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Dollar Cost Averaging: 9 Things You Need to Know

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

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Dollar cost averaging is a simple strategy that can increase your investment returns and reduce your risk. With this method, an investor purchases equal dollar amounts of an investment regularly over time instead of putting a lump sum of money into the market at once.

Using this strategy minimizes the chance of buying at a high point and can help lower an investment’s average purchase price, increasing an investor’s overall return. Here’s how dollar cost averaging works and nine things you need to know about it.

1. It can protect you against market fluctuations

Perhaps the biggest advantage of dollar cost averaging is the fact that it puts the stock market’s natural fluctuations to work for you.

If you buy in a large lump sum and mistime the market, it can be a long climb out of the hole. But by spreading out your purchases over time, you could avoid putting all your cash in at the top of the market and likely will buy some shares at a lower price. This can reduce your risk and help you buy at an average value over the period of your purchases.

2. Dollar cost averaging can keep you from making emotional decisions

If you commit to dollar cost averaging — buying regularly regardless of the market’s performance — you’ll avoid a temptation that hurts many investors. Some become fearful when the market drops and don’t buy, but when the market rises, they start buying again.

In the end, they pay a higher price than they ought to. Rather than trying to make decisions as the market fluctuates, commit to a regular schedule of purchases and take the emotion out of it.

3. It works best in a falling market

Dollar cost averaging often helps you achieve a lower price for your position. While the strategy really shines when the market’s falling, it can help lower your risk in all markets.

For example, let’s say you buy 100 shares of a $10 stock in a lump sum for $1,000. Your cost basis is $10. If the stock falls to $5, you’re suddenly down $500. Even if the stock later recovers to $7.50, you’re still down $250.

With dollar cost averaging, you take advantage of this drop. Let’s say you split your buys into two $500 chunks. At $10 per share, you spend $500 and receive 50 shares. Then at $5 per share, you spend another $500 and receive 100 shares. Now you own 150 shares with a cost basis of $6.67 per share. When the stock recovers to $7.50, your investment is now worth $1,125 and you’ve made a profit of $125, even though the stock has only partially recovered.

In a flat market, a lump-sum approach and dollar cost averaging produce nearly the same profit, but the investor had to have more money in the market and so took more risk. Meanwhile, the investor using dollar cost averaging had less money in the market, took less risk and had the potential to take advantage if stocks fell.

Even in a rising market, with less money in the market at one time, dollar cost averaging reduces your risk, though it will cost gains that you could have had with a lump-sum approach.

4. It’s a long-term strategy

Dollar cost averaging forces you to think long term. When you’re buying a stock, you want it to be as cheap as possible, and that means hoping for it to go lower before it finally goes higher.

At lower prices, you’ll buy more shares, so when the stock does rise, your gains will be even greater. But you have to think long term and be willing to stomach short-term losses and consider them great buying opportunities.

5. Beware the trading costs

Dollar cost averaging can run up trading costs if you don’t carefully manage how often you’re buying and how many securities you’re using this strategy for.

Purchasing just one or two stocks or funds? You’re probably all right. But pay attention to how often you’re buying. For most people, buying weekly is too much; if you purchase too often, you won’t give the market enough time to move. Biweekly or monthly is a better option for most.

Plus, if you trade too often, fees will eat up money that could be put into stocks. Of course, if you’re using a free trading app, such as Robinhood, those extra trades won’t cost you anyway.

6. Dollar cost averaging makes the most sense for volatile assets

Dollar costs averaging generally makes the most sense for volatile assets because it takes advantage of and protects against price fluctuation. That means the strategy is ideal for stocks, stock-based exchange-traded funds and mutual funds.

It’s likely not a great fit for relatively stable securities, such as bonds or high-yield savings accounts, because they don’t move around as much. These stable assets will move, of course, but over a much longer time frame, so mistiming a purchase is less costly.

7. This method lowers risk, but you could miss out on returns

Dollar cost averaging is a great strategy for individuals and less sophisticated investors, but in a rapidly rising market, this approach is going to cost you. In a rising market, a lump-sum purchase would have worked out better. But that requires timing the market correctly, a risky approach that savvy investors usually avoid. And no one — not even the top professionals — knows which direction the market is headed.

Because of that, it’s usually best to limit your risk, avoid timing the market and take advantage of the market’s drops.

8. Dollar cost averaging can be done automatically

If your idea of a good time is watching the calendar for the right day of the month to buy stock, then make your investments manually. For the rest of us, find a brokerage that’s able to automate the process so you can spend more time on the things you enjoy.

