7 Investment Questions and Answers For NewbiesStocks
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Just like anything else, investing can be confusing if you’re new to it. You have lots of questions, you don’t know about index funds or brokerages or IRAs or any of these things. So I know that investing can be intimidating, but the truth is that it really isn’t as complicated as some people want you to think.
Some of you are completely new to investing, some of you are looking for advanced strategies, and a lot of you are somewhere in between. But I think it’s really important to get a solid foundation before you move on to those specific strategies, so I thought it would be really helpful to write an article on some of the most common questions I hear from people who are new to investing. So some of you will be familiar with these points, but some of you won’t, but hopefully by the end of the video you’ll understand a little more about how investing works and how you can develop a strategy that works for your financial goals.
1. What Is Investing?
This first question sounds really simple, and in a sense it is. But before I talk about anything else, I want to explain what investing is. Now you probably know that investing involves buying stocks, buying real estate, and buying other assets, but I want to go a little deeper.
In general, what it means to invest in something is that you’re putting some resource into that thing with the goal of getting even more back. So if you say that you want to invest your time in building a language, you’re giving up some time that you could have used for something else because you want that skill more than you want the free time.
When it comes to investing money, you’re basically putting in cash upfront. It could be your own cash, or if you’re margin trading it could be a combination of your own cash and cash you borrowed from somebody else. But you’re using that cash to buy some asset that you think is going to provide more value for you than what you paid for it.
This could be real estate—maybe you want to flip the property for a higher price, or maybe you’re looking to get rental income. It could also be a business where you want to get a share of the profits. That’s essentially what a stock is, you are owning a small portion of a company and sharing in its earnings and its growth. But it doesn’t have to be stock, an investment could be anything that you’re paying into so that you can get more out later. That is all investing is in a nutshell.
2. Do I Need a Lot of Money to Invest?
To be clear, there are some real concerns about wealth inequality in the United States. In fact, more than half of all stocks are owned by the richest 1% of the population.
That leads some people to think that investing is only worth getting into if you’re in that category. Of course it’s true that rich people get more out of the stock market than anyone else, so I’m not dismissing those concerns, but it really isn’t true that investing is only worth it if you’re rich.
Getting into investing was a lot more complicated when everything went through actual human brokers. But in 2020, it’s pretty easy to start investing even if you don’t have that much extra cash on hand. You can use a brokerage like Webull, and they’ll give you two free stocks when you deposit at least $100, which will immediately give you a return on your investment.
And even though you may not think it’s worthwhile to invest $100 or something like that, any amount of money you can get into the stock market is going to be a good start. It’s hard to predict how the market is going to perform at any particular time, and you might be able to contribute more in some months than others, but say you put in just $100 per month for ten years. That works out to $12,000 in total.
With a $100 monthly contribution over ten years, and let’s say your investments gain an average of 7% per year, you’re going to end up with more than $20,000 at the end of those ten years. In other words, you would have gained almost $8,000 over that time compared to just keeping the money in cash.
Never underestimate the importance of taking that first step—even small contributions will add up over time if you’re able to make them consistently. So even if it’s just $50 or $100, it’s still a step in the right direction.
3. Should I Pay Off My Debts Before Investing?
Another really common question when it comes to investing is how high your investments should be on your list of priorities. So if you have some debt, and especially if you don’t have much in savings, you might be wondering how much progress you should make on those before you move on to investing.
Ultimately that decision comes down to the respective return on investment you expect to get from different options. If you have credit card debt that’s growing at 20% per year, then at least from a dollars and cents perspective that should be your top priority unless you have some other option that will give you a return of greater than 20%.
Keep in mind that when you pay off debt, you’re guaranteed to achieve that return, compared to what you would have been charged in interest. With investing, on the other hand, it’s not guaranteed at all. Furthermore, investment returns are usually taxed either upfront or in the future unless you never sell or do 1031 exchanges with real estate or something like that. But frankly, if you have high-interest debt, and I put high-interest debt as around 6% or more, I’d generally say focus on knocking out that debt fist or, even better, look at how you can refinance that debt at a lower interest rate.
Again, it’s impossible to predict how much an investment is going to return in the future. So I would generally say that credit card debt at 20% is more pressing than most types of investing. But with that being said, there are some notable exceptions to that rule, again depending on your specific situation.
For example, some employers either partially or completely match 401(k) contributions up to a certain limit. So maybe they offer a 50% match up to 6% of your salary. If you’re earning $50,000 a year, that means if you put $3,000 toward your 401(k) plan then your company will contribute an additional $1,500. That’s an immediately 50% return on your investment, and obviously a 50% return is a lot more than the 20% you’re paying on your credit card debt.
