Now that you’ve landed your first “real” job everyone including your mother is telling you it’s time to start building a diversified financial portfolio.
Great. You’re finally earning enough to upgrade from the dollar menu at Wendy’s to the Cheesecake Factory and the world flings a new fiscal responsibility in your face.
But investing doesn’t have to be painful. We’ve created this easy to follow beginner’s guide to walk you through the basics of putting your hard earned money to work for you.
No Pain, No Gain: Here’s why you need to get involved
Interest rates have been hovering around record low levels for quite a while now. This is great if you’re in the market for a new house but terrible if you’ve got a few grand earning pennies each year in a traditional savings account.
Did you know the average interest rate in a savings account doesn’t even cover the annual cost of inflation?
Nowadays you’ve got to take on a little risk to get a better return on your investments.
Your Very First Investment Account
Long before diving into managing your own portfolio of individual stocks the first investment account you need to open up is a 401k or a Roth IRA. Why? Because both of these types of retirement funds are allowed to grow over the years tax free.
The main difference is that a 401k is only available through your employer and anyone can open a Roth IRA no matter where they work.
To find out if your company has a 401k program talk to your Human Resources department. Be sure to ask if the company matches funds and if so, up to what percent. If your employer matches contributions take advantage of this opportunity to get free money.
Opening a Roth IRA is done either with a bank, mutual fund company, brokerage firm or insurance company. When looking at options be sure to compare management fees.
Many people have a 401k and a Roth IRA as both accounts offer distinct advantages. Investment options within your fund vary depending on the provider but most beginner investors will stick to mutual funds.
It’s important to note that once you put money into a retirement account it’s difficult to get it out early without incurring major penalties.
Let’s Take a Quick Tour of the Stock Exchange
When we said “beginner” we meant beginner. So let’s first talk about what exactly a stock is. Bonds? Umm, yeah, we’ll save that discussion for later.
When you purchase a stock you are essentially buying a small piece of that company and owning stock makes you a part owner.
Stocks provide earnings to owners in two ways: capital appreciation and dividends.
Capital appreciation is simply the rise in the price of one share of stock on the open market. Dividends refer to the sharing of a company’s profits with the shareholders in cold hard cash.
It’s important to remember that while the price of a stock can rise, it can fall, too. This is why all financial advisors recommend a balanced portfolio. By owning a wide selection of stocks you are protected against a big hit should one of the companies you own totally tank.
Mutual Funds for Dummies
The easiest way to buy a whole bunch of different stocks and build a balanced portfolio is to let someone else do it for you. By investing into a mutual fund you are essentially buying tiny pieces of a large mixture of shares purchased by a large financial institution.
Within your 401k or Roth IRA you can generally choose from a selection of different mutual funds to match your ideal risk tolerance.
What about Non-Retirement Investing?
It’s also possible to open up regular investment accounts that have nothing to do with retirement at all. You can buy and sell stocks, bonds, or mutual funds as you please and pull money out whenever you like. Profits from these accounts, however, are taxable at the end of the year.
Once you get the hang of it, you can even manage your own portfolio on the web with an online brokerage like eTrade, but let’s not get ahead of ourselves here. These are real dollars we’re playing with here and not Monopoly money.
Open up a retirement account and start stocking away for the future. The sooner you get started the faster you’ll start taking advantage of compound growth. After a year or two of reading through account statements you’ll start to gain a better understanding of where step two might be with your investment goals.
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