Invested Wealth: When To Use It And Why

Investing is a way to grow your money over time. It involves putting money to work for a period of time in some sort of project or undertaking to generate positive returns. The core premise of investing is the expectation of a positive return in the form of income or price appreciation with statistical significance. The spectrum of assets in which one can invest and earn a return is vast.

The best way to invest depends on your personal preferences and financial circumstances. The first step is to identify your financial goals and when you want to achieve them. This will help you determine how much money you should invest and for how long. For example, if you're investing for retirement, you might have several decades to grow your investment. On the other hand, if you're saving for a short-term goal like a vacation or a down payment on a house, you'll need to invest for a much shorter period.

Once you know your goals, you can decide whether you want to manage your investments yourself or work with a financial advisor or robo-advisor. You'll also need to choose the type of investment account you'll use, such as a taxable brokerage account or a tax-advantaged retirement account like a 401(k) or IRA.

When it comes to choosing specific investments, you can invest in stocks, bonds, mutual funds, exchange-traded funds (ETFs), real estate, or alternative investments like cryptocurrencies or commodities. It's important to understand the risks and potential returns of each type of investment and to diversify your portfolio to reduce risk.

According to experts, a good rule of thumb is to invest 15%-25% of your income. However, the amount you invest will depend on your unique financial situation, including your income, savings, debts, and risk tolerance.

Stocks and shares

There are two main types of investors: those looking for long-term growth to beat inflation, and those looking to make quick wins. Both are possible, but each requires a different approach, some risk, and often some hard work.

If you're looking to invest in stocks and shares, you can either buy individual stocks and manage the portfolio yourself (or through a professional) or buy exchange-traded funds (ETFs), which are a selection of investments traded on the stock market by a fund manager.

When investing in stocks, it's important to understand the risks involved. The value of your investments can go down as well as up, and you may get back less than you put in. It's also important to consider the costs involved, such as trading fees, ETF cost ratios, investment management fees, and administration charges.

Before investing, it's recommended that you:

• Pay off any high-interest debt
• Have an emergency fund set aside for unexpected expenses (3-6 months' worth of expenses is recommended)
• Can afford to invest your money for at least 5 years
• Only invest what you can afford to lose

If you're considering investing in stocks and shares, it's a good idea to seek financial advice from a regulated financial adviser to ensure you're making smart investment choices and understanding the risks involved.

Investment accounts

Individual Retirement Account (IRA)

An IRA is a tax-advantaged account designed for retirement savings. There are two main types: Traditional IRAs and Roth IRAs. Traditional IRAs allow you to contribute pre-tax income, which may reduce your taxable income. However, you will pay taxes on withdrawals in retirement. Roth IRAs, on the other hand, use after-tax dollars for contributions, and qualified withdrawals in retirement are tax-free.

401(k)

A 401(k) is an employer-sponsored retirement plan that allows you to contribute a portion of your paycheck pre-tax. Many employers match your contributions up to a certain limit, making it an attractive option. Similar to a Traditional IRA, you will pay taxes on withdrawals in retirement.

Brokerage Account

A brokerage account is a versatile investment account that allows you to invest in a wide range of assets, such as stocks, bonds, mutual funds, and ETFs. There are no contribution limits, and anyone can open an account. However, brokerage accounts do not offer tax advantages, and you may incur trading fees.

Health Savings Account (HSA)

An HSA is a tax-advantaged account designed for saving for medical expenses. To be eligible, you must have a high-deductible health plan. HSAs offer triple tax benefits: tax-deductible contributions, tax-free withdrawals for qualified medical expenses, and tax-free investment growth.

529 Plan

A 529 plan is a tax-advantaged investment account specifically for education expenses. It can be used for K-12 tuition, college expenses, and even student loan repayments. Investments within the account grow tax-deferred, and qualified withdrawals are tax-free.

Self-Directed 401(k) or Solo 401(k)

Self-employed individuals can open a self-directed 401(k), also known as a solo 401(k). This type of account offers high contribution limits and a wide range of investment options. You can contribute both as an employee and an employer, maximizing your tax-deductible contributions and tax-deferred growth.

Regular Investing Account

A regular investing account can be used for medium-term financial goals or simply to try out different investment strategies. You have the freedom to invest in a variety of assets, but keep in mind that this type of account does not offer tax advantages.

Each type of investment account serves a different purpose, and it's important to understand their features and how they align with your financial goals. Remember to consider factors such as tax implications, contribution limits, investment options, and associated fees when choosing the right investment accounts for your needs.

Risk and return

When considering investing, it's important to understand the relationship between risk and return. This relationship is a key aspect of investing and will determine the potential profits and losses that can be made.

The level of risk and return can vary even within the same asset class. For example, blue-chip stocks that trade on major exchanges like the New York Stock Exchange have a different risk-return profile compared to micro-cap stocks traded on smaller exchanges.

When investing, it's important to consider your risk tolerance. Beginner investors should carefully consider the mix of investments in their portfolio, as a diverse range of investments can help to reduce risk. Traditionally, high-risk investments like cryptocurrency or growth-focused stocks offer more volatility, while safer investments include treasury bonds, money market funds, and blue-chip stocks that pay dividends.

