In honor of Pi Day, which celebrates the mathematical constant pi, let's talk about another mathematical concept: compound returns.
Compound returns occur when you reinvest income that your investments produce, thus earning returns of their own. Just as pi's digits keep going without limit, the wealth-building powers of compounding are theoretically limitless. And the sooner you start investing (and the more you invest), the more powerful compounding can be.
That's why you need to start investing now if you haven't already. And to further celebrate today's special number, here are 3.14 ways to get your money working for you.
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1. Invest in a retirement account
You can invest in a taxable brokerage account, or a retirement account such as a 401(k) or IRA. Both have their benefits, with taxable accounts providing more flexible access to your money. But if you're just getting started investing, a retirement account is a good place to begin.
Retirement accounts come with big tax benefits. Depending on the account, you can either deduct the contributions you make up front in the year you make them or invest with after-tax dollars and take tax-free withdrawals as a retiree. Money can also grow tax-free while it's invested, so you don't have to worry about paying capital gains taxes. A 401(k) may also come with an employer match, which is free money your employer provides.
While some retirement accounts provide a wide array of investment choices, investing in a 401(k) is usually simpler. If your employer offers one, chances are good you'll have a limited selection of investments -- usually including a few funds that track the performance of the market as a whole or different sectors of it. That makes picking investments simple. In fact, your 401(k) account may even offer a suggested portfolio that you can decide to accept.
2. Buy an ETF
If you're investing in a taxable brokerage account or a retirement account with a brokerage firm, you'll have many more investment choices than in a 401(k). But you can simplify things if you aren't into becoming a stock-picking guru by purchasing an ETF.
ETFs, or exchange-traded funds, track different market indexes, such as the S&P 500, an index with around 500 of the largest U.S. stocks, which is widely considered to be a barometer of the market as a whole. The fees on ETFs are very low, and you don't need much financial knowledge (if any) to pick one to invest in.
When you buy an ETF, you'll get instant diversification since your money gives you a very small ownership stake in all the stocks the fund owns. And if you pick one that tracks the S&P, these funds have provided pretty consistent returns over the long haul, limiting your risk.
3. Purchase individual stocks
If you want to beat the stock market, buying an ETF or the investments available in a 401(k) probably isn't the way to do it. These types of investments aren't designed to outperform the market as a whole, but rather to mimic its performance (or the performance of specific sectors of it).
If you buy shares of individual companies, on the other hand, your fortunes can rise or fall with the business -- and sometimes rise dramatically if you're smart about which stocks you purchase. When you're willing to put in the time to develop an investment thesis and make smart choices about investing for the long term, this can be the best way to really maximize the wealth-building powers investing can offer.
.14 Buy fractional shares
So, what's the .14 mean? It's simple: Buy fractional shares.
Fractional shares are what their name suggests: fractions of shares. A growing number of brokers sell them, making it possible for people to buy a portion of a share of a stock with high per-share price. If you want to own Amazon or Tesla but don't have a few hundred or a few thousand dollars, you just specify how much money to invest and get whatever portion of a share that amount of money buys you.
Fractional shares make it easy to build a portfolio of stocks you believe in, since you aren't constrained in your purchases by a small investment budget. And since you don't have to put a fortune on the line, they're a great option for beginning investors to test their stock-picking prowess and build a diversified portfolio more quickly by buying small amounts of companies.
Now that you have 3.14 suggestions for how to start investing, take the opportunity on this Pi Day to implement at least one of these approaches. Even though we're celebrating an irrational number today, making compound returns work for you is a very rational choice.
