If you are like me, you have a few thousand dollars just sitting in a savings account, or worse, checking. You are a smart person who understands money, but you don’t really know what to do with it. Below breaks down some key investing terms you need to know to set you on the right path.
Key Investing Terms – Long Term Investing vs. Short Term Investing
Long term investing really means your retirement account, the ones you can’t touch until you are 59.5 years old. There are two ways this mainly happens. You either (a) have a 401k through your employer or (b) you have started an IRA on your own. Just because you have a 401k, it doesn’t mean you can’t have an IRA, people often have both.
Short term investing is holdings that you could liquidate quickly and not really pay a penalty on. It is pretty much everything outside of your retirement account. This can be many things but you should think more stocks and bonds. While stocks by themselves are risky, groupings of stocks (mutual funds or ETFs) are fantastic options.
Key Investing Terms – Retirement Investing Explained
401k – The most well known retirement plan. This is usually what you job allows you to invest in and they provide a match in most cases. Most employers will match up to 4%. If you are not utilizing at least this minimum, run to your computer and change that right now. This is the easiest money you will ever make. The match percentage is the minimum but you should be doing 10% of your paycheck if you want to be serious. 403(b) is another similar account you might get. For 401ks you are usually limited in your options of what you can invest in to the few portfolios your employer gives you access to. It is a downside but not really, usually the choices are solid.
IRA – This is basically a 401k but instead it is something you setup yourself. An “Individual Retirement Account” is something you would reach out to a financial investment service to setup and manage for you. You can put the money in tax free but you can’t touch it until you turn about 60 years of age. The difference tends to be that you have a little more control over your investments, with many options to choose from as opposed to just a few funds chosen by your employer. You can have both a 401k and an IRA, people will typically do this if you max out your contribution and want to donate more.
Roth vs. Traditional – The two different types of retirement accounts you can have (whether 401k, IRA or similar) are a traditional or a Roth. With traditional, the money is not taxed up front but when you take it out. For a Roth, the money is taxed up front, but not when you take it out. If you don’t know what to do, go with traditional. The reason you would want a Roth is if you feel like your taxable income will be higher at retirement and you would rather pay lower taxes now. Since when people retire, they generally have less taxable income, traditional is usually the way to go.
Compound Interest – This is the most magical thing in all of finance. The way it works is your money makes money (interest) and then in the future that money + interest makes money. It is the idea of exponential growth, the more money you add early, the more it will grow. That growth helps more growth. Say you invest $10,000 and after year one you make a 7% return (pretty standard), in year two you have $10,700. Well guess what, in year two you don’t make a 7% return on that original $10k, you make it on the $10,700 which is $749 making your new total $11,449. You aren’t just making that 7% growth, you are making the 7% plus the 7% of the previous interest.
Rolling Over a 401k to IRA – One important timely thing to note is that you can roll a 401k over to an IRA if you get let go from a job. You only have 60 days to do this so make sure to ask what your options are in this space. Bonus, your former employer will be impressed with how much of an adult you are. The reason to do this is to take more control over your investment and usually avoid large fees you start to incur when you no longer work for that employer.
Key Investing Terms – Short Term Investments
ETFs and Mutual Funds – As previously mentioned, stocks are risky and the general novice doesn’t really know the best may to spread around the money for consistent growth. That is where options such as mutual funds or ETFs come in. These are groupings of stocks/bonds/etc that some expert put together to mitigate risk. By investing in one of these, you can see strong growth without worrying (as much) about the risk. These can also be grouped in specific areas, like a “technology fund” or “clean energy fund” so you can invest in something you care about. The difference is that mutual funds are managed and can be changed once daily and ETFs (exchange-traded fund) are managed more instantaneously like stocks. Both are fine but ETFs have really come up as the best short term investing solution because of all the great options at very low costs.
Bonds – Bonds are similar to stocks in that they are traded regularly and the price regularly fluctuates up and down. Where it differs is that they tend to be more solid, less risk adverse options, but because of that have lower growth. Every good investment portfolio should have a mix of both stocks and bonds to help protect against risk. Bonds are safer that stocks (usually) and tend to be packaged debt that have more predictable payments. This could all change though as bonds are more effected by changing interest rates. Just know that having a mix of stocks and bonds is key.
Annuity – One investment that usually has a bad rap or is often ignored is an Annuity. It has less to do with the market, which makes it attractive. That is, if you have a very risky portfolio and you want some guaranteed income. An Annuity is something you buy that pays you a flow of study payments for life or a set term. Think of it like you are the bank and you sell someone a house. That home owner is paying you set monthly payments for 30 years or whatever. Sure things can change slightly, but you know you are owed money at specific terms and you will get it.