People invest for a variety of reasons that are completely unique to them. There is no one-size-fits-all strategy or turnkey solution. But there are a few basic concepts with which every investor should be familiar. Investing is fairly straightforward. It is a process that requires patience and discipline.
What Is Investing?
Investing is the process of buying an asset with the intention of receiving a return on it. The return on an investment can be realized through appreciation and/or income.
Appreciation occurs when an asset increases in value. Income is generated by assets that pay interest, dividends, or some other regular periodic distribution. Selling an asset at a price higher than you paid for it creates a capital gain. Before purchasing any investment, you should consider its potential for appreciation and income.
Why Do People Invest?
The purpose of investing is to build wealth. Like many other pursuits, success comes with planning. One establishes a specific goal that is measurable, achievable, personal, and that will be realized over time.
Investing is like running a marathon. You cannot successfully complete one without training for it. Training takes time and discipline. It is the same with successful investing. It also requires time and discipline. Being patient is very important.
Before you begin your investment program, you should consider your specific goals.
- What am I investing for?
- What am I trying to achieve?
- How will I spend my money?
- How much money will I need?
- When will I need the money?
How to Determine an Investing Strategy
Once you determine your objectives, it’s time to create the strategic framework for achieving them. Most people’s financial goals are realized over time. So, investment horizon – the time until the money will be needed – is a major factor to consider.
Time is an extremely important component of investment success. Time is on the investor’s side. It works in your favor. So, the sooner you start investing, the better. Time also sets up the framework for what to invest in.
You should strive to set money aside for short-, intermediate-, and long-term consumption goals. Viewing your investments in this way is called a Bucket Strategy. It figuratively sets money aside in different buckets to finance different goals that will be achieved at different times.
Money needed within a year should be invested in short-term conservative vehicles. You can afford to be more aggressive financing intermediate- and long-term goals. The longer the investment horizon, the more risk you may be able to take.
You investment horizon is closely linked to your age. If you are in your 20s, you can afford to take on more risk (and therefore consider more aggressive investments). If you are at or near retirement, you’ll want more conservative investments with lower risk of loss. Younger investors have time to recoup potential losses. Older investors may not.
That’s why you should also consider your risk tolerance.
- How much risk am I willing to take?
- How will losing money in the short-term make me feel?
- How will I react to economic or stock market volatility?
There is a tradeoff between risk and reward. Typically, the greater an investment’s risk, the greater its potential reward, and vice versa. The stock market can resemble a roller coaster. Still, historically, equities have provided better returns over less risky assets.
This is why you need to consider your investment horizon and risk tolerance before choosing any investment.
Choosing the Right Investment Vehicle and Account
Security selection is a big part of investment success. For investors starting out, mutual funds can be the best choice. Mutual funds help you own diversified portfolios of stocks and/or bonds. And mutual funds are among the easiest investment vehicles with which to get started.
Mutual funds can address many possible investment objectives across different asset classes, industries, sectors, and regions. They may own hundreds of stocks, hundreds of bonds, or a combination of each. As a result, mutual funds can help you build a balanced, diversified portfolio without investing enormous sums of money.
To help you gradually build your investment portfolio, consider a dollar cost averaging strategy. Dollar cost averaging is the regular and consistent purchase of assets over time. Dollar cost averaging can help smooth out short-term risk caused by volatility.
Periodic investment plans like dollar cost averaging do not ensure a profit or protect against a loss in a declining market, but the strategy encourages discipline and removes emotion.
In addition to using different types of funds to accumulate wealth, you can also use different types of accounts to optimize that accumulation.
For example, those saving for retirement can participate in their employer’s 401(k) program. That savings can be augmented (within certain limits) using a traditional IRA, a Roth IRA, or a combination of the two. Each of these accounts provides for some form of tax deferred growth.
The same is true of a 529 account. A 529 College Savings Plan can help parents save money for their children’s future education expenses. A Health Savings Account, or HSA, offers similar tax deferral to help pay for medical expenses now or in the future.
How do Taxes and Fees Impact Investments?
Taxes and fees can both lower investment returns. So, be mindful of the total operating expenses of the funds you consider buying. They are deducted from the fund’s gross investment returns.
If you sell a security at a profit, you’ll earn a capital gain. You can offset gains with losses, but if the net result is positive, be prepared to owe taxes on those gains.
You may also, depending on certain rules, owe taxes on the capital gains your mutual funds distribute to you. That is unless you own them in a tax-deferred account such as a 401(k) or an IRA.
529 plans and HSA accounts have specific tax considerations and advantages you should consider as well. Consult your tax professional about the rules affecting your various investments.
Where to Turn Next
You can't control the stock market or the economy. But you can control your own destiny. Having a plan is a great start. Taking advantage of educational resources can also provide you with the in-depth knowledge you need to be successful. You’ve already taken that first step. Victory Capital Member Service Representatives are available to help.