Understand These 7 Types of Investments and You'll Practically Be a Pro
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So you've stockpiled an emergency fund, you have your day-to-day expenses under control, and you're not burdened by debt. You're ready to invest. At least, that's what Wendy Liebowitz, CFP, Vice President of Fidelity Investments' Fort Lauderdale Investment Center says. According to her, these are the milestones you should hit before thinking of making any major investments.
If you have met this level of security and are thinking of taking your savings to the next level, it's time to understand the basic types of investments you can choose from. For example, if you're planning for retirement, you'll want to get up to speed on 401(k) investments and annuities, but if you're looking for something a little more exciting and risky, stocks might be a good option for you. Ready to expand your portfolio? Pay attention to Liebowitz's breakdown of these seven types of investments.
The Investment: A bond is a debt security of either a company, an organization, or the government. "You loan your dollars to the other institution and in return, they pay you an interest rate, and at a stated maturity date, they'll give you back your original investment," Leibowitz explains.
The Benefit: This type of investment allows you to generate more interest than what you would likely make with your money sitting in a checking or savings account. "It's more aggressive," she says. If you have a lump sum that you know you won't need to spend in the near future, this might be a good investment for you.
The Drawback: "There is risk involved given the interest rates," says Leibowitz. Essentially the rates can go up or down depending on how well the bond is doing. There's also a default risk. "You hope that the issuer of the bond is able to pay you back in full when the bond is redeemed," she says.
The Investment: "Stocks are ownership in a company, and it's great because you can participate in the long-term growth strategy of that company," Leibowitz says. You have the opportunity to choose whether you buy a stock or a single price per share and you can buy as many as you'd like.
The Benefit: The biggest benefit of buying a stock is the flexibility that comes with it. "You decide what to buy, you decide when to sell, you can set your parameters that you want to buy or sell at certain price points so there's lots of flexibility there with an opportunity for growth." You can also trade stocks throughout the day, as opposed to other investment options with stricter time constraints.
The Drawback: "You take the risk that the stock will succeed," she points out. There are many factors that contribute to a stock's success. The company could hit a rough patch or garner negative press, driving down the price per share. On the other hand, positive media attention could cause the stock to go up. You have to be comfortable with this type of volatility in order to make this investment.
The Investment: "Annuities are a vehicle to use for retirement," says Leibowitz. These are insurance contracts generally used to generate regular income payments once you retire. You can use deferred annuities to grow your funds and income annuities to produce an income stream.
The Benefit: You'll grow your assets without paying taxes each year, however, you'll still have to pay income taxes on earnings made in retirement. The main benefit of this type of investment is that it sets you up to have a steady income during retirement.
The Drawback: Funds invested in annuities cannot be withdrawn before you reach the age of 59 and a half. If your situation changes and you wish to spend your savings before retirement, you'll have to pay income taxes on the growth and a 10% penalty fee. It's a lofty commitment that you shouldn't take lightly.
The Investment: A 401(k) is a savings plan that is sponsored by your employer. By enrolling, you can invest a portion of your paycheck before taxes are deducted and your contribution will generally be met by your employer. "Essentially it's free money from your company."
The Benefit: Leibowitz suggests having 15% of your pre-taxed income saved for your retirement, and investing in a 401(k) can help you meet that goal. Some companies offer a Roth 401(k), which uses after-tax dollars so when you withdraw funds for retirement they will be tax-free.
The Drawback: Put simply, Leibowitz says, "do you want to pay yourself now or pay yourself later?" The main drawback here is simply that you're giving up some of your liquidity because you're planning to use the funds later in retirement. However, you may also want to consider the fact that your company is making the call on how your money is invested. "It may not be as robust of an investment selection as if you had it in a regular investment account," she notes.
The Investment: Buying a home can be a major investment. Leibowitz suggests thinking about this kind of endeavor if you have the money saved up, you're able to manage your regular budget, and you've reduced your debt. You'll also want to consider where you see yourself living in five years. If you're ready to plant down roots, it may be time to think about owning a home, but if you foresee a move in the near future, it's probably more beneficial to rent.
The Benefit: The perk of homeownership is that you can build equity with the goal of selling your property for a greater amount down the road. This type of investment is also a separate asset class. "You're diversifying with how the appreciation may take place with a real estate property versus your other investments that you have under consideration, and there may be a tax benefit as well from an interest on your mortgage standpoint," she points out.
The Drawback: "There are lots of responsibilities to think about as a homeowner, versus if you were a tenant," says Leibowitz. She notes the price of maintaining a property when it comes to improvements and repairs. There's also the potential for your property to decline in value and the expense of taxes to consider.
The Investment: "A mutual fund is a great way to diversify your investment strategy," Leibowitz claims. Think of it as a basket of stocks, bonds, or a combination of the two.
The Benefit: Buying mutual funds allows you to invest a small amount of money in as many as 100 different companies, as opposed to making individual purchases that each come with their own fees, she explains. You can also hire professional managers to decide which stocks or bonds to buy or sell or you can choose an index mutual fund, which mirrors the market. This is what Leibowitz calls a passive investment.
The Drawback: "Mutual funds, again, are not guaranteed investments, as they're variable," says Leibowitz. The price could go up or down. Additionally, mutual funds are only priced once a day at 4 p.m., meaning that you can only sell your funds at that specific time. This doesn't leave much room for flexibility.
The Investment: "A managed account means you’re going to hire a service to do the investment decision–making for you," says Leibowitz. This could be a computer-based program known as a robo-investor or an advisory group that meets with you to make decisions tailored to your needs.
The Benefit: This type of investment allows professionals to do the work for you. "To manage your accounts you have to have the time, the inclination, or the desire to want to do it," Leibowitz states. If you're not comfortable or able to make these decisions on your own, you can hire others to invest on your behalf.
The Drawback: "You’re in control when to hire and when to exit a managed portfolio but not the decisions in between." Essentially, you have to trust someone else's judgment to make major financial decisions for you, which runs a certain kind of risk. Some may ask for your opinion, but the majority won't ask before buying or selling for you, you'll simply receive rationale explaining why decisions were made.
Up next: meet with a financial planner.