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How to Make Money in Stocks

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone and is not intended to be a source of investment advice. It may not have not been reviewed, commissioned or otherwise endorsed by any of our network partners or the Investment company.

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Investing in stocks is one of the best steps you can take toward building wealth. To make money in the stock market, you need to give your investments time to compound interest and appreciate in value, as well as make sure to diversify your holdings and invest on a regular cadence.

This article covers everything you need to know about how money is earned by purchasing stock market holdings, and what you can do to maximize the gains you make.

How can you make money in stocks?

The way the stock market works — and works for you — is as simple as a high school economics class. It’s all about supply and demand, and the way those factors affect value. Investors purchase market assets like stocks (shares of companies), which increase in value when the company does well. As the company in question makes financial progress, more investors want a piece of the action, and they’re willing to pay more for an individual share.

That means that the share you paid for has now increased in price, thanks to higher demand — which in turn means you can earn something when it comes time to sell it. (Of course, it’s also possible for stocks and other market holdings to decrease in value, which is why there’s no such thing as a risk-free investment.) Historically, the average rate or return for the stock market has hovered around 10%.

Along with the profit you can make by selling stocks, you can also earn shareholder dividends, or portions of the company’s earnings. Cash dividends are usually paid on a quarterly basis, but you might also earn dividends in the form of additional shares of stock.

5 best practices to invest in stocks and make money

You likely won’t see serious growth without heeding some basic market principles and best practices. Here’s how to ensure your portfolio will do as much work for you as possible.

1. Take advantage of time

Although it’s possible to make money on the stock market in the short term, the real earning potential comes from the compound interest you earn on long-term holdings. As your assets increase in value, the total amount of money in your account grows, making room for even more capital gains. That’s how stock market earnings increase over time exponentially.

But in order to best take advantage of that exponential growth, you need to start building your portfolio as early as possible. Ideally, you’ll want to start investing as soon as you’re earning an income — perhaps by taking advantage of a company-sponsored 401(k) plan.

To see exactly how much time can affect your nest egg, let’s look at an example.

Say you stashed $1,000 in your retirement account at age 20, with plans to hang up your working hat at age 70. Even if you put nothing else into the account, you’d have over $18,000 to look forward to after 50 years of growth, assuming a relatively modest 6% rate of return. But if you waited until you were 60 to make that initial deposit, you’d earn less than $800 through compounding — which is why it’s so much harder to save for retirement if you don’t start early. Plus, all that extra cash comes at no additional effort on your part.

2. Continue to invest regularly

Time is an important component of your overall portfolio growth. But even decades of compounding returns can only do so much if you don’t continue to save.

Let’s go back to our retirement example above — only this time, instead of making a $1,000 deposit and forgetting about it, let’s say you contributed $1,000 a year (this comes out to less than $20 per week).

If you started making those annual contributions at age 20, you’d have saved about $325,000 by the time you celebrated your 70th birthday. Even if you waited until 60 to start saving, you’d wind up with about $15,000 — a far cry from the measly $1,800 you’d take out if you only made the initial deposit.

Making regular contributions doesn’t have to take much effort; you can easily automate the process through your 401(k) or brokerage account, depositing a set amount each week or pay period.

3. Set it and forget it — mostly

If you’re looking to see healthy returns on your stock market investments, just remember — you’re playing the long game.

For one thing, short-term trading lacks the tax benefits you can glean from holding onto your investments for longer. If you sell a stock before owning it for a full year, you’ll pay a higher tax rate than you would on long-term capital gains — that is, stocks you’ve held for more than a year.

While there are certain situations that do call for taking a look at your holdings, for the most part, even serious market dips reverse themselves in time. In fact, these bearish blips are regular, expected events, according to Malik S. Lee, certified financial planner and founder of Atlanta-based Felton & Peel Wealth Management.

So-called market corrections are healthy, he said, not that “it shows that the market is alive and well.” And even taking major recessions into account, the market’s performance has had an overall upward trend over the past hundred years.

