Investing is one of the best ways to grow your money over the long term, but it intimidates a lot of people, because of the inherent risk and the perceived difficulty of investing properly. There's no denying that education and practice can help you invest your money more wisely, but you don't have to know a lot about investing to get started. Here are five tips anyone can use to start growing wealth today.
1. Choose low-cost investments
Investing always carries some cost. Your broker will likely charge you fees, and the assets you invest in may have them as well. Mutual funds, for example, charge an annual fee, called an expense ratio, to all shareholders. This is usually a percentage of your assets, and it can eat into your profits over time. You can figure out how much you're paying in fees by looking into your broker's fee schedule and the prospectus for your investments.
Try to keep your costs as low as possible to maximize profits. Index funds are a great choice because they offer instant diversification and low costs. They're mutual funds -- bundles of stocks and bonds -- that you purchase as a package. But unlike regular mutual funds, which are made up of assets chosen by fund managers that can change often, index funds passively track a market index, like the S&P 500. Because there's less work for fund managers to do, index-fund expense ratios are low, often under 0.5%.
2. Use the right accounts
Retirement accounts are where most people do their investing, and for good reason. Money you contribute to tax-deferred retirement accounts, like most 401(k)s and traditional IRAs, reduces your taxable income for the year, though you must pay taxes on distributions in retirement. Roth retirement accounts don't give you a tax break this year, but after you pay taxes on your initial contributions, your money grows tax-free.
Both accounts have the potential to save you money on your taxes while enabling you to grow your wealth. But the right type of account depends on how you think your current income stacks up against your income in retirement. Tax-deferred accounts make the most sense if you believe you're in a higher tax bracket today than you will be in during retirement, while Roth accounts are better if you think you're in the same or a lower tax bracket today than you will be in when you retire. In either case, you must stay mindful of the annual contribution limits. These are $19,500 to a 401(k) in 2020 and $6,000 to an IRA. Adults 50 and older may contribute an extra $6,500 and $1,000, respectively.
If you max out your retirement accounts or you want to be able to access these savings before 59 1/2 without penalty, consider investing through a taxable brokerage account. These accounts don't offer the same tax advantages as retirement accounts, but they can still help you save money. If you hold on to your investments longer than one year, they become subject to capital gains tax instead of income tax. Here's a comprehensive guide if you're interested in learning how this works, but regardless of your income, you should end up paying less in taxes on your investment earnings than if you were charged income tax on the same amount.
3. Stay well diversified
Diversification is important no matter how much money you're investing, but it becomes increasingly important as you invest larger sums. Putting most or all of your money into a single stock could come back to bite you if the stock plummets. It could take years to recover what you lost, or you may never recover it at all. That's why it's a good idea to spread your money among many different assets. Mutual funds are a simple way to do this because they're bundles of many stocks and bonds, so no single stock or bond can affect your portfolio too much.
You also need to make sure you're diversified among many different industries and sectors. If you have all your money in tech stocks, for example, and the tech industry takes a huge hit, you could lose a lot even if you have your money invested in several different companies.
4. Practice dollar-cost averaging
Dollar-cost averaging is a simple strategy where you invest a set dollar amount in an asset according to a regular schedule -- once a week, once a month, etc. The idea here is that you'll end up paying a fair price in the long run because sometimes you'll buy when the price is higher and sometimes when it is lower. This is a better approach than trying to time the market, because if you guess wrong, you could lose money by investing when prices are at their peak.
5. Consider help from a financial adviser or robo-adviser
If you don't trust yourself to invest your money effectively, consider enlisting a financial adviser who can do the work for you. You must pay for these services, but this could be worth it in the long run because advisers can choose investments and strategies that will help you grow your money more quickly than if you were just investing it on your own.
Choose a fee-only financial adviser over advisers who earn commissions. The latter might be tempted to recommend investments that earn them a profit even if they're not ideal for you. Look for an adviser who has been certified by the National Association of Personal Financial Advisors (NAPFA) or a similar organization.
Another option is a robo-adviser. These are computer programs that invest your money according to a certain algorithm based on questions you answer when you set up your account. The costs are typically lower than what you'd pay a financial adviser, but the advice also isn't as tailored.
Even if you follow all of the above advice, you're always taking a bit of a risk when you invest. But it's worth it because if you don't, you're guaranteed to lose money as inflation erodes the value of your savings. Try some of the above tips to start growing your wealth today.