Barnett and Company

Back to Basics: Investing 101

By now, many of the New Year’s resolutions have fallen by the wayside (or waistline) already. But a new year is an excellent time to get started with a basic investment plan if you have been on the sidelines. Here are some tips.

Start with the big picture. Define your one or two biggest goals. For most of us, retirement saving tops the list, but you may have other preferences in mind as well. Then make an honest assessment of your time horizon: 5 years or 35 year? Investing is not about catching lightening in a bottle with the hottest stock; it is a steady and systematic journey toward your eventual destination.

Assess your options. “Tax-deferred” investing involves holding your portfolio inside a vehicle that lets the money grow but postpones the tax bill until later. The first place to start is any employer plan available to you like a 401(k), 403(b) or other so-called “defined contribution” plan. Under a qualified plan, you can typically direct part of your pay into an investment account and reduce your current taxable income by that amount at tax time. You pay less in taxes each year and allow those savings to continue growing over time. In addition, many employer plans will match a certain portion of your own contribution as a benefit. Strive to take maximum advantage of any free money on offer.

If your workplace has no plan, you can open your own IRA account and generally deduct contributions from your taxable income up to $6,000 ($7,000 if you are 50 or older). Here again, earnings grow tax-deferred until you start pulling them out.

If you are unable or unwilling to commit funds to tax-deferred accounts, consider a Roth IRA that accepts after-tax contributions but exempts earning from income taxes subject to certain conditions. Finally, you can open a traditional brokerage account. This avoids potential early withdrawal penalties and offers flexibility but creates a tax liability each year.

Create an asset allocation. To many people this may sound like jargon. But it is truly the most important part (after the “getting started” part). It simply means deciding how to split up your money among major “asset classes” including stocks, bonds and cash. In general, the longer your time frame the greater percentage you should stuff into stocks, but your own appetite for risk or safety plays a role as well. Here you may need some help, and most online brokers offer free assessment tools based upon the “big picture” you defined. At some point you will probably want to consult with a financial planner or investment advisor but using broad rules of thumb from an online retirement calculator is fine if you’re just starting out.

Keep it simple – and cheap. Beginning investors can find the array of investment choices bewildering, so pay attention to simplicity and cost. Stick with broad-based fund investments like Exchange Traded Funds (ETF) or Mutual Funds. Start with low-cost funds that track a broader stock market or bond index and don’t try to pick individual stocks or make bets on particular sectors. There will be time for that later once you have established a nest egg. And avoid complex bundled or packaged products that are difficult to understand (and more expensive). Remember that the more opaque an investment is, the easier it is to embed additional fees and expenses. In the beginning, stay with simple, inexpensive index funds.

Things get more complicated as you build wealth. But if you are just starting out, focus on the basics and let time work for you.

Christopher A. Hopkins, CFA


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