4. Maintain a diverse portfolio

All investing carries risk —  it’s possible for some of the companies you invest in to underperform, or even fold entirely. But if you diversify your portfolio, you’ll be safeguarded against losing all of your assets when investments don’t go as planned.

By ensuring you’re invested in many different types of securities, you’ll be better prepared to weather stock market corrections. It’s unlikely that all industries and companies will suffer equally or succeed at the same level, so you can hedge your bets by buying some of everything.

5. Consider hiring professional help

Although the internet makes it relatively easy to create a well-researched DIY stock portfolio, if you’re still hesitant to put your money in the market, hiring an investment advisor can help. Even though the use of a professional can’t mitigate all risk of losses, you might feel more comfortable knowing you have an expert in your corner.

If you’re looking for an expert to specifically help with your investments, it could be worth considering a financial advisor. Financial advisors focus on providing personalized advice on your investment portfolio, typically for a fee based on a percentage of assets under management.

Another lower-cost way to get a little guidance on investing is to use a robo-advisor. This can help you build a diversified portfolio and rebalance it when needed, often for a lower fee than a traditional financial advisor — though, of course, this service is digitally based, rather than provided through a human relationship.

3 common stock market mistakes to avoid

1. Trying to time the market

One of the most common mistakes that investors make is letting their emotions derail their long-term plans, by buying or selling stock based on movement in the market. However, as we noted earlier, investing in the stock market is a marathon, not a sprint. While it might be hard to sit tight when the market is plummeting, keep in mind that the stock market has always recovered from downturns.

Acting on emotion and buying or selling stock based on movement in the market — or trying to time the market —  is not a solid investing strategy. Instead, try dollar-cost-averaging, which is when you invest your money evenly and routinely over a longer period of time.

2. Picking the new, hot stock

Snapping up the buzziest new IPO might be tempting, and it can certainly make investing feel exciting. However, experts generally recommend against picking and choosing individual stocks to invest in — not to mention you should generally try to leave your emotions out of the equation.

As we mentioned earlier in this article, you should maintain a diversified portfolio, and that doesn’t include just the latest and greatest new stocks. To do this, a better bet might be to consider index funds, which are made up of a well-diversified mix of stocks and bonds that replicate the makeup of an underlying index.

This can be a simple and low-cost way to invest in a diversified mix of assets, as opposed to just cherry-picking individual stocks. This will ensure that you’re not overexposing yourself to any one area, and thus taking on too much risk.

3. Not respecting your risk tolerance

Another major mistake that new investors can make is not respecting their risk tolerance, and either taking on too much or too little risk. Your risk tolerance is based on an array of factors, like your time horizon and personal comfort level, and it should be the basis for the asset allocation of your portfolio.

If you take on too much risk, you can face big losses or be forced to cash out of the market too soon. On the other hand, play it too safe, and you can miss out on compounding gains. A key to making money from the stock market is figuring out your risk tolerance, and then abiding by it.

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How to Set Up Your 401(k)

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone and is not intended to be a source of investment advice. It may not have not been reviewed, commissioned or otherwise endorsed by any of our network partners or the Investment company.

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Thanks to its high contribution limits and automatic, straight-from-your-paycheck deferrals, a 401(k) is an excellent way to build a sizable nest egg over time. But before you get that ball rolling, you’ve got a little bit of homework to do. In this post, we’ll walk you through how to set up a 401(k) and go over all the nitty-gritty details so you understand exactly where your money is going.

What is a 401(k)?

First things first: What is a 401(k), anyway?

Like IRAs, 403(b)s and other retirement accounts, a 401(k) is an investment account specifically designed to help you meet your savings goals for retirement. It’s governed by certain rules and regulations set up by the IRS.

So what sets the 401(k) apart from the rest of the alphabet soup? Well, for one thing, it’s sponsored by an employer — which means it’s available only to those who work for a company that offers a 401(k) as part of its suite of benefits. (There is such thing as a solo 401(k), but it’s offered exclusively to sole proprietors and business owners without any employees.)

