Retirement Account: Investing Beyond $5500

Investing more than $5,000 is a realistic goal for many people, and there are several ways to achieve it. Here are some options to consider:

- Retirement Accounts: Maximising contributions to a 401(k) or IRA account is a popular choice, especially if your employer offers matching contributions. This provides tax advantages and a relatively safe way to invest.

- Robo-Advisors: These services offer complete portfolio management, often with low fees. Some robo-advisors, like Wealthfront, even manage small amounts for free.

- Exchange-Traded Funds (ETFs): ETFs are a diverse and low-cost way to invest, often with no minimum investment. They can be purchased through an IRA or brokerage account.

- Stocks: While riskier, investing a small portion of your portfolio in individual stocks can be rewarding. It's important to use a low-cost broker to minimise fees.

- Mutual Funds: While often requiring higher minimum investments, mutual funds can provide access to a wider range of investments.

- Real Estate: Investing in real estate, either directly or through a real estate investment trust (REIT), can be a way to diversify your portfolio. However, this option typically requires a larger initial investment.

Remember, investing doesn't have to be complicated. The key is to start with a solid financial foundation, do your research, and choose investments that align with your risk tolerance and goals.

Pay off high-interest debt

Paying off high-interest debt is often recommended as a priority before investing. This is because the interest rates on credit cards and some student loans can be 20% or more, which is higher than the average annual earnings of the stock market. Therefore, paying off debt with a 20% interest rate is the equivalent of earning a 20% return on your money.

One strategy for paying off high-interest debt is the "snowball method". This involves organizing debts from the smallest balance to the largest and paying off the smallest balance first. While this may not be the fastest way to pay off debt, it can help keep people motivated by giving them quick wins.

Another strategy is the "avalanche method", which involves paying off the debt with the highest interest rate first. This approach can save you the most money but may be discouraging if you have a large balance as it could take a while to pay it off.

Before investing, it's important to have a solid financial footing. This includes paying off high-interest debt and setting up an emergency fund to cover unexpected expenses.

Set up an emergency fund

Setting up an emergency fund is an essential part of a solid financial plan. It can help you pay for unexpected expenses and avoid taking on more debt from high-interest credit cards or loans. It can also help you feel more secure and in control of your finances.

• Set realistic and achievable savings goals: Start by aiming for a smaller amount, such as one month's worth of expenses, and gradually increase your goal. This will help you stay motivated and build momentum.
• Start with small and regular contributions: Determine a contribution amount that you can commit to without straining your cash flow. You can cut back on non-essential expenses, such as a monthly coffee habit or a new pair of shoes, and allocate that amount towards your emergency fund.
• Automate your savings: Set up a separate savings account dedicated to your emergency fund and automate your contributions. Most employers offer direct deposit, allowing you to allocate a certain amount directly to your emergency fund. You can also use savings apps or ask your bank to automatically transfer a percentage of your paycheck into this account.
• Maintain your savings discipline: Avoid increasing your monthly spending or opening new credit cards. Instead, focus on building your emergency fund and consider increasing your savings rate over time.
• Don't oversave: Once you've reached your emergency fund goal, you can stop contributing to this account and start allocating your savings towards other financial goals, such as retirement accounts.
• Balance debt repayment and emergency savings: If you're paying off high-interest loans or credit cards, strike a balance between saving for your emergency fund and repaying your debt. You may want to set a more modest initial emergency fund goal and focus on reducing your debt, as the interest charged on your debt can negate your savings progress.

The recommended amount for an emergency fund is typically three to six months' worth of living expenses. However, this may vary depending on your personal circumstances, income, goals, and age. It's a good idea to keep your emergency fund in a high-yield savings account that offers easy access to your funds when needed. Online-only banks often provide higher yields and lower fees compared to traditional brick-and-mortar banks.

Understand compound growth

Compound growth, or compound interest, is a process in which an asset's earnings are reinvested to generate additional earnings over time. This growth is calculated using exponential functions. The earnings can come from either capital gains or interest.

Compound growth is different from linear growth, where only the principal earns interest each period. With compound growth, interest is credited to an existing principal amount as well as to interest already paid. This is often referred to as "interest on interest" and can be thought of as a "snowball effect".

