A Basic Introduction to Investing
By Christine Schmidt
At the start of this year, we discussed and emphasized the importance of being good stewards with our money, using what we are entrusted with purposefully and wisely. Breaking down how to do this practically, we have been exploring the various accounts and categories that people typically put their money towards: bills, saving, investing, protecting, and charitable giving. The previous two articles discussed some strategies for saving and its place within the big picture of our personal finances. The next couple of months we’ll be focusing on the second category: investing. While investing can be intimidating for beginners, it is a great way to grow your money toward certain goals, as well as make a significant societal impact!
Most people are unfamiliar with stock markets and what they are used for. The media is especially detrimental in portraying the stock market negatively and influencing the public into being fearful of the market; they encourage people to purchase when the stocks prices are climbing and when the market prices decline to sell those same stocks. Because of this, people are led to believe that the market is unstable, has drastic fluctuations, and that only those who are knowledgeable, well-connected, or wealthy can profit from investing.
Unfortunately, these attitudes are reflected by the fact that only 14% of the population has money in the market outside of retirement vehicles. Of that 14%, the majority are the top earners in the country, meaning the average citizen has little-to-no money invested. This can be problematic for an individual’s personal financial wellbeing, as well as the national community’s wellbeing. Having a proper understanding of the stock market and where they fit into personal and communal stewardship, however, can be a remedy to these depressing statistics. To begin, we’ll explore what investing in the market is, as well as what it is used for.
Why Investing is Important for Personal Finance
In February, we talked about discerning what your money was going to do for you. Is there something you need versus want? What is the timing on that item or experience you’re working towards? By defining goals, one is better able to discern how to save money. However, not everything is a short-term goal nor an emergency. Some goals happen later in life, sometimes five to fifteen years down the road, such as a big vacation, a new home, or even retirement. While money may be saved away in one of the savings accounts mentioned before, this is not always the best way to prepare for these longer-term goals.
While savings accounts are liquid, they have noticeably low interest rates for keeping your money in them long-term. While this is good if you want to be assured of your money, it is not best utilized for things you want in the future. This is because of inflation. For those of us that can remember, think back to your teenage years when you went to grab a coffee or pretzel at the mall with your friends. Ten years ago, these items were only two or three dollars. Now, going to coffee with friends is more expensive, costing four, five, or six dollars for that same treat. This is because, over time, money loses some of its purchasing capabilities, and more of it is needed to buy the same product.
For example, if you were planning on purchasing a home in the future and you saved the amount of money currently needed to make a down payment on a house, when you were finally ready to make an offer you would need more money to be a viable applicant. In this situation, there are two options to move forward: save even more money so you can still make the purchase or put away the money needed today to purchase the home into an account that keeps pace with inflation. In a few moments I shall explain more about what kinds of accounts these are. This is where the market is best utilized. Being cognizant of your goals allows you to be a better steward of your income since you are setting yourself up for future success––allowing you to take care of yourself, but also for greater flexibility with helping others.
Defining & Understanding the Stock Market
During the recent GameStop situation, it became apparent that the stock market is widely misunderstood. Simply put, the market is a place where people may buy and sell shares of corporations. When someone buys a share it means they are an owner in a particular company. Although the market is technically a physical place––the New York Stock Exchange Building––most sales and purchases are made online.
One does not need to be a licensed financial professional to place the actual trades; you can do so by making a request through a third party. There are multiple ways to make this request: through investment companies, websites like Vanguard, or even using an app, like RobinHood. You can sell / purchase either individual stocks in one or more companies, or sell / purchase mutual funds.
Mutual funds are the best way for someone to invest if they do not have much money to spend each month, such as a young professional who is just starting out in a career. Say she would like to use her monthly budget of $150 to purchase and own stock in well-rated stocks like Google or Apple. Unfortunately, today one share of Google costs around $2,000, which is out of the young professional’s budget. Mutual funds are her solution since the fund manager will pool people’s money together to buy a variety of stocks and fractionally split the shares amongst the participants. Because she paid part of the cost of owning the stock, she will have a partial ownership of and be a shareholder in a stock such as Google, while sticking to her budget. Additionally, another benefit for our young professional is that she is able to own multiple companies’ shares; so even though she is only putting aside $150 per month to invest, she is well diversified (all her eggs are in different baskets, to borrow a colloquialism).
