It’s no secret that investing your money is the best way to build wealth and make your way toward financial independence. Deciding to start investing can be a big decision in itself, but for most new or even experienced investors, the more difficult decision is yet to be made. With seemingly endless options, the hardest decision can be figuring where to invest your money.
As an investor, we’d like to think we are already doing more to help our financial future, but are we making smart investments? Is there more we could be doing, or is there something we could be doing differently? Unfortunately, the answer isn’t very cut and dry. Making the best investment or the smartest investment depends on a lot of factors. Let’s take a look at what makes a smart investor, starting from the beginning.
When is the Smartest Time to Invest?
Determining a smart time to invest is a relatively easy question to answer. Invest as soon as you can and never try to time the market. Investing earlier will increase your compounding gains, and trying to time the market will only drive you nuts.
Invest as Soon As Possible
The sooner you can start investing, the more powerful each investment will become. Investing earlier in life is better due to the compounding gains your investments will earn. The more time your money is invested, the more compounding gains you’ll see. The thing about compounding gains is that they start slow then take off later on. Even starting with a low investment amount now will pay off far more than trying to play catch up with larger investing amounts later.
Let’s look at three examples of compounding gains:
There are two things to notice here. Not only does the smallest monthly investment end up with the highest total, but they also contributed the least amount of money. The lesson here is that the first step to smart investing is just to simply start investing!
Don’t Time the Market
Another significant factor of when to invest is the idea of timing the market. Yes, the best way to invest your money would be to invest at the lowest point possible and sell at the highest. That is practically impossible to do once, never mind consistently. Instead of trying to find the absolute best times to invest, just invest, and in the end, everything tends to level out. As we saw in our last example, keeping your money on the sidelines for any reason will typically result in lost gains. No matter what the market is doing, you should constantly be investing your money.
Be a Smart Investor Before You Invest a Dime
You might be thinking about how you can be a smart investor before you even start investing. Although investing is the best way to grow your money, you should only invest money you are okay with potentially losing. If your financial situation doesn’t allow for that, you shouldn’t be investing just yet. Here are some financial checkboxes you should be able to knock off your list before investing.
Debt is the number one killer on finances. Debt is money that is out the window before you ever get a chance to see it. On top of that, you are likely paying a decent amount of money toward interest, making it even harder to pay off. Before investing, you should have most if not all of your debt paid off (except your mortgage). This is an essential part of establishing a solid financial foundation. Once you’ve eliminated your debt, you’ll be well on your way to investing.
The ONLY exception to this is having low debt and an even lower interest rate. There is no guarantee on any investment, but the interest on your debt is. If the interest rate is low enough where the returns on an investment are likely higher, it might make more sense to leave the debt and invest. In all reality, the gains would have to significantly outpace the interest rate for this strategy to be worthwhile. As previously stated, no investment has guaranteed returns. Far more often than not, paying off the debt first is the best course of action.
Finances in Order
After getting your debt cleared away, your next step to smart investing is getting your finances in order. There are a few boxes to check off here as well. For one, you’ll need a budget. You can’t invest until you understand where the rest of your money is going and what it’s being used for. Again, any money you invest should be money you don’t need for essential living expenses, and you can afford to lose. Without a budget, you’ll likely be guessing.
On top of having a budget, you’ll need to be living below your means. If you are spending more than you are making, there simply isn’t any money to invest. Before you start investing, make sure that your money earned is greater than your money spent. Sometimes that means cutting back on non-essential spending, but trust me, the payoff for investing your money rather than spending is well worth it.
Emergency funds are staples in most financial plans. Now that you’ve successfully cleared your debt and are living below your means, you should have a solid emergency fund before investing. Most financial gurus will say to have anywhere between four to six months worth of expenses put aside in case of, well, an emergency.
The hard part about the emergency fund is that it can take quite a while to save the amount of money suggested, delaying your investing. As we went over earlier, the sooner you invest, the better. At this point, how much you put toward the emergency fund each month and how much you invest is a matter of preference and personal comfort. If it were me, I would have at least two to three months worth of expenses before investing. Continue to contribute to the emergency fund until you’ve reached the goal amount. Then you can really start making smart investments.
