Extra Cash: Smart Investment Strategies For Beginners

If you have extra cash, you may be wondering if you should invest it or pay off debt. Here are some options for what to do with your extra cash:

- Fully fund your emergency cash account: It's recommended to keep between 3-6 months' worth of expenses in an emergency fund.

- Invest in a brokerage account: A brokerage account is a popular type of non-retirement investment account with no income restrictions or funding limits.

- Increase contributions to a retirement account: If you don't already have a 401(k), now is a good time to start, especially if your employer offers a match.

- Pay off high-interest debt: If you carry a balance on a credit card or loan with a high-interest rate, you may save money in the long run by paying it off.

- Save for other financial goals: You can save for a down payment on a house, start a college fund for your children, or invest in stocks, real estate, or cryptocurrency.

Invest in a brokerage account

A brokerage account is a popular type of non-retirement investment account. With no income restrictions or funding limits, a brokerage account provides the most options for investing extra money. Unlike retirement accounts, assets in a brokerage account can be used for any purpose at any time without early withdrawal penalties.

A brokerage account is funded with after-tax dollars, like savings in your bank account. The account is also subject to tax annually for dividends, interest, or capital gains distributions from mutual funds and ETFs received during the year, even if you did not sell an investment and reinvested the proceeds. When you sell a fund in your account, there will usually be a taxable capital gain or loss depending on your purchase price and cost basis, which will be taxable in the current year.

A brokerage account offers many other benefits, including tax planning opportunities in retirement, funding an early retirement, paying for college, and even leaving an inheritance with tax benefits.

If you are new to investing or have been sitting in cash for years, it's not too late to put your money to work. Here are some steps to consider to help you get off the sidelines:

• Let go of the past: Don't focus on past missed opportunities. Make peace with any regrets and resolve to move on.
• Focus on the future: You can't capture past gains, but you can still share in future ones. The stock market has historically risen over the long term, and being invested in stocks and bonds has provided better growth than cash over long periods.
• Figure out the big picture: Work out how much risk you want to take on and what your big-picture investment mix will be (your asset allocation).
• Consider which investments could work for you: Pick specific investments to fill out your asset allocation, whether with mutual funds, exchange-traded funds (ETFs), individual stocks and bonds, or other choices.
• Pick a pace for getting in: Decide whether to buy in all at once with one or more big trades, or buy in gradually over time with consistent, smaller purchases.
• Don't get stuck on timing: Don't obsess over the perfect timing for your trades. Stay focused on your end goal of actually getting invested.
• Get help if you need it: If you're finding it hard to follow through on your investing plan, check in with a financial professional.

Increase contributions to a 401(k) or IRA

If you have extra cash, consider increasing your contributions to a 401(k) or an individual retirement account (IRA). Even a small increase in contributions can make a big difference in your retirement savings. Here are some things to keep in mind:

Financial professionals recommend saving 10-15% of your income for retirement. This may vary depending on your age and when you start saving. If your employer offers matching contributions, it's generally a good idea to contribute enough to get the maximum match.

The frequency with which you can adjust your 401(k) or IRA contributions may depend on your employer and retirement plan. In some cases, you may be able to make changes as often as you like, while other plans may only allow adjustments once a year.

The contribution limits for retirement accounts can vary from year to year. For example, in 2024, the contribution limit for 401(k) plans is $23,000, with an additional $7,500 allowed for those aged 50 or older. For IRAs, the contribution limit is $7,000, with an additional $1,000 allowed for those aged 50 or older.

Contributions to traditional IRAs are often tax-deductible, while Roth IRAs offer tax-free income in retirement if the account has been open for at least five years. Consult with a tax professional or financial advisor to understand the tax implications for your specific situation.

Should I hire a financial advisor?

If you feel overwhelmed by the choices and investment options, consider hiring a financial advisor or using a robo-advisor service. These professionals can help you navigate the complexities of investing and provide guidance based on your financial goals.

Pay off high-interest debt

If you have extra cash, it's a good idea to pay off any high-interest debt. This is because high-interest debt can be costly in the long run, and paying it off can save you more money than you might make by investing in the stock market or other investments.

There are several strategies for paying off debt, but the two most common are the "avalanche method" and the "snowball method".

The avalanche method involves making the minimum monthly payments on all of your debts, and putting any extra money towards the debt with the highest interest rate. This method can save you money, but it might be discouraging if you have a large balance, as it could take a while to pay it off.