Being an owner in an institution gives you certain rights. Some of these rights can include voting on what the company supports or the direction a company will go; other rights can include participating in the company’s profits. If you have the right to share in company profits, then you will receive dividends as well. All of these benefits, when utilized well, can influence the greater community, which we will discuss in depth in the next article.
The Accounts Used for Investing: Understanding Non-Retirement & Retirement Accounts
There are different accounts within the brokerage world in which people can use to invest. While there are rare instances when you can buy stock directly from a company, one usually needs to have a brokerage account to purchase stock. Like bank accounts, brokerage accounts ensure that you are a legitimate user, as opposed to someone using the stock market for illegal or terrorist purposes (per PATRIOT Act requirements). Brokerage accounts come in two main forms: retirement and non-qualified accounts.
These accounts are made to buy and sell shares of companies or mutual funds. Money may be placed in these accounts in order to trade, or transferred out into a bank account in order to be used.
Most people invest in one of these two ways, either for retirement or to utilize the stock market with intentions of using the money before retirement, in a joint or single “non-qualified” account. The major difference between these two umbrella categories are the rules for taking the money back out and tax incentives. Since retirement accounts are for post-working years, the money may only be withdrawn without a 10% percent penalty if one is 59 ½ or older, whereas joint or individual accounts are able to have money withdrawn anytime, even the next day, without a penalty. Therefore, it is most beneficial to have one of each.
There are a few things to keep in mind when figuring out which account to use. First, what goal are you using an investment account for? The answer to this question decides which kind of account you will use––either one for retirement or one for future goals, prior to retirement. Many young people have nearly 20-30 years before they retire, but have goals that they are working towards prior to ending their career.
Retirement Accounts:
Traditional Accounts; including but not limited to 401k, 403b, SIMPLE, SEP
This account is meant to save money for your retirement years when you will not be making a steady income. You may save money in this account up to a certain limit each month and year, and during the time you waited to withdraw it would grow, keeping pace with inflation. The money becomes available to be withdrawn without penalty at age 59 ½ , and required minimum distributions would begin at age 70.
Roth Accounts: including but not limited to Roth 401k, Roth 403b
Like the traditional accounts, Roth accounts are used to save for retirement. Unlike the traditional accounts, however, Roth accounts are taxed immediately. While this means that there would be taxes paid the same year you contributed, it also means that, at retirement, funds may be withdrawn without paying taxes, including the growth due to inflation. Currently, many people take advantage of this option since it means that the additional funds accumulated would not be taxed. Additionally, many of those who use these accounts find that the tax rates today are exceptionally low, and would prefer to pay the amount indicated for this year instead of risking a potentially higher rate further down the road.
Non-Retirement Accounts
Individual (Non-Qualified) Accounts:
An individual account, while still allowing you to purchase and sell stocks and mutual funds, differs from a retirement account in a key way. While retirement accounts have limitations on how much you may contribute each month and when you may access the funds without penalty, the individual accounts have no limits and you may access your money daily without penalty. This allows you to continue to take advantage of the market and use those funds to accomplish your future goals, such as buying a home or paying for a wedding. You use after-tax dollars, and when you withdraw funds you only have to pay taxes on growth above what you put in.
Joint (Non-Qualified) Accounts:
These work the exact same way as individual non-qualified accounts; the only difference is how many people are on the account and have access to the money and the ability to buy / sell.
Put to Use:
For the single young professional with $150 to invest each month, there are several possibilities for her to invest her money. If her work does not provide a retirement account, she may want to look into creating an Individual Retirement Account, where she saves for her future. Monthly, she can choose to allocate $75 to her retirement account, knowing that she cannot use that money until she reaches retirement, and $75 to her individual non-qualified account, which she can access anytime and use when she has a goal she would like to fund.
Just like savings, investing is an important part of personal financial stewardship. By having forethought with your potential goals, we are able to use our income to its fullest ability. Since it is inevitable that inflation and time will cause cost increases, investing allows us to better prepare. The market, when understood properly, becomes a useful tool to accomplish this, since it will keep pace with inflation.
Though the media may say otherwise, the market is for everyone and doesn’t need to be avoided. By utilizing these different accounts for investing, we may be better able to accomplish whatever goal we have in mind, be it long-term or retirement. Being intentional with our money will give us the ability to approach our goals with less stress and more hope, allowing us to be more present to those around us, be it friends, family, or those we serve.