A 401(k) allows you to make contributions, or deferrals, by setting aside a portion of your employee wages, usually measured as a percentage of your total pay. Deferrals with traditional 401(k)s are tax-deductible, meaning they won’t count toward your total taxable income for the year. Employers also can make contributions to your 401(k), which they often do in the form of a percentage match — something we’ll go over in more detail in the next section.

A 401(k) is one of the most common types of retirement accounts available to employees. Ask someone in the human resources department if you aren’t sure whether your company offers a 401(k).

What to ask your boss about your 401(k) plan

So you’ve ascertained that your company does, in fact, offer a 401(k). That’s great news; however, not all 401(k)s are created equal. Here are a few questions to ask HR or your boss about your new 401(k).

When will I be eligible to contribute?

Even if your company has a 401(k), you might not be able to contribute immediately. There’s often a probationary period (about three months, on average) to ensure you’ll be a fit for the position before you’re allowed to start making deferrals.

Compound interest works its magic only when it’s given the benefit of time, which means you’ll want to start investing as quickly as possible.

Does your plan feature automatic enrollment?

Some companies automatically enroll their employees in their 401(k) plan, taking deferrals out of your wages unless you specifically instruct them not to. Your employer is required by law to give you the option to forgo participation or to change the amount of your paycheck that will be withheld.

Saving for retirement is almost always a sound financial decision, but if you’re paying off debt or dealing with some other financial matter, you may not be ready to make large deferrals right away. On the other end of the spectrum, you may want to contribute more to your 401(k) than the automatic enrollment stipulates. Either way, knowing how your plan works ahead of time will help you make informed, intentional decisions about your investments.

Do you offer a match?

As we mentioned above, one of the best parts of a 401(k) is its sky-high contribution limits. For the 2021 tax year, you can defer up to $19,500 of your wages, but the total contribution cap is a whopping $58,000 or 100% of your compensation, whichever is lower. So how does that difference get made up?

Your employer also can contribute to your 401(k) account, which is most commonly done through a percentage match. For example, your company may opt to match your elective contributions (the ones coming out of your paycheck) up to 4% of your salary. That means that for every dollar you defer up to that 4% mark, you’ll get another dollar added to the account by your employer.

Although employers also can help you max out your 401(k) through profit-sharing contributions or bonuses, a match is one of the best ways to ensure you’re getting the most out of your retirement plan.

Is there a vesting period?

So now that you know your company matches 401(k) contributions, the account is yours to keep, right? Not so fast — you’ll need to make sure you know when you’ll be vested.

“Vesting” means obtaining total ownership of your retirement plan, and, depending on your company’s policies, it may take several months, or even years, to get there.

For instance, you may be able to immediately make matched contributions, but you won’t be fully vested until you’ve spent six months with the company. If you leave the company (or are let go) before that six-month period is up, any employer contributions and capital gains will be forfeited. (You will, however, always own the money you contribute to the account.)

Companies may offer full vesting after a certain amount of time or vest employees gradually over an extended period. For example, you might achieve 20% vesting after two years of service, 40% after three and 100% after six. On the other hand, some companies offer full vesting immediately upon hire, so it’s worth inquiring about the vesting schedule of your plan.

Can I make Roth contributions?

You’ve probably heard of a Roth IRA — a retirement account that allows you to make taxable contributions today so you can take tax-free distributions later.

But did you know there’s also such thing as a Roth 401(k)?

If your company offers a Roth 401(k), it is possible to make contributions — and it’s a lot more common than you might think, according to Malik S. Lee, certified financial planner and founder of Felton & Peel Wealth Management. “Most employers’ plans have Roth 401(k)s, but a lot of people don’t know to ask for it or to look for it,” he said, calling the Roth 401(k) “a “hidden gem.”

As nice as it is to get a tax break today, tax-free retirement income is tempting, especially if you’re planning to reach a higher tax bracket by the time you get there. (Here are more details on the differences between Roth and traditional 401(k) plans.)

What’s the annual fee?

Whether it’s a third-party custodian or someone in-house, someone has to manage your 401(k) — and that’s not free. You must pay an annual administration fee simply to participate.

