Investing is not necessary.
This statement used to be true back in the mid to late 20th century. People would work for a single company for 40 years, retire at the age of 65, and live quite well financially. Not only did they have Social Security to rely on, but many people also had a nice pension that they earned throughout their working career.
However, times have changed.
In most industries, pensions are going away. Social security isn’t going away, but its benefits will continue to shrink. The three-legged retirement stool of investing, pensions, and social security is getting weaker.
And even though investing didn’t used to be necessary, it is now.
Without investments, it will be impossible to maintain our lifestyle when we retire.
When most people think of retirement, they think of travel, relaxation with grandkids, or perhaps learning new skills and working on new projects. They don’t want to be forced to work at a job they dislike. They also don’t want to be forced out of retirement, just to pay for basic living expenses.
Of course, this is where investing becomes necessary.
Determine your risk tolerance
When you start to invest, the first thing that you should do is think about your risk tolerance. You may want to ask yourself this question:
If I lost a large amount of money, would I be able to sleep well?
For instance: I purchased a house in 2006 that I wanted to fix up and sell. Unfortunately, right after I purchased this house, the real estate values in my area dropped dramatically. I ended up being stuck with this house for years as I waited for its value to go back up. I lost a lot of sleep over that house and it ended up being one of my biggest financial mistakes.
What I now know is that my risk tolerance was not aligned with the risk I took on when I purchased that house. Other investors with a higher risk tolerance were able to purchase houses for less and make huge amounts of money. But this was too much risk for me.
Cash equivalents
The least risky investment (besides burying your money in your backyard) is investing in cash equivalents. These can be things like Certificates of Deposit or Money Market accounts.
The good thing about cash equivalents is that they have extremely low risk.
You probably won’t lose your money.
However, you also won’t make much money either. Current rates on these investments vary from 0-3%. If inflation is 1-3%, then you will struggle to simply break even on this investment.
Bonds
As we move up the risk scale, the next things that we encounter are bonds. Bonds are simply a loan to a company or a government. In return for making the loan, the investor will make a fixed rate of return over a specified period.
Since bonds are a little more risky than cash, they will pay a higher rate than cash. However, they usually offer a lower average rate of return than the stock market.
Just like with stocks, there are a lot of ways to buy bonds. You can buy individual bonds and bet on the future of a particular government or corporation. You can also buy bond mutual funds or bond index funds. These are just a collection of individual bonds. Buying groups of bonds can lower the risk of buying bonds even further.
Stocks
Although stocks are typically riskier than bonds, you can get a higher return by investing in the stock market. Many people like to invest in bonds and stocks at the same time because they usually move in opposite directions. For instance, if the stock market is booming, bonds will often provide a lessor return. When the stock market struggles, bonds will help to pick up the slack.
Many investors will invest in individual stocks. Others will invest in mutual funds or index funds, which are a group of stocks. When investing in mutual funds, it helps to pay close attention to the expense ratios, or the amount of money a mutual fund charges to invest in it. Simply by sticking with index funds instead of expensive mutual funds can save the average investor a ton of money (like $200,000) over their investing lifetime.
Real estate
If you want to get a bit more hands-on with your investments, then you can invest in real estate. Usually, real estate will provide a higher rate of return than stocks or bonds. However, real estate investors have to know what they are doing or they run the risk of losing a lot of money.
Even though real estate can be risky, it may be enjoyable to purchase a house and work to fix up that house. As a real estate investor, you can get a lot of pride in ownership and actually see that you are making a positive difference by fixing up your community.
Starting a business
Although starting a business is very risky, this investment has the highest potential rate of return. Starting a business can range from opening a physical location such as a store, restaurant, or a factory to opening a business that is run out of your home.
Many of the wealthiest people in the world became wealthy by opening their own business. People like Bill Gates and Elon Musk would have never achieved such wealth by investing in stocks or even owning rental real estate. Instead, they made their money through the great businesses that they have started.
However, besides being risky, starting a business can also be extremely time consuming. People speak of quitting their 9-5 and getting out of the rat race only to be faced with working more than 40 hours per week to get their business started.
Investing for retirement
After determining risk tolerance, the next thing to think about is what you are investing for. Most people are simply investing for retirement, but they may also be investing for a big purchase such as college or a home, or even a business purchase.
If you are investing for retirement, you will want to make sure to take advantage of the tax benefits that many investment vehicles offer.
Investment vehicles for retirement
Names like 401(k), 403(b), and 457(b) sound confusing, but they are just sections of the tax code. Basically, they all mean the same thing: retirement account. Depending on where you work, you may be able to put money into one or more of these investment vehicles.
This will be pre-tax money, so investing in one of these vehicles will help to lower your taxes.
Other investment vehicles include the Roth and Traditional IRA. Choosing between these two IRAs involves comparing your taxes in retirement to your taxes today. If you feel that your taxes will be higher during retirement, invest in a Roth IRA. Otherwise, invest in a Traditional IRA. For a closer look at these two IRAs, check out this article.
What to invest in
Once you decide which retirement plan you will invest in, you still need to figure out what to invest in within that retirement plan. It is not enough to say that you will invest in a 401(k). You also have a lot of choices within that investment vehicle.
- Do you want to invest in bonds, stocks, or something else?
- Which mutual fund is the best for you to buy?
- What percentage of your money should you keep in cash equivalents?
As you can see, the 401(k) is just the holding account. There are a lot of options within that holding account. Personally, I invest in index stock mutual funds because the fees are incredibly low and the returns are typically the same or better than other mutual funds. For my explanation on why this is, just check out this article. You can also see the exact funds that I invest in as well as other recommendations by reviewing this page.
However, you probably have a different risk tolerance than I do. Perhaps you are comfortable investing in rental real estate. Or maybe you would rather purchase more bonds than stocks. No matter what, it helps to realize that there is not one perfect investing option that is right for everyone.
Let us know in the comments if you have started investing yet and what you invest in.
And thanks for reading!
~Nathan
Let’s keep living a great life … with the help of money. So what’s next?
- You can travel for free by using rewards credit cards.
- You can get motivated and get out of debt.
- You can check out the next post or the previous post and continue to learn.
But no matter what you decide to do, let’s leave the ordinary behind and take action today!