Determine What Kind of Investor You Are and Why You’re Investing
Whether you’re investing $10 or $1,000, to be a smart investor, you need to understand yourself. Making smart investments isn’t the same for everyone or every situation. Before you start investing, you’ll need to figure out what kind of investor you are and what the goals of each investment will be.
When determining what kind of investor you are, it all comes down to your risk tolerance. Risk tolerance simply put means how much risk you are willing to take on any given investment. Some people are just more willing to take risks than others, and there is nothing wrong with that. Being more willing to take risks doesn’t mean you should have a portfolio full of risky investments. Still, before investing, you should understand where you fall on the spectrum.
Figuring Out Your Goals
A significant aspect of smart investing is determining what your goals are for your investing. Each investment might have slightly different goals, but they should all be getting you to the same place in the end. If your goal is to build long-term wealth as opposed to investing to save up for a house addition, you will invest differently. A smart investment for one goal wouldn’t be a smart investment for the other.
A big reason for investing differently based on a goal is the timeframe in which you’ll want to use your money from any investment. If you are looking at a short-term investment, you don’t have time to see your principal drop in value, so you’d invest in something a bit safer. Suppose you have years or decades even before you’ll need the money. In that case, you can invest in an opportunity that may drop at first. Still, overall the long haul will give you more significant returns.
Another aspect of investing goals may be why you need to invest. If you are looking to supplement income, you would be better off in a stock or fund that pays dividends but has lower overall returns. If the goal is to grow the money, then stocks or other investments that would give better returns would be something you’d want to consider.
Understand You’re Not Going to Get Rich Quick
We’ve all heard the success stories of some buying a stock and hitting it big. Of course, we’d love that to happen to us, but for ninety-nine percent of investors, it just doesn’t happen that way. If your investing strategy is to constantly take big risks to try and hit the jackpot, you will more than likely end up with little to nothing to show for your investing. To be a smart investor, you need to think long-term and understand that wealth doesn’t come overnight. It takes a mountain of time and patience.
Keep Emotions Out of It
Believe it or not, investing can be pretty emotional. Not in the “I love my investments” kind of way (okay, maybe a little bit), but the primary emotion is typical fear or panic. The market and other investments will go through ebbs and flows of gaining and losing; it’s just the nature of the cycle. It can be difficult to watch an investment that once looked unstoppable take a big hit. Many investors fear that the price will never come back and wind up selling at the wrong time.
Greed can also become a factor when the market is doing well. Feeling that all investments are bound to continue to rise can come back to bite an investor in the you know what. Fear that they’ll be missing out on significant gains can lead investors to start buying up investments they wouldn’t have otherwise.
The smartest way to invest is to have your plan and stick to it no matter what the market is doing. As the market goes through its ups and downs, you can keep steady, and everything levels out in the long run.
Now You’re Ready to Invest, but What are Smart Investments?
You’ve done all your prep work, and you’re ready to invest, but what makes a smart investment? There are many options out there, and depending on the answers to the questions above can determine what will make an investment smart for you.
Invest Money You Can Afford to Lose
Investing should be helping you improve your financial standing, not creating more strain. When investing, don’t use money that if it all disappeared tomorrow, you wouldn’t be able to make ends meet. We would all like to invest as much as possible, but putting further strain on your finances isn’t the way to go. Keeping your investment funds limited to the money you can afford to lose will still go a long way. Remember, it’s not all about how much money you invest, but how long you have it invested.
Invest in What You Understand
Another staple rule of investing is to invest in what you understand. You don’t have to go out and be an expert in each stock or fund you decide to invest in, but you should understand what could affect your investment. If you know nothing about real estate, don’t invest in real estate. Don’t know anything about a company, don’t buy its stock. The idea here is not to rush into anything. It can be tough fighting the fear of missing out on an opportunity. Still, there will always be another hot stock in the investing world to invest in when you are more prepared. A smart investor will at least have a basic understanding of their investments and how they work.
Contribute to Retirement Funds
Retirement funds can be a smart investment for any investor. With tax advantages and the possibility of employer contributions (literally free money!), most investors should be taking full advantage of the options available to them.
401ks are the most common type of investment funds, but 403b’s are very similar in nature. These retirement funds are typically set up through one’s employer. Both employees and employers can make contributions to the account. When an employee makes contributions, they are considered pre-tax contributions. Meaning if you elect to invest 5% of your salary each paycheck, it is done before taxes are taken out.