The snowball method involves making minimum payments on all debts, and putting any extra money towards the smallest debt first. Once that's paid off, you move on to the next smallest debt, and so on. This method can be motivating because you'll see progress faster and get quick wins. However, it may take longer to become debt-free, and you could end up paying more in interest.

Before deciding on a debt repayment strategy, it's important to take a hard look at your finances and consider factors such as the type of debt, interest rate, outstanding balance, and impact on your credit score. You should also ensure that you have an emergency fund of three to six months' worth of expenses before allocating extra cash towards debt repayment.

Save for a down payment on a house

Saving for a down payment on a house is a common goal, but it can be challenging. Here are some detailed and instructive tips to help you save for that dream home:

Assess Your Financial Situation:

Start by evaluating your current financial situation. Determine your income, expenses, debts, credit score, and debt-to-income ratio. This will help you understand how much house you can afford and how much you need for the down payment and closing costs. Most lenders require a minimum credit score of 620 for conventional mortgages, and they prefer a debt-to-income ratio of less than 36%.

Set Clear Savings Goals:

Use the 28/36 rule to determine your maximum monthly housing payment. This rule states that your housing expenses should not exceed 28% of your gross monthly income, and your total debt payments should not be more than 36%. Once you've calculated this, you can set a clear savings goal for the down payment and closing costs.

Develop a Savings Plan:

Consider setting up a separate savings account dedicated to your home down payment. Look for high-yield savings accounts or money market accounts that offer higher interest rates. You can also automate your savings by setting up direct deposits or automatic transfers into your savings account. Additionally, consider cutting back on unnecessary expenses, such as dining out, entertainment, and subscriptions.

Increase Your Income:

If possible, explore ways to increase your income. This could include getting a promotion, taking on a side hustle, or starting a small business. Every extra dollar you earn can get you closer to your savings goal.

Explore Down Payment Assistance Programs:

There are various down payment assistance programs available, especially for first-time homebuyers. These programs can provide grants, forgivable loans, or other forms of financial support. Check with your local or state housing authority to see what programs you may be eligible for.

Save Windfalls and Extra Income:

Commit to saving any unexpected cash inflows, such as tax refunds, bonuses, or gift money. By sending these windfalls directly to your savings account, you can accelerate your progress toward your savings goal.

Monitor and Adjust Your Savings Plan:

Regularly review your spending plan and savings progress. This will help you stay motivated and make adjustments as needed. Visual aids, such as a savings tracker or a debt thermometer, can also help you stay on track and celebrate your milestones.

Remember, saving for a down payment on a house requires discipline and a clear plan. By following these steps and staying focused on your goal, you'll be one step closer to achieving your dream of homeownership.

Invest in stocks

Investing in stocks is a great way to make your extra cash work for you. Here are some tips to help you get started:

Do Your Research

Before investing in stocks, it's important to do your research and understand the risks involved. Stocks can be volatile, and their value can fluctuate significantly based on various factors. It's crucial to understand the companies you're investing in and their potential for growth or decline. Diversifying your portfolio by investing in different sectors and industries can help mitigate some of the risks.

Choose the Right Investment Vehicle

You can invest in stocks through various vehicles, such as a brokerage account, retirement account (IRA), or employer-sponsored plans like a 401(k). Each option has its own advantages and tax implications, so it's important to understand the differences before deciding. For example, investing through a brokerage account offers more flexibility in using your assets, while retirement accounts provide tax advantages.

Consider Working with a Financial Professional

If you're new to investing, consider seeking guidance from a financial advisor or robo-advisor. They can help you assess your risk tolerance, create a diversified portfolio, and provide ongoing advice and support. Working with a fiduciary, who is legally bound to act in your best interest, can be beneficial.

Start with a Practice Account

If you want to test your investing skills before committing real money, consider using a practice account or paper trading platform. These platforms allow you to simulate investing in stocks without risking your own funds. It's a great way to gain experience and build your confidence.

Invest for the Long Term

Investing in stocks is typically a long-term strategy. Don't get caught up in short-term market fluctuations. Focus on choosing solid companies with strong fundamentals and hold your investments for the long term to ride out any short-term volatility.

Dollar-Cost Averaging

Consider dollar-cost averaging, which involves investing a fixed amount of money in stocks at regular intervals. This strategy helps smooth out the highs and lows of the market and can reduce the risk of investing a large sum at the wrong time.

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

Frequently asked questions