You can set up your account to buy on a preset schedule, and all you’ll have to do is make sure the money is available. Even easier, many brokerages can pull the money right from your bank account.

This automatic approach is great because it keeps your emotions out of the investing process. Instead, set it and forget it.

9. This strategy is the norm for 401(k) programs

Do you contribute regularly to a 401(k) program and invest your contribution in the market? Then you’re already using dollar cost averaging. You’re using the power of automatic investing to continue buying even when the market dips and keeping your emotions out of the decision-making process. It’s the way to be pleasantly surprised when you check your account balance.

Dollar cost averaging doesn’t always lead to maximum gains, but it works well in many situations and can help protect your portfolio from bad outcomes. And because it’s a formulaic purchasing plan, it’s even better for beginning and intermediate investors who don’t want to spend their time thinking about how and when to invest.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

James F. Royal, Ph.D.
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James F. Royal, Ph.D. is a writer at MagnifyMoney. You can email James here

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Investing

What Is After-Hours Trading, and How Does It Work?

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

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Are you interested in trading stocks? If you pay attention to financial media, chances are you’ve heard that “the market moved lower in after-hours trading” at some point. While the stock exchanges might be closed, that doesn’t mean trading isn’t happening — and you might be able to profit as a result.

Here’s what you need to know about trading in the hours after the market is “closed.”

How after-hours trading works

What is after-hours trading? Trading in the after-hours session is just what it sounds like: buying and selling stocks after regular market hours are over. The New York Stock Exchange (NYSE) has a “core” trading session on weekdays from 9:30 a.m. to 4 p.m. ET, as does the Nasdaq. However, investors can continue to make certain trades after the market closes for the day.

The Nasdaq allows for an after-hours session from 4 p.m. to 6:30 p.m. ET, and the NYSE’s Arca electronic communication network (ECN) has a late trading session from 4 p.m. to 8 p.m. ET. You also can find regional exchanges with their own after-hours trading.

Using ECNs for after-hours trading

Aftermarket trading makes use of ECNs that connect buyers and sellers. ECNs are used for trading currencies and options in addition to stock market transactions.

According to the Securities and Exchange Commission, ECNs are considered alternative trading systems. They are computer-based and can manage transactions based on the best bid and ask quotes. You place your order with certain parameters, and the computer automatically looks for something that matches — and then executes the trade.

In most cases, you still need to place orders through your broker in order to participate in after-hours trading in the stock market. However, thanks to the rise of the internet and technology surrounding investing, many brokers can accommodate after-hours orders.

Check with your online broker to see when and how to place orders after the market closes. For example, your broker might make you wait until 4:05 p.m. ET to start placing orders even though, technically, aftermarket trading has already started.

Limits on types of orders for aftermarket trading

Realize, though, that you can place only certain types of orders during after-hours trading. In many cases, you’ll find that you can request the following types of trades after the regular markets have closed:

  • Buy
  • Buy to cover
  • Sell
  • Short sale

However, many brokers require that most (or even all) of your orders be limit orders. There also might be additional limits as to the timing of placing and executing different types of orders. It’s important to understand your broker’s after-hours trading policies before you start.

Can you trade before the market opens?

After-hours trading often is finished by 8 p.m. ET. But what if you want to trade early in the day? For that, exchanges also offer premarket trading.

The Nasdaq offers premarket trading from 4 a.m. to 9:30 a.m. ET, while the NYSE offers an early trading session from 7 a.m. to just before 9:30 a.m. ET. However, the NYSE Arca has a session that starts at 4 a.m. ET. With the NYSE, you actually can enter orders and queue them up half an hour before the open of the early auctions.

Together, aftermarket trading and premarket trading are known as extended-hours trading.

Why people trade stocks during extended hours

The news doesn’t stop when the market closes, especially when you consider that market hours don’t coincide exactly with acknowledged business hours. You never know when a major economic event, report or other news will break. Extended-hours trading allows investors to move on the news quickly rather than having to wait for the market to open before making a move.

Additionally, not everyone is available to trade during the day. Like a bank branch that stays open late or opens early, extended-hours trading is more convenient for some investors.

It’s also helpful to technical traders who like to run their numbers on the final transactions of the day. Using that information, it’s possible to buy or sell immediately during after-hours trading, depending on the patterns they see at the end of the day.

Risks of extended-hours trading

Any type of investing comes with a level of risk — and that’s true of after-hours trading. Before you decide to get involved with extended-hours trading, it’s important to understand that there are downsides.

