Everything You Need to Know about Investing

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Nearly everyone has heard the word “invest” and been told their whole semi- lives they should be investing their money…but what does that really mean?

This article will explain to you what many do not understand: There are different ways of investing your money, adjusting for the amount of risk you’re comfortable taking on.

From a Roth IRA to a high yield savings account, this article will cover everything you need to know when thinking about how to invest your extra money.

Common Ways of Investing

Roth IRA

A Roth IRA is a type of individual retirement account that allows your investments to grow tax-free. Unlike traditional IRAs, contributions to a Roth IRA are made with after-tax dollars, meaning you pay taxes on the money before it goes into your account. However, when you start withdrawing funds in retirement, you owe no taxes on either the contributions or the gains. This makes Roth IRAs particularly attractive if you expect to be in a higher tax bracket in retirement than you are now.

Individual Stocks

Buying individual stocks involves purchasing shares of ownership in a single company. When you own stock in a company, you are essentially buying a piece of that company’s future earnings and growth. The value of your investment can go up or down depending on how the company performs and how investors perceive its future prospects. Investing in individual stocks requires research and a willingness to take on risk, as the success of your investment hinges on the fortunes of the company you invest in.

Index Funds

Index funds are investment funds that aim to replicate the performance of a specific index, such as the S&P 500. These funds hold all (or a representative sample) of the stocks or bonds in the index they track, providing investors with a way to invest in the overall performance of a broad market segment or the entire market. Index funds are known for their lower fees and passive management style, as the fund simply follows the index without attempting to pick individual winners.

High Yield Savings Accounts

High yield savings accounts are savings accounts that offer a higher interest rate compared to regular savings accounts. They are a secure place to keep your money while earning a return that outpaces the typical savings account. These accounts are ideal for emergency funds or saving for short-term financial goals. They are insured by the FDIC or NCUA, making them a low-risk investment.

Cryptocurrencies

Cryptocurrencies are digital or virtual currencies that use cryptography for security and operate on decentralized networks based on blockchain technology. Bitcoin and Ethereum are among the most well-known cryptocurrencies. Investing in cryptocurrencies can offer high returns, but it comes with high risk due to market volatility. Cryptocurrencies are not backed by any central authority, making them an entirely different asset class that is speculative and subject to regulatory scrutiny.

Assessing Risk:

Although these are the most common types of investments, they have very different levels of risk associated with them. Let’s start with the riskiest type of investment:

Cryptocurrency Risk Profile:

• Volatility: Cryptocurrency prices can be highly volatile, with sharp and unpredictable swings in value. Prices can rise and fall dramatically in a short period of time.

• Lack of regulation: The cryptocurrency market is still largely unregulated, which makes it more vulnerable to instability and manipulation. Shifting regulations around the world can contribute to this volatility.

• Technical and cybersecurity risks: Cryptocurrency platforms and wallets are susceptible to hacking, bugs, and other technical issues that can put investors' funds at risk. There is also no way to reverse or cancel a cryptocurrency transaction once it has been sent.

• Unclear valuation: It is difficult to determine the true underlying value of many cryptocurrencies, as they are still a relatively new and speculative asset class. This makes it challenging to assess their long-term prospects.

• Lack of investor protections: Unlike traditional financial instruments, cryptocurrency transactions often have limited legal protections against fraud or theft. Investors may have little recourse if they lose money.

  Individual Stocks Risk Profile:

• Lack of diversification: Investing in individual stocks means your portfolio is not diversified, exposing you to higher risk if that particular company or sector performs poorly. Diversification is an important risk management strategy.

• Speculative nature: Many individual stocks, especially those of smaller or newer companies, are highly speculative investments. There is often limited information available about their long-term prospects and growth potential.

• Susceptibility to market conditions: Individual stock prices can be heavily influenced by overall market conditions, industry trends, and company-specific news - factors that are difficult for the average investor to predict or control.

• Time in the market is KEY…Buy and Hold!

Index Funds Risk Profile:

• Low costs: Index funds have very low expense ratios, often around 0.05-0.50%, compared to 1-2.5% for actively managed mutual funds. This helps maximize returns.

• Diversification: By investing in all the stocks or bonds in an index, index funds provide broad diversification, reducing risk compared to investing in individual securities.

• Passive management: Index funds are passively managed, meaning the fund manager simply replicates the index rather than trying to actively pick outperforming stocks. This reduces the potential for human error or misjudgment.

• Market-matching performance: Index funds aim to match the performance of the market index they track, rather than trying to beat it. This can be an effective long-term strategy, as many actively managed funds struggle to outperform the market.

• In short—Over time Index Funds have proven gains, and are not considered risky.

Roth IRA Risk Profile:

• Withdrawal restrictions: While you can withdraw your contributions at any time tax and penalty-free, you generally cannot withdraw the earnings in the account until age 59 1/2 and the account has been open for at least 5 years. Early withdrawals of earnings may incur taxes and penalties.

• Contribution limits: Roth IRAs have annual contribution limits that are lower than 401(k) plans, limiting the amount you can save for retirement in a tax-advantaged account.

• Potential tax disadvantage for high earners: If you expect to be in a lower tax bracket in retirement compared to your current bracket, a traditional IRA may be more beneficial than a Roth IRA.

• But all in all, there is little risk here, if you plan on holding until that 59 ½ age!

High Yield Savings Risk Profile:

• Withdrawal limits: High-yield savings accounts may come with monthly withdrawal limits, such as 6 withdrawals per month, and can charge fees if you exceed this limit. This limits the accessibility of your money.

• Limited access methods: High-yield savings accounts often have fewer withdrawal methods than traditional savings accounts. Many online banks don't offer ATM networks or debit cards, so transferring funds to your checking account may take extra time.

• Overall, there is essentially no risk to a high yield savings. Right now, you get a guaranteed 5% return on your money for just letting it sit there…

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