The main advantage to these accounts is that any of the funds contributed by an employee help reduce their overall tax liability. Suppose an investor with a salary of 75k a year contributes 7k toward their 401k\403b. In that case, when it comes to tax time, only the 68k remaining is considered taxable. The typical strategy with these accounts is to contribute as much as possible to lower tax liability and raise potential returns as much as possible.
It’s also common, but not required, that employers will contribute to the accounts as well. The contribution amount is typically predetermined by a company and capped at a certain amount of an employee’s salary. It’s again advantageous for employees to contribute at a minimum the amount required to hit the contribution cap by their employer.
IRA’s are similar to 401ks because they are geared towards retirement, but there are a few differences. For starters, no one will contribute to the account besides the individual investor. 401ks investment options are typically restricted to 20-30 different funds selected by the employer. With an IRA, you are free to invest in whatever you like. Like 401ks, the amount contributed toward an IRA is tax-deductible. However, the benefits there can get reduced based on your income if you or your spouse also have a 401k.
There is also the option of using a Roth IRA. A Roth IRA is a different kind of IRA where the money going in is post-tax and not deductible, but your future withdrawals are tax-free. Roth IRAs are best when you think your taxes will be higher in retirement than they are right now. You need to be careful if you decide to go this route, as once you hit a certain income level, you can no longer contribute to the account.
Smart Investment For: Overall, retirement accounts are a smart investment for anyone. Each having its advantages; it’s least worth considering each type of account, especially the 401k.
High-Yield Savings Accounts, Money Market Accounts and Certificates of deposit (CDs)
Not typically viewed as investing, but High-Yield Saving Accounts, Money Market Accounts, and CDs will offer a smart and safe way to grow your money. High-yield savings accounts and money market accounts will act like your traditional savings account but with higher interest rates.
With a Certificate of Deposit, you’ll essentially be loaning money to a bank. After a predetermined amount of time, they give your money back, plus interest. Most banks offer CD’s and typically, the longer the length of the loan, the higher the interest rate you’ll earn.
Smart Investment For: With almost no risk of losing their principal value but meager returns, these “investments” are best used as a short-term investment to gain a few extra bucks.
Investing in bonds is another relatively safe way to grow your money, but again, with lower returns. The most common three are municipal bonds, corporate bonds, and government bonds. Like CDs, you are essentially loaning your money out for a certain amount of time. It will gain interest at a predetermined rate for the duration of the loan.
Bond laddering is an investment strategy that aims to help further reduce risk by investing in bonds with different maturity dates. Instead of having one bond with a large amount invested, you can break it up into smaller investments, each with a different maturity date.
For example, you might have 20k to invest. Instead of investing it all in a ten-year bond, you might decide to invest 5k in a one-year bond, 5k in a five-year bond, and 10k in a ten-year bond. With this, your money isn’t locked up for ten years, and if you need it, you have cash handy. Suppose you don’t need the money when any particular bond matures. In that case, you can reinvest in the same fashion, eventually creating a scenario where you will constantly have bonds maturing each year.
Smart Investment For: Like the HYSA, MMA, and CD, bonds are another smart way to gain small but safe returns over the short term. The bond laddering strategy can be a smart strategy for anyone with enough capital to diversify their bond portfolio enough. This will create a portfolio with decent returns and help supplement income for retirement or in case of an emergency.
When most people think of investing, they think of investing in stocks, which makes sense seeing that they are the most common type of investment. Buying a share of a company’s stock is the equivalent to buying a very tiny fraction of that company. This essentially gives you the right as an “owner” to the company’s assets and profits. The more shares of stock you own for that company, the more you are entitled to.
Historically speaking, stocks have produced the most significant returns for investors. However, they are also the most volatile. When investing in stocks, there are a lot of factors to consider. A smart investor will look at many factors before investing their money in a company. Some factors you might want to consider are:
- How long has the company existed?
- Is it profitable?
- Is the company growing?
- Does the product they sell have a long-term need or solve a long-term problem?
- How does the stock typically perform?
- Is the price too high right now?
These are just a few factors worth considering.
