How to start investing in 2020

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According to a 2017 study by Ally Investing, 61 percent of adults find investing in the stock market “scary or intimidating.” It’s made scarier by major declines in the market, such as those caused by the novel coronavirus or the housing crisis. Despite these fears of loss, investing in financial markets is one of the best things that Americans of any age can do to get on the road toward financial well-being. Investing helps you build a more secure future.

No matter where you are on your financial journey, this guide can help you get started.

Why investing is important

Investing is the most effective way Americans can build their wealth and save for long-term goals like retirement. Or paying for college. Or buying a house. And the list goes on.

The sooner you begin investing, the sooner you can take advantage of compound interest, which allows the money you put into your account to grow more rapidly over time. Your money earns money – without you doing anything. Ultimately, you’re looking for your investments to grow enough to not only keep up with inflation but to actually outpace it, to ensure your future financial security. If your gains exceed inflation, you’ll grow your purchasing power over time.

1. Look into retirement accounts

For many people, the best place to begin is your employer-sponsored retirement plan (likely a 401(k)) offered through your employer’s benefits package.

In a 401(k) plan, the money you contribute each paycheck will grow tax-free until you begin withdrawals upon reaching retirement age. Many employers even offer matching contributions up to a certain percentage for employees who participate in their sponsored plans.

These plans have other benefits, too. A traditional 401(k) allows you to deduct your contributions from your paycheck so that you don’t pay taxes on it today, only when you withdraw the money later. A Roth 401(k) allows you to withdraw your money tax-free – after years of gains – but you have to pay tax on contributions. Here are all the 401(k) details.

Use Bankrate’s 401(k) calculator to see how much your money can grow throughout your career.

The logistics of a 401(k) can be confusing, especially for recent grads or those who have never contributed before. Look to your employer for guidance. Your plan’s administrator – which is sometimes a big broker such as Fidelity, Schwab or Vanguard – may offer tools and planning resources, helping you educate yourself on good investing practices and the options available in the 401(k) plan.

If your employer doesn’t offer a 401(k) plan, you’re a non-traditional worker, or you simply want to contribute more, consider opening a traditional IRA or Roth IRA. A traditional IRA is similar to a 401(k): you put money in tax-free, let it grow over time and pay taxes when you withdraw it in retirement. A Roth IRA, on the other hand, invests taxable income then is not taxed upon withdrawal. There are also specialized retirement accounts for self-employed workers.

The IRS limits the amount you can add to each of these accounts annually. For 2020, the contribution limit is set at $19,500 for 401(k) accounts (before employer match) and $6,000 for an IRA. These limits increase for workers over age 50 to allow for catch-up contributions. Older workers can contribute an additional $6,500 to a 401(k), while an IRA allows an additional $1,000 contribution.

2. Assess your risk tolerance

Risk tolerance is one of the first things you should consider when you start investing. When markets decline as they have during the coronavirus crisis, many investors flee. But long-term investors often see such downturns as a chance to buy stocks at a discounted price. Investors who are able to weather such downturns may enjoy the market’s average annual return – about 10 percent historically. But you have to be able to stay in the market when things get rough.

Some people want a quick score in the stock market without experiencing any downside, but the market just doesn’t work like that. You must endure down periods in order to enjoy the gains.

As you think about risk in regard to long-term investing, it all comes down to diversification. You can be a bit more aggressive in your diversification of stocks and bonds when you’re young and your withdrawal date is distant. As you inch closer to retirement or the date you’re looking to withdraw from your accounts, start scaling back your risk. Your diversification should grow more conservative over time so you don’t risk major losses in a market downturn.

Investors can get a diversified portfolio quickly and easily with an index fund. Instead of trying to actively pick stocks, the manager of an index fund passively owns all the stocks in an index. By owning a wide swath of companies, investors avoid the risk of investing in one or two individual stocks, but they won’t eliminate all the risk that comes from stock investing. Index funds are a staple choice in 401(k) plans, so you should have no trouble finding one in yours.

Another common passive fund type that can put your risk aversion at ease and make your investment journey easier is a target-date fund. These “set it and forget it” funds automatically adjust your assets to a more conservative mix as you approach retirement. Typically they move from a higher concentration in stocks to a more bond-focused portfolio as you approach your date.

3. Long-term vs. short-term

Your time frame can change which types of accounts are most effective for you.

If you’re focusing on short-term investments, those you can access within the next five years, money market accounts, high-yield savings accounts and certificates of deposit will be the most useful. With these accounts insured by the FDIC, you can be sure your money is going to be there when you need it. Your return won’t usually be as high as long-term investments, but it’s safer in the short term.

It’s generally not a good idea to invest in the stock market on a short-term basis because five years or less may not be enough time for the market to recover if there’s a downturn.

The stock market is an ideal vehicle for long-term investments, however, and can bring you great returns over time. Whether you’re saving for retirement, looking to buy a house in 10 years or preparing to pay your child’s college tuition, you have a variety of options – index fundsmutual funds and exchange-traded funds all offer stocks, bonds or both.

Getting started is easier than ever with the rise of online brokerage accounts designed to fit your personalized needs. It’s never been cheaper to invest in stocks or funds, with brokers slashing commissions to zero and fund companies continuing to cut their management fees. You can even hire a robo-adviser for a very reasonable fee to pick the investments for you.

4. Don’t fall for easy mistakes

The first common mistake new investors make is being too involved. Research shows that actively traded funds usually underperform compared to passive funds. Your money will grow more and you’ll have peace of mind if you keep yourself from checking (or changing) your accounts more than a few times each year.

Another danger is failing to use your accounts as they’re intended. Retirement accounts such as 401(k) and IRA accounts offer tax and investing advantages but specifically for retirement. Use them for almost anything else, and you’re likely to get stuck with taxes and an additional penalty.

While you may be allowed to take out a loan from your 401(k), not only do you lose the gains that money could be earning, but you also must pay the loan back within five years (unless it’s used to purchase a home) or you’ll pay a 10 percent penalty on the outstanding balance.

Your retirement account is meant to be used for that retirement, so if you’re using it for another purpose, you’ll want to stop and ask yourself whether that expense is truly necessary.

5. Learn a little, save a lot

The good news is you’re already working on one of the best ways to get started: educating yourself. Take in all the reputable information you can find about investing, including books, online articles, experts on social media and even YouTube videos. There are great resources available to help you find the investing strategy and philosophy that’s right for you.

You can also seek out a financial planner who will work with you to set financial goals and personalize your journey. As you search for an adviser, you want to look for one who is looking out for your best interest. Ask them questions about their recommendations, confirm that they are a fiduciary acting in your best interest and make sure you understand their payment plan so you’re not hit by any hidden fees.

Generally, you’re going to have the least conflicts of interest from a fee-only fiduciary – one whom you pay, rather than being paid by the big financial companies.

Bottom line

Many people are afraid of investing, but if you learn the basics, a sensible approach can make you a lot of money over time. Starting to invest can be the single best decision of your financial life, helping set you up with a lifetime of financial security and a happy retirement, too.

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