Learning exactly how much that annual fee will eat away at your nest egg is important. It may be expressed as a percentage, or an “expense ratio,” such as 1% of your assets under management. That 1% isn’t too bad when you have $30,000 or less invested, but when that number inches closer to a million dollars later on, you’ll feel its impact.

How much control do I have over my portfolio?

Because your 401(k) is set up by your employer, you may not have as much control over it as you would with a personal brokerage account.

According to FINRA, the average 401(k) offers between eight and 12 alternatives (or investing options), which you may or may not be able to access through a digital portal.

You may be limited not only in your investment choices but also in how often you can reallocate your assets. You might be able to change your investments as often as you want or as seldom as once a quarter, which is why it’s so important to seek clarification before you enroll.

How to set up your 401(k)

When it comes to the actual setup process, you’ll need to follow the instructions given to you by HR or your employer. In most cases, you’ll access an online interface, where you’ll be asked a variety of personal questions and questions about your investments. Here are a few you’ll probably encounter.

Which type of contributions will you make: Roth or traditional?

As we discussed above, you may have the option to make Roth 401(k) contributions. However, it’s important to note that if there’s an employer match, those funds will be deposited into a traditional account — which means you’ll still need to pay taxes on them when it’s time to take distributions.

What percentage of your income will you defer?

It’s always a good idea to sock away at least some of your income for retirement. The exact amount you should defer will vary depending on your personal financial landscape and goals.

If your employer offers a match, it’s wise to contribute at least up to that percentage unless you’re dealing with extensive debt or other mitigating financial circumstances.

Finally, be aware of the maximum contribution limit — which is $19,500 in elective deferrals for 2021 (with an additional $6,500 in “catch-up contributions” for those age 50 and over). Taking employer contributions into account, the limit is $58,000 per year. If you contribute more than the limit, the deferrals will count toward your taxable income — and be taxed upon withdrawal.

How will you allocate your assets?

Whether you have only a few mutual funds to choose from or an entire brokerage window, allocating your assets well is the key to weathering inevitable market fluctuations and coming out with the nest egg you need.

While we can’t offer specific investment advice, here’s how to research your investment options:

  • Look for low fees. You’re already paying an annual fee for your 401(k) account, so you want to keep other expenses, such as trading fees and commissions, as low as possible. Choosing investments with low expense ratios will keep more of your money in the market.
  • Research historical performance. Although nobody can predict the future, looking at how an asset has performed historically can be a good indicator of how it will continue to behave in the future.
  • You’ve heard it before, but we’ll say it again: diversify, diversify, diversify. The old adage about having all your eggs in one basket is true, so choose as many different types of assets as possible. You can buy different types of securities (such as stocks and bonds) and diversify their types (such as foreign or domestic companies, technology, and commodities). Doing so will help you avoid a catastrophic loss in the case of a crash or recession.

Your 401(k) is set up — now what?

Your contributions will automatically be deducted from each paycheck, so you won’t have to worry about making them manually. You’ll want to check your first pay stub to ensure the right amount is being deducted.

Remember: A retirement plan is all about the long haul, so don’t panic if things go south for a while or if you aren’t currently happy with your specific investments. You can always reallocate as your plan allows.

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401(k) Contribution Limits in 2021

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone and is not intended to be a source of investment advice. It may not have not been reviewed, commissioned or otherwise endorsed by any of our network partners or the Investment company.

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Contributing to your company-sponsored 401(k) is one of the easiest ways to make sure you’re set up when your golden years arrive. By starting early and maximizing your contributions, you’ll give yourself ample time to take advantage of the unique magic of compound interest — which, given enough years, can turn even modest savings into impressive cushions.

However, it’s important to remember that there are limits to how much you can sock away in a retirement plan, 401(k)s included. Furthermore, those limits have recently changed. Here’s what you need to know.

2021 401(k) contribution limits

Here’s a quick look at the IRS’ updated 401(k) contribution limits for 2021.

