Investing 101: The Investing Basics

Why Invest?

Put simply, investing is the most effective and safest way to make your money work for you. There is a lot to learn, and there are certainly bad investments, but by following some simple rules of investing, you can decrease your risk and grow your money into wealth.

Stocks or Mutual Funds?

Simple – both.

A mutual fund, because it is an investment in many different securities, will provide the necessary stability against sudden fluctuations in any given security.

But mutual funds can rarely offer the significant returns of individual stocks. So it is important to hold both.

The stocks will take more time to research, and we will walk you through the process of finding suitable stocks to invest in, in Stocks 101.

But don't skimp on the research when choosing mutual funds, as dogs abound. We'll walk you through the basics in Mutual Funds 101.

What Kind of Account?

A retirement account like a 401(k) or IRA is the default suggestion for beginning investors, primarily because of the immediate tax benefits – contributions to traditional IRAs are tax-deductible for the current tax year, while contributions to a 401(k) are pretax earnings and not subject to income tax (401(k) contributions are, however subject to FICA withholdings).

But these accounts are illiquid– they cannot be sold without severe tax consequences (including a 10% penalty off the top of your earnings). Further, when you finally get around to retiring, withdrawals will be taxed as ordinaary income.

Taxable brokerage accounts, however, are almost always taxed at a lower rate than regular income (especially if you hold your investments for over one year), and can provide much-needed liquidity in the case of an emergency.

Finally, the Roth IRA, which is an IRA where the contribution is after tax but withdrawals are after-tax, provide the perfect environment for short-term trading, since gains are tax-free. If liquidity is not an issue, then a Roth is the place to make short-term trades.

Eventually you will have both IRAs and taxable accounts, and possibly a 401(k). But speak with a tax professional or Certified Financial Planner to determine which kind of account is best for your needs right now.

How Much to Invest?

When starting investing it is important to determine what level of investment you should commit to. If you invest too much, you may not have the money you need to cover emergency situations like unexpected health expenses. With your money in investment accounts you cannot liquidate without adverse tax consequences.

Conversely, if you invest too little you may not achieve your investment goals.

It is common for financial planners to suggest holding threee to six months of salary in a savings account before moving any money into investments. While in a perfect world this would be ideal, we feel it is unnecessarily high for young investors. If you're holding two months' salary in a savings account you should be able to cover any unexpected expenses. Holding any more in a savings account will limit the potential of your investments.


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