The formula for the future value (FV) of a current asset takes into account the present value of an asset, the annual interest rate, the frequency of compounding (or the number of compounding periods) per year, and the total number of years:

> FV = PV x (1 + i/n)^(nt)

Where:

• FV = Future value
• PV = Present value
• I = Annual interest rate
• N = Number of compounding periods per time period
• T = The time period

The effects of compounding strengthen as the frequency of compounding increases. For example, assume a one-year time period with a 20% annual interest rate. The future value of the investment with annual compounding (one compounding period) would be $1,200,000. With monthly compounding (12 compounding periods), the future value would be $1,219,391.

Compound growth can occur on investments where savings grow more quickly, or on debt where the amount owed may grow even if payments are being made. It is an important concept in finance and is the motivation behind many investing strategies.

One example of compound growth is dividend reinvestment plans (DRIPs). These plans allow investors to reinvest their cash dividends to purchase additional shares of stock. By reinvesting in more of these dividend-paying shares, investor returns compound because the increased number of shares will consistently increase future income from dividend payouts.

Another example is high-yield savings accounts. In this case, interest earned is added to the cash balance, which is then eligible to earn interest.

Dollar-cost averaging

Joe works at ABC Corp. and has a 401(k) plan. He receives a paycheck of $1,000 every two weeks. Joe decides to allocate 10% or $100 of his pay to his employer’s plan every pay period. He chooses to contribute 50% of his allocation to a large-cap mutual fund and 50% to an S&P 500 index fund. Every two weeks, 10% or $100 of Joe’s pre-tax pay will buy $50 worth of each of these two funds, regardless of the fund's price.

The table below shows the half of Joe's $100 contributions that went to the S&P 500 index fund over 10 pay periods. Throughout 10 paychecks, Joe invested a total of $500, or $50 per week. The price of the fund increased and decreased over that time.

The results of dollar-cost averaging:

• Joe spent $500 in total over the 10 pay periods and bought 47.71 shares.
• He paid an average price of $10.48 ($500/47.71).
• Joe bought different share amounts as the index fund increased and decreased in value due to market fluctuations.

The results if Joe spent one lump sum:

• Say that, instead of using dollar-cost averaging, Joe spent his $500 at one time in pay period 4. He paid $11 per share.
• That would have resulted in a purchase of 45.45 shares ($500/$11).
• There was no way for Joe to know the best time to buy. By using dollar-cost averaging, though, he was able to take advantage of several price drops despite the fact that the share price increased to over $11. He ended up with more shares (47.71) at a lower average price ($10.48).

Invest in stocks

Investing more than $5,500 in stocks is a great way to make your money work for you. Here are some tips on how to get started and make the most of your investment:

Select an Investment Account

The first step is to choose an investment account that suits your needs. If you're investing for retirement, an individual retirement account (IRA) is a great option as it offers tax perks. You can also open a taxable brokerage account if you're already on track for retirement or planning to use the money for a different long-term goal.

Choose Hands-on or Hands-off Investing

You can either invest your money yourself or use a robo-advisor, which will build an investment portfolio for you based on your goals, risk tolerance, and investment time horizon. Robo-advisors are a more hands-off approach, while investing yourself gives you more control but requires more time and research.

Diversify Your Portfolio

When investing in stocks, it's important to diversify your portfolio to spread your investment risk. You can do this by investing in exchange-traded funds (ETFs), which are a type of mutual fund that tracks a specific market index, such as the S&P 500. ETFs allow you to purchase a variety of different investments in a single transaction, providing instant diversification.

Consider Commission-Free ETFs

Look for commission-free ETFs to avoid paying fees each time you buy or sell. Most brokers offer a list of commission-free ETFs, and these can be a great way to build a diversified portfolio without incurring high transaction costs.

Long-Term Investment

Investing in stocks is typically a long-term strategy. It's recommended to stay invested for at least five years to ride out the market's ups and downs and give your money time to grow.

Dollar-Cost Averaging

Consider using a strategy called dollar-cost averaging, where you invest a fixed amount regularly, such as $500 per month. This way, you buy more shares when the market is down and fewer shares when the price goes up, lowering your average cost per share over time.

Do Your Research

Before investing in any stock or ETF, be sure to do your research and understand the company's business, financial health, and growth prospects. Diversify across different sectors and industries to further reduce risk.

Remember, investing in stocks carries risk, and it's important to do your own research and consult with a financial professional before making any investment decisions.

Frequently asked questions