Of course, it isn’t always that simple—failing to pay off debt can lead to some other consequences. If getting your employer match means that you’re going to have to miss mortgage payments, it probably isn’t worth it because of all the risks that come along with getting behind on your mortgage.
On the other hand, if you’re in a situation where you can reliably manage that debt and at least make the minimum payments, you will probably get a better return through your employer’s 401(k) match then you would by making extra debt payments. Again I can’t speak to your specific situation, but I would say that you should at least wait to invest until you feel like you have your other financial obligations under control.
4. Should I Invest After the Next Market Crash?
If you’ve been following the economy recently, you probably know that the stock market had a really quick recovery after the initial coronavirus crash. A lot of people are worried that the economy still isn’t that healthy, so there’s a concern that we’re going to have another market crash in the near future.
OK, this makes sense on one level—unemployment is still up, eviction protections are running out, and it’s intuitive that those problems would lead to a bear market somewhere down the line. And if you’re thinking about investing, then you might be thinking you should wait until the market goes down so that you avoid taking any losses during a future crash.
I can’t tell you what the market is going to do, so I can’t necessarily say when the right time to invest is, but what I can tell you is that timing the market rarely works out. So to be clear, it’s entirely possible that there will be a huge market crash in the near future. But even then, the problem is knowing when to get in.
Let’s say the market drops 10%—do you get in then? What about 20%? You might buy too early and end up taking losses anyway, but you might also buy too late and miss out on the upswing. So it’s not as simple as, “Oh, I’m going to wait until the market crashes and then buy.” It just doesn’t work like that practically.
In fact, timing the market is probably the single biggest mistake among new investors. If you haven’t invested much before, you might think that you can invest at the right times by following the news or something like that. And of course, it might work out for you this time—as I said, there’s always an off-chance that you’ll pick the perfect time.
Unfortunately, the reality is that it’s extremely difficult to time the market successfully over any significant period of time. And even if you’re better than average, you’re still going to come out behind compared to what you would have earned by ignoring market timing and just making consistent investments. Better yet, you can just automate your investments, and then any time you would have spent trying to figure out the market can go into a side hustle or something else that’s actually going to earn you money.
Consistently putting money into the market at regular intervals is called dollar-cost averaging. The basic idea is that the best way to maximize the value of your money is to spread out your contributions equally over time. So if you’re able to contribute $500 per month to your portfolio, you should make that contribution on the same day of the month and try to stay as consistent as possible.
Yes, there are always going to be bad months where you would have been better off to have waited until the next month. On the other hand, there are going to be even more good months that make up for those losses. This strategy is also a lot simpler, and it will help you get started if you’re still waiting for the market to drop. I would actually say that you shouldn’t even look at your portfolio value very often. You don’t want to get caught up on whether the market is up or down on any particular day, you want to stay focused on the long-term trends and goals that you’re really investing for.
5. Should I Try to Avoid Risk?
One of the most common things you’ll hear is that investing is risky, and that’s true. But you’ll also hear that you shouldn’t invest because of how risky it is, and that definitely isn’t true.
It’s important to understand what risk means in the context of investing. There are times when it’s good to avoid risks, and there are times when it makes sense to take on a higher level of risk in order to give yourself a potentially greater reward.
Now when you’re investing over a short period of time, the kind of risk that you need to worry about is different from the risk you would be concerned about if you were investing for the long run. So someone who’s investing to earn money for next year is going to invest very differently from someone who’s investing for retirement 30 years down the line.
These are called time horizons, and the first thing you need to do when you’re putting together an investment strategy is figure out what kind of time horizon you have in mind. If you’re 45, and say you want to retire at 65, your time horizon is going to be at least 20 years, and some of that money will have an even longer horizon since you won’t be withdrawing it all as soon as you retire.
And if that’s your situation, you should really be thinking about how you can put yourself in a position to get the best possible results over 20 years. So I don’t want to get too deep into the specific examples here, I’ve talked about this more in other videos and articles, but the point is that the risk of a market crash or something like that is much greater if you’re planning to pull your money out in the near future. Think of it like this—if stock prices fall tomorrow and you need the money next week, you’re going to be in trouble. But if you don’t need the money until 2040 or 2050, then you don’t really need to be worried about where the market is in 2020. So there’s a lot more I could say on this topic, but I want you to at least take away that risk isn’t necessarily good or bad—it depends on what you want to get out of investing.
