You don’t even need to be rich to invest, yet so many of us fail to get started managing our money because were intimidated or don’t know where to start.
Inflation lops an average 3.87% off your moneys value every year, and investments are one of the only ways to grow your money fast enough to outpace it.
Investing takes on many different forms from contributing to a tax-advantaged retirement account to buying stocks and investing in mutual funds and its up to you to decide where to put your money.
To help you navigate the field of investing, here are 12 basics to understand before diving in:.
Investing is always a risk.
Little, if anything, is guaranteed when it comes to investing.
You could earn money or lose it, so if you’ll need quick access to liquid cash in the short term, you won’t probably won’t want to invest. Some professionals say you shouldn’t invest money you’ll need in the next five years, because if the market goes down, you won’t have enough time to recoup those funds.
Starting early is a major advantage.
In your 20s especially, your biggest asset is time. For nearly every type of investing — including retirement savings — nothing can make up for the effect of compound interest. Plus, if you lose money in the market, you’ll have more time to make it back before you need it.
That said, “it’s too late to start investing” is not a good excuse to keep your money under the mattress. It’s still better to start late than never — as long as you aren’t tempted into taking unnecessarily high risks to make up for lost time.
Just like in virtually every other aspect of personal finance, you don’t want to rely on investing to “get rich quick.”
You invest differently depending on how much time you have.
Your time horizon is the number of years between now and when you’ll need to use the money you’re investing. It should become evident after you establish your goal.
Once you have a time horizon established, you’ll have a better idea of where to put your money and will be able to form a strategy. Generally, the more time you have until you need the money, the more risk you can take. That way, if something goes wrong, you have time to recoup those losses.
“In general, there are three types of asset classes in investing: cash, bonds, and equities (stocks),” White explains. “And each of these three types have their own ranges of rates of return that you can more or less expect over a period of time.” Understanding these rates of return will help you determine how to invest.
Note that no matter what your timeframe, you’ll want to maintain a properly diversified portfolio of investments (more on that in a moment). However, the following time frames may help give you an idea of where you might want to put more of your money:
If you need your money in 0-2 years …
The first asset class White mentions, cash, has several different sub-categories: savings accounts, CDs, and money market accounts. Cash typically has a low return rate, but is stable. Therefore, this is your best option if you need your money in the short term, White says.
If you need your money in 2-5 years …
“Bonds in general, over a period of time, will generate anywhere from three to as high as eight percent,” White explains. “If you have an objective to reach in two to five years, bonds are most appropriate, because they’re more stable than stocks, yet they’ll generate a higher income than cash. They’ll fluctuate, but not to the degree of stocks in general.”
If you need your money in 5 or more years …
For any goal that’s over five years out, you can weight your portfolio more toward stocks, as they’re the most likely to eventually outpace inflation and get you the most return. “You should expect fluctuations,” White notes. “Stocks have a huge range of returns, going from negative 38% as we saw in 2008, to even 30-plus percent coming out in 2009 and 2010. But over a longer period of time, stocks have been reliably generating about 8% return over the course of 70 or 80 years.”
You’ll be charged fees, no matter how you invest.
Investing isn’t free. If you’re working with an investment professional, you’ll pay them either a percentage of your portfolio or a flat fee (you’ll want to know if your adviser is “fee-based” or “fee-only” before you sign on).
The online investment platforms known a robo-advisers, such as Personal Capital, Betterment, and Wealthfront, each have their own fee structures — depending on the size of your account, they will take a certain percentage each year.
Mutual funds and ETFs also charge fees, which they disclose upfront as “expense ratios,” expressed as a percentage and usually ranging from 0.2% to 2%, and “loads,” which are transaction fees. There are many no-load mutual funds available. Investopedia has a nice explainer on the difference between load and no-load funds, as well as mutual fund fees overall and how ETFs are different.
Warren Buffett and John C. Bogle, founder and former CEO of the Vanguard Mutual Fund Group, both recommend investing in low-cost index funds, which are a type of mutual fund tied to a specific market index — in Buffett’s case, he recommends funds tied to the S&P 500.
Do your research to minimize fees. You can find a fund’s expense ratio, the minimum investment required, and other helpful information about index funds by searching them in the “quote” field on Morningstar.
You have the option of investing through ‘robo-advisers.’
We mentioned it briefly before, but there’s a relatively new online investment platform — “robo-advisers” — which aims to make investing effortless. They’re online investment management sites that manage your investments for you through unique algorithms. All you have to do is open an account, deposit your money, and the robo-advisers will provide a diverse portfolio, and even re-balance it for you.
The fee structures vary depending on the adviser and how much you decide to invest. Of the two biggest names in the space, Wealthfront will manage your first $10,000 for free, and then charge 0.25% in advisory fees after that. Betterment charges a 0.15% to 0.35% management fee, depending on the size of your account.
This option is best-suited to people with relatively uncomplicated financial situations, who want professional expertise on their investments but don’t want to hire an investment adviser or financial planner.
You can’t just ‘set and forget’ your investments forever.
Yes, you should keep your hands off your money … to a point.
Life happens, and there are times — particularly big life changes — when it’s smart to make financial adjustments.
For example, if you’re expecting a baby, you may want to consider contributing towards a 529 savings plan, which allows you to funnel up to $14,000 a year, per parent, into a tax-deferred account.
Or, if you decide to retire early, you’ll need to readjust your time horizon and the amount of risk you choose to take in your portfolio.
As your money grows, and as you get closer to the end of your time horizon, the original portfolio you created may no longer suit your needs. Adjusting it to fit your current situation is called rebalancing, and Investopedia explains it nicely.
This article was written by Business Insider without the involvement of Merrill Lynch.
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