How Do I Make Money Investing?

Is it better to invest or pay off debt first?

As a rule of thumb, the answer to this question depends on two things. First, the cost of the debt or the interest expense, and second, the potential return or earnings on the money invested.

For example, if the mortgage interest expense on a single-family rental property loan is 4% and the anticipated annual return is 8%, it makes more financial sense to not pay off a low-interest rate debt, everything else being equal. On the other hand, if the interest rate on credit card debt is 18%, it might be difficult to find an investment that generates a higher return that isn’t exceptionally risky.

According to Money Crashers, a website dedicated to helping people take control of their finances, there are several steps to take when deciding whether to invest or pay off debt:

  • Get intimate with debts by building a list to understand the associated costs, such as interest rates and annual fees.
  • Proactively reduce the cost of existing debt by rolling high-interest debts into a balance transfer credit card or refinancing an existing high-interest rate loan.
  • Understand the potential risk and rewards by learning about different types of investments, such as owning stocks and bonds or investing in rental real estate.

Once you’ve made the decision to invest, the journey begins with understanding the $1,000 per month rule.

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How to select investments in your investment account

When you start saving in an investment account and select your investments, you don’t buy stock in just one company. You’re investing in a fund that in turn is invested in a range of companies. There are hundreds of different types of these funds, and the choices can be overwhelming. That’s why most people with investment accounts select investments based on age or risk tolerance. For both, it’s important to understand the role of risk and diversification in your investment selections.

Investment account risk

Investment funds are generally classified based on risk, from conservative to aggressive. The riskier the investment, the more potential for growth or loss. If you have more time before you need your investments, you may be able to withstand more risk. The closer you are to retirement, the less able you may be to tolerate risk.

Investment account diversification

Each investment fund includes a diverse array of companies; if one company does poorly in a year, another might do well, which offers balance in loss and growth. Funds might also allocate their assets (i.e., your money) in diverse ways, putting a certain percentage in stocks, another in bonds, and the rest in cash. Both are an example of diversification, which can help to spread out the risk.

3. Reinvest Your Dividends

Many businesses pay their shareholders a dividend—a periodic payment based on their earnings.

While the small amounts you get paid in dividends may seem negligible, especially when you first start investing, they’re responsible for a large portion of the stock market’s historic growth. From September 1921 through September 2021, the S&P 500 saw average annual returns of 6.7%. When dividends were reinvested, however, that percentage jumped to almost 11%! That’s because each dividend you reinvest buys you more shares, which helps your earnings compound even faster.

That enhanced compounding is why many financial advisors recommend long-term investors reinvest their dividends rather than spending them when they receive the payments. Most brokerage companies give you the option to reinvest your dividend automatically by signing up for a dividend reinvestment program, or DRIP.

Having a savings account isn’t enough

Saving money is important, but it’s only part of the story. Smart savers start by building sufficient emergency savings within a savings account or through investment in a money market account. But after building three to six months of easy-to-access savings, investing in the financial markets offers many potential advantages.

Choosing an Investor

You may feel tempted to take the first business investment offer you receive. Remember, however, that you need to work with this person for the duration of your business. Before you jump, look for investors who have experience in your industry and who get involved with companies at certain stages.

The advantage of an angel investor – besides the money they bring to your business – is that they’re usually experienced, successful entrepreneurs who know the ropes, so they can act as advisers to help you reach your business goals. For example, if you’re a start-up, you typically can approach angel investors who understand what’s needed to get a business in your industry off of the ground and are comfortable giving capital to new businesses.

Total Return

Of course, many types of investments provide more than one type of investment return. Common stocks can provide both dividends and capital gains. Fixed-income securities can also provide capital gains in addition to interest or dividend income, and partnerships can provide any or all of the above forms of income on a tax-advantaged basis. Total return is calculated by adding capital gains (or subtracting capital losses) to dividend or interest income and factoring in any tax savings.

Time Can Be Your Friend or Foe

Based on historical data, holding a broad portfolio of stocks over an extended period of time (for instance a large-cap portfolio like the S&P 500 over a 20-year period) significantly reduces your chances of losing your principal. However, the historical data should not mislead investors into thinking that there is no risk in investing in stocks over a long period of time.

For example, suppose an investor invests $10,000 in a broadly diversified stock portfolio and 19 years later sees that portfolio grow to $20,000. The following year, the investor’s portfolio loses 20 percent of its value, or $4,000, during a market downturn. As a result, at the end of the 20-year period, the investor ends up with a $16,000 portfolio, rather than the $20,000 portfolio she held after 19 years. Money was made—but not as much as if shares were sold the previous year. That’s why stocks are always risky investments, even over the long-term. They don’t get safer the longer you hold them.

This is not a hypothetical risk. If you had planned to retire in the 2008 to 2009 timeframe—when stock prices dropped by 57 percent—and had the bulk of your retirement savings in stocks or stock mutual funds, you might have had to reconsider your retirement plan.

Investors should also consider how realistic it will be for them to ride out the ups and downs of the market over the long-term. Will you have to sell stocks during an economic downturn to fill the gap caused by a job loss? Will you sell investments to pay for medical care or a child’s college education? Predictable and unpredictable life events might make it difficult for some investors to stay invested in stocks over an extended period of time.

Still have questions?

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