When dealing with stocks, some are considered to be safer. If a stock is considered “safe,” it doesn’t mean the stock’s price will always rise. It typically means the company itself is a stable and profitable one with a lower risk of having its stock price hurt by a poor economy or market conditions. These are typically more prominent companies with stockpiles of cash that can outlast poor conditions better than smaller establishments. When thinking smart investing with stocks, consider credit card companies, popular service providers (think Verizon, AT&T), or essential goods manufacturers and sellers(Costco baby!).
Dividend stocks are another smart investment you may want to consider. Dividends are a sum of money paid regularly (typically quarterly) by a company to its shareholders out of its profits. Dividend investing is generally seen as a way to replace income typically earned through other means. However, smart investors can use dividends to reinvest in the same stock to gain more shares. You’ll need to remember that when a company pays out dividends, its net assets are lowered by that same amount. The value of its stock price will be reduced accordingly.
Smart Investment For: Although stocks have the potential for the best returns, there is no guarantee any stock’s price will rise at any point. Stocks are best for anyone looking to invest for the longer term and weather any ups and downs the market goes through.
Dividend investing can be a smart investment over the long term. Dividend investing is typically seen as a better investment for those nearing or in retirement to supplement any income you are no longer earning.
Index Funds, Mutual Funds and Exchange-traded funds (ETFs)
Due to the inherent riskiness of buying individual stocks and difficultly knowing which will succeed and which will fail, many smart investors choose to have a smaller portion of their portfolio in individual stocks. A bulk of their portfolio will be held in different types of funds. Although this will typically reduce their overall returns, it will significantly reduce their overall risk as well.
Mutual Funds are an actively managed collection of stocks. To be considered actively managed, a fund must have a fund manager making trades on behalf of the investors. Instead of buying one stock, funds will look to purchase many different stocks or other investments. Before investing in any mutual funds, take a look at its prospectus or investing strategy.
Mutual funds can invest in any of the previous investment options we’ve gone over. As with stocks, mutual funds come with a wide array of risk vs. reward, but since your investment is spread out over multiple options, the risk is lower than picking individual stocks. Mutual funds investing in all stocks will be riskier than a mutual fund investing in all bonds. Furthermore, a mutual fund investing in some of the riskier stocks can be far risky than a mutual fund investing in more well-established stocks.
You should also be aware of the expense ratios associated with a managed fund. Managed funds will charge investors with the fund manager’s cost, research, and other expenses it incurs. Smart investors will attempt to find a mutual fund with the right risk level for them and lower expense ratios.
Index Funds and Exchange Traded Funds
Index funds and Exchange Traded Funds (ETFs)are great for investors of any age and experience level. Like mutual funds, both index funds and ETF’s are a collection of stocks or other investments. These types of funds are not typically managed as much as their mutual fund counterpart. They will normally attempt to track a market index as a whole. Over the long term, Index funds and other passive investments typically outperform most mutual funds. With the funds’ passive nature, the expense ratios associated with them are much lower as well.
Smart Investment For: Mutual Fund, Index Funds, and Exchange Traded Funds can be a smart investment for anyone looking for a long-term, reduced risk investment. Some can be riskier than others, but for the most part, they are safe investments that will grow over the long haul. There are even investment strategies that only involve funds.
Although the stock market is the most common way to invest, there are plenty of other smart ways to invest your money. Here are just a few ideas.
Peer to Peer Lending (P2P)
With peer-to-peer lending, instead of going to a bank, you become the moneylender. On a typical P2P lending site, you can sign up as an investor and start buying what are known as notes. These are essentially the IOU from borrows saying that they owe you the money. The notes on such sites are typically $25, but you can buy multiple notes for any particular loan if you wish. Investors will then be paid back on their investment plus interest every month as the borrows make their monthly payments as they would with a bank. Borrows are vetted out by the site and come with different risk levels. You can invest with a predetermined risk algorithm or buy each note on your own.
Smart Investment For: Any investor looking to create another stream of income that doesn’t depend on the stock market. Be careful not to get too risky as borrows can default on these loans leaving you with the bill.
CryptoCurrency has been around for much longer than people think but has become far more popular in the past few years. It’s also becoming increasingly easier to invest in the leading crypto coins like bitcoin, litecoin, and ethereum or altcoins like Tezos, Ripple, and even Dogecoin. The prices of these coins can range from a few cents to tens of thousands each. The value of any coin can be highly volatile, and unlike the stock market, the trading never stops.