6. Should I Pay for Professional Management?
Investing is obviously a complicated topic, and if you don’t have much experience then it’s easy to feel like you don’t know the best way to invest your money. So a lot of people in that situation feel more comfortable paying a professional portfolio manager or financial advisor, and that might work for some people. But in general, and especially if you’re like me and you don’t have a net worth in the multi-millions. then I would recommend against paying extra money for someone to give you investment advice or invest your money for you.
What this question really comes down to is whether the fund manager can generate good enough returns to make up for whatever they’re charging you. The problem is that you can find index funds that just passively track the market and only charge a few hundredths of a percent in fees. On the other hand, a professional manager might charge closer to a full percent, which is going to cut into your earnings.
This is just me, but personally I like my odds of coming out ahead by just tracking the market and getting those long-term gains while losing as little as possible to investment fees. I don’t want to tell you that paying for a portfolio manager is a bad idea, there’s definitely some peace of mind that comes with letting them handle those investment decisions, but at the same time every investment has risk and it’s extremely hard to beat the market consistently.
7. Will Investing Make My Taxes Complicated?
OK the last thing I want to bring up is how and when investments are taxed, and as a CPA this is a question I hear a lot. You might have heard of capital gains tax, and that comes up when you sell after your assets have gained value, but you might also need to pay other taxes even in years where you don’t sell at all from cash flow.
So dividends, interest from bonds and savings accounts, rental income and losses are going to be reported as income on your tax return. And you will be taxed on that income whether or not you withdraw the money from your account.
If we’re talking about stocks, your brokerage will send you a nifty little packet after the beginning of the year with your 1099-dividend. That tells how much you earned in dividends during the year. They’ll also send you a 1099-B, that covers the proceeds of your stock transactions, and it’s usually accompanied by a gain and loss statement.
Fortunately, these are all pretty easy to work with and input in your tax return software. If you’re concerned about that process, don’t worry—I’ll be posting some walkthroughs in TurboTax or other tax softwares on my Youtube channel as we get closer to tax season.
So taxes on investments aren’t really that complicated once you learn a little about them. And even if you do your own taxes, you shouldn’t have any trouble accounting for your investments and making sure they’re accurately represented on your taxes.
In fact, it will probably take longer to calculate income in situations where you have to come up with the numbers yourself. If you have rental income or rental expenses, you’re going to have to do some bookkeeping, get your depreciation correct, all that accounting, but if you’re only investing in stocks or bonds or something like that then you should be just fine with your tax software.
An important point to remember is that the capital gains tax works differently depending on whether you held the asset for at least a year until selling. If you buy bonds or stocks and sell them within a year, any gains are going to be taxed at your ordinary income rates. For example, say you buy $1,000 in stocks, they grow to $1,100 in value in just a few months, and you’re happy with those returns so you’re ready to cash out for a gain of $100. That $100 will be added directly to your taxable income, which means you’ll be responsible for paying taxes on them based on whatever tax bracket you’re in.
Now what’s complicated here is that the tax rules change once you hold onto those assets for more than a year—at that point, they’ll be taxed at the long-term capital gains tax rate. But, if you can bring down your overall taxable income, you can actually avoid the long-term capital gains tax entirely. So this is going to include the capital gains themselves, but you’ll also be able to take advantage of some deductions. And if your taxable income is lower than about $40,000 for single filers, or about $80,000 if you’re married and filing jointly, then your long-term capital gains are taxed for federal purposes at 0%. Yes, you might still owe for state taxes, but Uncle Sam won’t take a piece.
And even above that, the long-term rate is just 15% up to an income of $500,000 dollars a year. That being said, I would rather you not pay any taxes at all on your appreciated stocks. Why pay taxes at all, right? Just hold on to them if you can, if you think you made a solid investment in a good company. I’ll probably do a dedicated video on capital gains at some point in the future, but I think that’s a fine summary for now.
All right everybody, thank you for reading, hopefully this cleared up some questions you had about investing and you feel a little more comfortable with these topics. If you’d like more information on investing, be sure to check out my video on investing for beginners where I cover some of these ideas in a little more detail. Thanks again for reading, make sure to leave your thoughts in the comments, and I will see you next time.
Logan is a practicing CPA and founder of Choice Tax Relief and Money Done Right. After spending nearly a decade in the corporate world helping big businesses save money, he launched his blog with the goal of helping everyday Americans earn, save, and invest more money. Learn more about Logan.