Additionally, the appropriate level of risk depends on your investment goals and timeline. If you're investing for the long term, such as for retirement, you may be able to take on more risk as you have a longer time horizon to recover from potential losses. On the other hand, if you're investing for shorter-term goals or need access to your money in the near future, you may want to choose less risky investments to preserve your capital.

It's also worth noting that while investing in individual stocks can be lucrative, it requires time and knowledge to do it successfully. If you don't have the expertise or risk tolerance for individual stocks, investing in exchange-traded funds (ETFs) or mutual funds can provide exposure to the stock market while reducing risk through diversification.

In summary, when considering the risk and return of your investments, it's crucial to assess your financial goals, risk tolerance, and investment horizon. Diversifying your investments can help manage risk, but it's important to remember that higher returns typically come with higher risk.

Short-term vs long-term goals

When it comes to investing, it's important to distinguish between short-term and long-term goals. Here's a detailed guide to help you understand the differences and make informed decisions about your invested wealth:

Short-term goals:

Short-term goals are those that you want to achieve in the near future, typically within the next five years. Examples include saving for a dream vacation, building an emergency fund, or purchasing a desired item. Money for short-term goals should not be invested in risky assets. Instead, opt for more conservative options such as high-yield savings accounts, money market accounts, or certificates of deposit (CDs). These options offer liquidity and a guaranteed return, ensuring that your funds are readily available when you need them.

Long-term goals:

Long-term goals are those that are at least five years away, such as retirement planning, saving for a down payment on a house, or funding your child's education. For these goals, you can consider investing in stocks, bonds, mutual funds, or exchange-traded funds (ETFs). These investments offer the potential for higher returns over time but come with a higher level of risk.

Key considerations:

• Risk tolerance: Your risk tolerance plays a crucial role in deciding between short-term and long-term investments. If you're comfortable with taking on more risk and can handle potential losses, long-term investments might be more suitable. On the other hand, if preserving your capital is a priority, short-term investments might be preferable.
• Time horizon: The time horizon for your goals is a critical factor. If you need the money within a few years, short-term investments are generally recommended. For goals that are decades away, long-term investments can help you maximize your wealth.
• Financial situation: Evaluate your current financial situation, including your income, expenses, debts, and emergency savings. If you have extra funds after covering your essential expenses and building an emergency fund, consider allocating a portion towards long-term investments.
• Diversification: Diversifying your investments across different asset classes and industries can help reduce risk and improve your overall portfolio performance. This strategy is especially important for long-term investments.
• Professional guidance: Consult a financial advisor or a fiduciary financial advisor to help you make informed decisions about your investments. They can provide personalized advice based on your goals, risk tolerance, and financial situation.

In summary, short-term and long-term goals require different investment strategies. For short-term goals, prioritize liquidity and capital preservation, while for long-term goals, focus on wealth accumulation and potential higher returns. Remember to regularly review and adjust your investment strategies as your goals, financial situation, and risk tolerance evolve.

Investment strategies

Investing is a smart financial move, and there are numerous investment strategies to consider. Here are some of the most common ones:

• Retirement accounts: One way to begin investing is through a retirement account, such as a 401(k) or an Individual Retirement Account (IRA). It's generally a good idea to contribute to a 401(k) first if your employer offers one, especially if they provide a company match. IRAs give you access to a wider range of investments than a 401(k).
• Buy-and-hold investing: This strategy involves seeking out investments that are expected to perform well over the long term, and holding onto them through market dips and drops. It requires careful evaluation of investments upfront but can save time and often beat the returns of more active trading strategies.
• Active trading: Active investors trade more frequently to capitalise on market fluctuations. This can include swing or spread trading, momentum investing, and event-driven strategies.
• Dollar-cost averaging: This strategy involves spreading out stock or fund purchases over time, buying the same amount at regular intervals. It helps to smooth out the purchase price and reduce the impact of market volatility.
• Passive investing: Passive investors put their money into index-tracking mutual or exchange-traded funds (ETFs), which offer built-in diversification and a hands-off approach. While these funds can't outperform the market, they benefit from lower fees and potential savings at tax time.
• Value investing: Value investors look for stocks they believe are undervalued and have strong long-term prospects. This strategy requires an active approach, keeping an eye on the market and news for clues about which stocks might be bargains.
• Growth investing: Growth investors seek out investments with strong upside potential for future earnings. They evaluate the health of a company and its potential to grow, rather than looking for low-cost deals.
• Momentum investing: Momentum investors believe that winners keep winning and losers keep losing, so they buy stocks that are trending upwards and may short-sell those that are losing value. This strategy relies heavily on technical analysis and data-driven trading decisions.

When considering which investment strategy to use, it's important to assess your financial situation, risk tolerance, and investment goals. Each strategy requires different levels of liquidity, opportunities, and risk, so it's essential to choose one that aligns with your comfort level and financial objectives.

Frequently asked questions