Smart Investment For: Anyone willing to take a considerable risk as this might be the biggest of them all. Any money invested in CryptoCurrency should not be needed for anything else. It can quickly lose most of its value.
Angel investing is when you invest in a startup company, meaning it’s not available on the public stock market. This would be done, hoping that the company will become successful and go public at a higher stock price than your original investment. The risk is typically much higher as most startups rely on angel investors for cash. They are not making enough money to cover their expenses yet.
The draw to angel investing here is much higher returns if the company starts to turn a profit and\or holds an IPO. In the past, angel investing was limited to high net worth individuals. Still, in recent years, crowdfunding has been applied to angel investing as well. Sites like Wefunder.com have appeared, allowing more individual investors to invest small amounts of money into these startups.
Smart Investment For: Anyone willing to be very patient on their investment and willing to accept they may never get a dime they invest back.
Royalties are payments to owners of property for the use of that property. Most commonly, royalties are associated with the rights to someone’s intellectual property (IP), such as music. Whenever a song is played on the radio, heard on a TV show or movie, the owner of that IP is paid their royalty fee. Sites selling the rights to different kinds of intellectual property have also started popping up in recent years, making them more available to individual investors.
Smart Investment For: Like dividend investments or P2P, royalties are suitable for anyone looking to create another income stream apart from the stock market.
Real estate is an excellent investment for anyone willing to put in the work. It can be challenging to get started as you’ll need a large amount of capital to purchase a property. Still, once you get started, it will get easier. It is imperative to do your research before buying a property. A smart investor will research the area they are looking to invest in and the laws and regulations surround being a landlord, as they can vary from state to state. Finding the right property may take some time, but it can turn out to be one of your more lucrative investments. Owning a property adds an additional income stream to your portfolio, but when it comes time to sell the property, most investors make some real cash.
If you are interested in Real Estate but don’t have the capital and\or don’t want to do the work associated with it, you still have a few options. Some funds only invest in different types of real estate called Real Estate Investment Trusts (REITs) available to you in the stock market. REITs will typically pay investors with higher dividend yield but don’t increase much in overall value.
Another passive real estate investing option is a crowdfunding site like Fundrise.com. When investing with sites like Fundraise, you’ll typically be crowdfunding the purchase of larger real estate properties like apartment complexes. The best part is the site does all the work! As with other investments, they have different investment portfolio options available. The different portfolios have different objectives for your investments. Some have a long-term approach by investing in growth, while others will have more of a short-term outlook producing higher dividends and less growth. Either can be a smart investment as long as it aligns with your overall investing goals.
Smart Investment For: Real estate investing in any sense is a smart investment to add diversity to your portfolio. While owning physical property is typically seen as a long-term investment, with sites like Fundrise.com, you can now invest small amounts of money to earn long-term growth or start earning high dividend yields for short-term gains as well.
Remember to Review and Rebalance
Part of being a smart investor is taking a look at your portfolio and determining two things.
- What is working and what isn’t.
- Does it still align with my goals?
The first one can be a bit easier to figure out as it’s easier to quantify. If the investment is making you money, then more than likely okay to hold on to. If it’s losing value or not making as much as it should, it could be time to move on.
As you travel on your investing journey, your goals and priorities may shift. When starting young, you might be more willing to take risks as you have the most time you’ll ever have to regain any losses. As we age, our overall investment strategy and outlook may change, so our investments should change with us. Selling one of your riskier investments that have been profitable and reinvesting in a safer, more stable investment might now make more sense. You may need to shift investments around to more of an income-producing focus in another five or tens years. Smart investing never ends, and going back at previous investments is a big part of it.
No matter your investing situation, there is a smart investment out there for you. Some investments are better suited for those willing to take more considerable risks; others are better for those looking to supplement income. Most of us will be a mix of the two, shifting our investment types as our investing goals change. Having a diverse and well-balanced portfolio will always be the key to smart investing. There have never been more options available to us both in and outside the stock market. As long as your investments are in line with your overall goals, you can’t go wrong.
Jeff is a fan of all things finance. When he’s not out there changing the world with his blog, you can find him on a run, a Mets game, playing video games, or just playing around with his kids.