The Basics Of Understanding Investing

What exactly is investing?

The definition of the word ​invest is:

to commit (money) in order to earn a financial return - Merriam-Webster

Further, an investment ​is:

the outlay of money usually for income or profit : capital outlay - Merriam-Webster

The purpose of investing is to make an initial purchase of something (the outlay) in hopes of income our profit in the future. The income or profit is typically assessed as a return on investment (ROI) and could come in the following forms:

• Dividends - such as owning a stock that pays monthly or quarterly dividends to you for owning that stock
• Interest Payments - payments you receive at a fixed rate typically agreed upon when you initially open the account or lend the money
  • Bonds, Money Market Accounts, Bank Accounts, CD's (technically a dividend but taxed like ordinary income)
• Capital Gains - the profit generated from the sale of a property/investment - dictionary.com

How can you start investing?

There are actually many ways you can begin investing but perhaps the simplest and most common way is investing in the stock market, online. 

Whether you choose to begin with automated savings to a retirement plan with your employer, or elect to manually make deposits into your savings and investing account, you first need to identify if you will "do it yourself" or utilize a professional money manager. Doing it yourself can save a significant amount of money over time, but if you are not willing to learn and study about investing and finances, consider hiring a professional. 

Here are some types of accounts where you can invest in the stock market:

• Employer retirement plans (401(k), 403(b), etc.)
  • Contact your HR department at work and ask about what forms/information needed to set up this account
  • *NOTE: If your company offers a matching contribution, I strongly advise you contribute whatever amount gives you the maximum matching contribution, otherwise you are leaving "free money" on the table from your employer. I would ask my employer "How do I get the maximum matching contribution from our company?".
• Roth or Traditional IRA's
  • Just call or visit Fidelity or Vanguard's website (you can pick whatever company you want) and follow the steps for setting up an IRA and link your bank account. It really is that simple.
• Taxable Brokerage accounts - Again, you may choose whatever company you want.

With all of the accounts listed above, I like to purchase low cost index funds in either a Roth IRA or 401(k)/403(b) plan due to the tax advantages of retirement accounts. Many in the financial independence community also utilize retirement plans to purchase low-cost index funds due to the specialized tax treatment for retirement accounts. Ultimately, the decision is yours. 

For traditional 401(k) and 403(b) and traditional IRA plans, you may be able to lower your current taxable income, but note that you will still have to pay tax later on withdrawals once you retire (based on age 59 1/2 or older for these types of accounts). This "tax break" occurs by notifying the IRS that you set money aside to these tax-advantaged accounts, thereby lowering the amount the IRS can tax you on. With traditional accounts, there is also required minimum distributions (RMD's) starting at age 70 meaning you have to take out at least some money, even if you do not wan to. Keep in mind that their are income limits for these tax breaks so if you are a high earner, find out what income level phases you out of these tax advantages. 

For Roth 401(k)/403(b) plans and Roth IRA's, you get to withdrawal the money in retirement tax-free (typically starting at age 59 1/2). The downside is no "tax break" now like the traditional accounts offer outlined above. 

Be advised that there are limits to the amount of annual contributions you can make to these types of accounts. Visit IRS.gov for present year contribution limits for all types of accounts. 

In Closing

By no means is this investment advice nor is it designed to be a comprehensive outline of the entire investing world. 

The most common problem remains that most people get scared off by the "complexities" of investing. In reality, as highlighted above, getting an account open to start investing is actually quite simple. After your account is open and you put in your first small sum of money, then you can consider yourself a beginner investor. Realize that over time, you will fill in the gaps in knowledge just by having an account and asking questions (and making a few mistakes along the way).


Leave a comment below on how you feel or felt about first entering the "investing world".