It’s more important now than ever to build wealth and the best time to form this habit is early in your lifetime. The sooner you start, the better your chances of retiring rich. While this might seem obvious, figuring how to go about it can be quite challenging.
Investment, in any form, involves a certain amount of risk but the earlier you start, the more likely you are to be able to recover from the inevitable misstep. By starting small your risks are smaller as well. In this digital age, there is tons of information available to help you choose the right investment option and every other thing you need to know. However, as helpful as the information might be, you could get overwhelmed with the number of sources you have to filter and read through.
The stock market:
When people think of investing they generally think of the stock market as the place to be. When investing in the stock market you are buying shares of a company’s stock, so you get to own a very small portion of the company. If the company does well, the value of your shares also increase over time. If you decide to invest in the stock market, you could buy individual stocks but that involves putting all your eggs in one basket (or at most a few small baskets). New investors are much better off diversifying their investments by buying a mutual fund which invests in a variety of stocks. There are a variety of different types of funds including Index Funds, Large Cap funds, Small Cap Funds and funds that invest is certain sectors like high tech, gold, or utilities.
Consider alternatives to large-cap funds:
Large-cap companies are generally the companies that you have heard of all your life they have a market capitalization of over $10 Billion and are like slow lumbering giants. They primarily make up the indexes like the DOW Jones (30 Stocks) and the S&P 500 (the top 500 companies on the Standard and Poor’s list) and you can easily invest in them by buying a mutual fund that mimics the Dow or the S&P 500. These companies are the most stable and should give above average performance over the long run. Smaller companies like those on the NASDAQ index may outperform Large Cap stocks during good times but do much worse during bad times. And then sector stocks may perform better or worse depending on a variety of market conditions.
Buy stock as if you are buying that company:
Reasons for buying individual stocks vary from person to person, but one major thing to consider while buying is to see it as buying the company itself. Don’t just go for any stock but one whose company you would love to own. Legendary investor and billionaire Warren Buffett said, “Risk comes from not knowing what you’re doing.” So be sure you do your research on a specific company before you buy. In his book One Up on Wall Street, “Peter Lynch doesn’t advise you to buy stock in your favorite store just because you like shopping in the store, nor should you buy stock in a manufacturer because it makes your favorite product or a restaurant because you like the food. Liking a store, a product, or a restaurant is a good reason to get interested in a company and put it on your research list, but it’s not enough of a reason to own the stock! Never invest in any company before you’ve done the homework on the company’s earnings prospects, financial condition, competitive position, plans for expansion, and so forth.”
What about Taxes?
Everyone seems to worry more about taxes than about gains. First you have to make a gain before you have to worry about the taxes. If you are investing for retirement you should invest through a tax free or tax deferred vehicle like an IRA or Roth IRA, or a 401k.
According to Bankrate.com:
- Short-term capital gains tax is a tax commonly applied to profits from selling an asset you’ve held for less than a year. Short-term capital gains taxes are pegged to your federal tax brackets, so you’ll pay them at the same rate you’d pay your ordinary taxes.
- Long-term capital gains tax is a tax applied to assets held for more than a year. The long-term capital gains tax rates are 0%, 15% and 20%, and they’re typically much lower than the ordinary income tax rate.
- Property sale tax: Home sales are a very specific form of capital gains, and are governed by their own set of rules.
So if you trade a lot in a nonexempt/non-deferred account your profits will be taxed at the higher ordinary income rate so you are almost always better off to hold your investments for more than a year in order to pay the lower long-term capital gains rate. On the other hand if you have a loss you are better off taking it before the year is over for two reasons.
- So you can directly reduce your your other earned income and
- Because the old Wall Street adage “Cut your losses short and let your winners run.”
Physical commodities:
Another area of investing is in physical commodities such as physically-owned assets, including gold, silver, copper, cattle, soybeans or of any other form. Some of these can be held personally or in a safety deposit box while others can be bought in paper form in mutual funds or on commodity exchanges. One of the most common physical assets that people invest in is a home. Home prices do not always go up as we saw in the aftermath of 2008 but they can still be a good long term investment. The major advantage of buying a house is that it forces people to invest in it regularly. The initial investment is made using “OPM” i.e. other people’s money and then you pay them a portion and a portion goes toward your equity every year. And at the end of your mortgage period hopefully the value of your home will have kept up with inflation and you will have a nice tax free “nest-egg”.
Invest your spare change:
It is easy to spend the little money you get as change without much thought. But that “spare change” can add up. Harv Eker says “How you do anything is how you do everything” by that he means that if you are frivolous with small amounts of money you are more likely to waste bigger amounts. So, get into the habit of investing your spare change rather than spending every bit of it on miscellaneous items that you don’t even need. No matter how little it might be, learn to put it to work. For example, applying it to your student loan, your credit card debt or storing it in your emergency fund. Apart from building a saving and a successful investing habit, the little money adds up over time and could make a tangible difference.
If you are in debt, you need to eliminate that with something like national debt relief, before you consider investing but you need to take your head out of the sand and face your financial situation head on. Once you do that you will be able get your financial situation under control.
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