Type of Contribution

Limit Amount

Employee Contribution

$19,500

Catch-Up Contribution

$6,500

Employer Contribution

$38,500

Total Contribution

$58,000 or $64,500 with catch-up contributions

As you can see, the total contribution limit ($58,000) is broken down into different contribution methods, including elective deferrals — i.e., your own regular 401(k) contributions automatically taken out of your paycheck — as well as catch-up contributions and employer contributions, which are frequently made via an employer match program.

Let’s go over how each type of 401(k) contribution works in detail.

Employee contributions: the lifeblood of your 401(k)

The bulk of your 401(k) is likely to be made up of what the IRS calls “elective deferrals” — the percentage or dollar amount you contribute to your 401(k) from your wages each pay period.

Note that 401(k) contributions can be made either pre-tax or post-tax, depending on what kind of account you have. In a traditional 401(k), your contributions are tax-deductible and won’t count toward your taxable income for the year in which you make them. They will, however, be taxed when you withdraw them later.

In a Roth 401(k), on the other hand, your contributions will count as taxable income but won’t be taxed when you take them out. Furthermore, Roth 401(k)s are not subject to the same required minimum distribution rules as their traditional counterparts, said Malik S. Lee, a certified financial planner at the Atlanta-based Felton & Peel financial advisory firm.

“Most employers’ plans have Roth 401(k)s, but a lot of people don’t know to ask for it,” said Lee. Roth 401(k)s are “one of the hidden gems” you might find in your onboarding documentation, so be sure to read your paperwork carefully.

How employer contributions can maximize your stash of cash

Maximizing your 401(k) is the best way to rest assured you’ll be set when the time comes for retirement. In most cases, the easiest way to do that is to take advantage of your employer’s 401(k) match.

A match program works exactly as advertised: Your employer will “match,” dollar for dollar, the money you put into your 401(k) up to a certain percentage of your income, generally between 3% and 6%.

That might not seem like much, but it’s money. Given the incredible power of compound interest, that small match can work out to a lot of money over time.

For example, let’s say you were making $50,000 and contributed 5% of your salary toward your 401(k). That works out to an annual contribution of $2,500. Now let’s say your employer matched up to 3%, which works out to an additional $1,500. You’ve just bumped your contribution from $2,500 to $4,000 — almost doubling your savings with zero additional effort. Pretty cool, huh?

Your employer also can make contributions outside of a matching program. For instance, the company might contribute a percentage of your overall salary regardless of how much you elect to pay in or a percentage of its annual profit. You have less control over these contributions, but they add to your total and count toward the limit.

Catch-up contributions: are you eligible?

If you’re age 50 or over, you’re eligible to make “catch-up contributions,” which means you can electively defer an additional $6,500 per year without incurring any tax penalties.

If you got a late start saving for retirement or were unemployed — and therefore unable to contribute to your 401(k) for a while — it makes good financial sense to make catch-up contributions to maximize your retirement savings.

However, if you’ve been steadily saving and already have a significant nest egg built up, it might make more sense to seek out alternative investment options, which can diversify your overall portfolio, said Lee. A financial advisor with fiduciary responsibility can help you decide which option is best for your personal goals.

What happens if you go over the limit?

Given the generosity of the 401(k) maximum contribution limit, it’s rare to exceed it. In fact, Lee said he hasn’t seen this financial faux pas happen in his career.

Although saving too much for retirement might sound like an oxymoron, if you do somehow exceed the limit, the tax benefits that make these accounts so powerful will stop working in your favor. In fact, you’ll be penalized by paying taxes twice: The excess contributions will count toward your taxable annual income, and they’ll be taxed when you withdraw them.

If you do overshoot the contribution limit, you should ask your account custodian to withdraw the excess amount by April 15 of the following year. Because it’s done to keep your account within the IRS guidelines, this money will not be subject to the 10% early withdrawal fee you would incur otherwise. It’s important to keep in mind, however, that any income earned on the excess deferral will be taxed as regular income.

Contributing to your 401(k) is an important step to take toward a well-deserved rest after a fulfilling career. Be sure to stay within the contribution limits to maximize your returns and minimize your taxes.

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