an emergency fund or your Christmas piggy bank.

In this post, we’re largely focusing on long-term goals. We’ll also touch on how to invest with no specific goal in mind. After all, the aim to grow your money is a fine goal by itself.

Money for short-term goals generally shouldn’t be invested at all. If you need the money you’re saving in under five years, check out our recommendations for how to invest money for short-term goals.

2. Decide how much help you want

Once you know your goals, you can dive into the specifics about how to invest (from picking the type of account to the best place to open an account to choosing investment vehicles). But if the DIY route doesn’t sound like it’ll be your cup of tea, no worries.

Many savers prefer having someone invest their money for them. And while that used to be a pricey proposition, nowadays it’s quite affordable — cheap, even! — to hire professional help thanks to the advent of automated portfolio management services a.k.a. robo-advisors.

These online advisors use computer algorithms and advanced software to build and manage a client’s investment portfolio, offering everything from automatic rebalancing to tax optimization and even access to human help when you need it.

3. Pick an investment account

To buy most types of stocks and bonds, you’ll need an investment account. Just as there are a number of bank accounts for different purposes — checking, savings, money market, certificates of deposit — there are a handful of investment accounts to know about.

Some accounts offer tax advantages if you’re investing for a specific purpose, like retirement. Keep in mind that you may be taxed or penalized if you pull your money out early, or for a reason not considered qualified by the plan rules. Other accounts are general purpose and should be used for goals not related to retirement — that dream vacation home, the boat to go with it or a home renovation down the line.

Here’s a list of some of the most popular investing accounts:

If you’re investing for retirement:

  • 401(k): You might already have a 401(k), which is offered by many employers and takes contributions right from your paycheck. Many companies will match your contributions, up to a limit — if yours does, you should contribute at least enough to earn that match before investing elsewhere.
  • Traditional or Roth IRA: If you’re already contributing to a 401(k) or don’t have one, you can open an individual retirement account. In a traditional IRA, your contributions are tax-deductible but distributions in retirement are taxed as ordinary income. A Roth IRA is a cousin of the traditional version, with the opposite tax treatment: Contributions are made after-tax, but money grows tax-free and distributions in retirement are not taxed. There are also retirement accounts specifically designed for self-employed people.

If you’re investing for another goal:

  • Taxable account. Sometimes called nonretirement or nonqualified accounts, these are flexible investment accounts not earmarked for any specific purpose. Unlike retirement accounts, there are no rules on contribution amounts, and you can take money out at any time. These accounts don’t have specific tax advantages. If you’re saving for retirement and you’ve maxed out the above options, you can continue saving in a taxable account.
  • College savings accounts. Like retirement accounts, these offer tax perks for saving for college. A 529 account and a Coverdell education savings account are commonly used for college savings.

Choose investments that match your tolerance for risk

Figuring out how to invest money involves asking where you should invest money. The answer will depend on your goals and willingness to take on more risk in exchange for higher potential investment rewards. Common investments include:

  • Stocks: Individual shares (piece of ownership) of companies you believe will increase in value.

  • Bonds: Bonds allow a company or government to borrow your money to fund a project or refinance other debt. Bonds are considered fixed-income investments and typically make regular interest payments to investors. The principal is then returned on a set maturity date. (Here’s more on how bonds work.)

  • Mutual funds: Investing your money in funds — like mutual funds, index funds or exchange-traded funds (ETFs)— allows you to purchase many stocks, bonds or other investments all at once. Mutual funds build instant diversification by pooling investor money and using it to buy a basket of investments that align with the fund’s stated goal. Funds may be actively managed, with a professional manager selecting the investments used, or they may track an index. A Standard & Poor’s 500 index fund, for example, will hold 500 of the largest companies in the United States.

  • Real estate: Real estate is a way to diversify your investment portfolio outside of the traditional mix of stocks and bonds. It doesn’t necessarily mean buying a home or becoming a landlord — you can invest in REITs, which are like mutual funds for real estate, or through online real estate investing platforms, which pool investor money.

For growth, invest in stocks and stock funds

If you have a high risk tolerance and can stomach volatility, you’ll want a portfolio that contains mostly stocks or stock funds. If you have a low risk tolerance, you’ll want a portfolio that has more bonds, since these tend to be more stable and less volatile. Your goals are important in shaping your portfolio, too. For long-term goals, your portfolio can be more aggressive and take more risks — potentially leading to higher returns — so you’ll probably want to own more stocks than bonds.

Whichever route you choose, the best way to reach your long-term financial goals and minimize risk is to spread your money across a range of asset types. That’s called asset allocation. Then within each asset class, you’ll also want to diversify into multiple investments.

  • Asset allocation is important because different asset classes — stocks, bonds, ETFs, mutual funds, real estate — respond to the market differently. When one is up, another can be down. So deciding on the right mix will help your portfolio weather changing markets on the journey toward achieving your goals.
  • Diversification means owning a range of assets across a variety of industries, company sizes and geographic areas. It’s like a subset of asset allocation.

Building a diversified portfolio of individual stocks and bonds takes time and expertise, so most investors benefit from fund investing. Index funds and ETFs are typically low-cost and easy to manage, as it may take only four or five funds to build adequate diversification.

Culled from nerdwallet.com by Tiffany Lam-Balfour, James Royal, Ph.D.

Leave a Reply

Your email address will not be published. Required fields are marked *