  • Lower liquidity: Not every equity is available during after-hours trading. Additionally, with fewer investors involved, it’s not always possible to find the trades you want. You might want to make a trade that involves 1,000 shares, but there might be only 800 available at that time. Without market liquidity to meet your parameters, your orders might not be executed.
  • Bigger spreads: With extended-hours trading, there’s a bigger difference between the bid price and ask price. As a result, you might have a harder time getting a good price on your transaction.
  • Higher volatility: Prices have the potential to fluctuate wildly during extended-hours trading. Because of lower volume and liquidity, it’s more likely that small pieces of news have outsize impacts.
  • Competition against bigger investors: Institutional investors have been engaged in aftermarket trading for much longer than individuals. Plus, they’re often bigger players with access to more resources. You’re directly matched against these investors, and it can be hard to compete when you’re an average investor.

Even with these risks, though, some investors find it worthwhile to engage in extended-hours trading. Carefully consider your own risk tolerance before you move forward.

Bottom line

After-hours trading can be a great way to boost your portfolio’s returns. It allows you to move quickly on news and events that take place outside normal trading hours, potentially giving you an edge.

However, there are risks associated with aftermarket trading, and it’s not suitable for all investors. If you decide to try extended-hours trading, make sure to use only money you can afford to lose and that it fits with your overall long-term investing strategy.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Miranda Marquit
Miranda Marquit |

Miranda Marquit is a writer at MagnifyMoney. You can email Miranda here

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Investing

Wondering How Much to Contribute to Your 401(k)? 8 Things to Consider

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

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It’s easy to overlook the details of your 401(k) plan when you start a new job — there’s the excitement of learning the ropes, bringing in a fatter paycheck and finding the quiet bathroom.

Unfortunately, neglecting your 401(k) contributions can have a serious effect on your future. That’s because the money you invest early in your career has decades to grow, so even the most modest contributions can become an impressive nest egg with compound interest.

Even if you’re aware that you need to contribute to your 401(k), it can be tough to decide how much, especially if you have competing financial priorities. Here are eight factors to consider when deciding how much to contribute to your 401(k).

1. Know the IRS limits on 401(k) contributions

Your 401(k) plan is a tax-deferred retirement account, which means you deduct your contributions from your annual income at tax time. This also is described as funding your account with pre-tax dollars.

Since Uncle Sam won’t immediately see any taxes on the money you set aside, the IRS sets 401(k) contribution limits to prevent individuals from using their 401(k) accounts as vehicles to dodge taxes on large sums of money. In 2019, the employee contribution limit is $19,000 for participants who are under age 50.

If you are in a position to afford a $19,000 annual contribution, you should plan to send $1,583 per month ($19,000/12 = $1,583) to your 401(k) and call it day. If you’re a mere mortal with bills to pay, you’ll need to use other strategies to maximize your 401(k) contribution.

2. Take advantage of company matching

Many employers offer to match 401(k) contributions up to a certain amount. For instance, your company might offer to match 50% of your contributions up to 6%. This means that if you contribute 6% of your salary to your 401(k), your company will put in 3%, giving you 9% in total contributions.

“Your first goal should be to contribute enough to get the company match. This can be difficult if you’re just starting out, but saving has to be a little bit painful,” explained Jim Blankenship, a certified financial planner and the principal of Blankenship Financial Planning in New Berlin, Ill.

If contributing enough to reach the full company match is unaffordable, Blankenship recommended that you increase your contribution every time you get a raise or set up an automatic increase of 0.5% or 1% every six months. That will help you ease into contributing enough to get the match without feeling the bite all at once.

Another important thing to remember is that your employer’s contributions on your behalf don’t count toward your $19,000 contribution limit. Your employer may contribute as much as $37,000 to your 401(k) in 2019.

3. Contribution goals should not be static

It’s not a good idea to adopt a “set it and forget it” attitude when it comes to your contributions. “Your goals should evolve over time. Even if your initial goal is to get the full company match, you shouldn’t rest on your laurels once you get there,” warned Blankenship.

He recommended that you eventually max out the annual IRS contribution limits or put aside 20% of your annual salary — whichever is feasible. For instance, a worker earning $35,000 per year probably will not be able to afford the $19,000 401(k) contribution limit. However, setting aside $7,000 per year may be an achievable goal.

4. Make sure you understand vesting

While the company match is an excellent perk, it’s important to remember that the matching amount is not necessarily yours the moment it appears in your account. You will have to wait to be vested before you can consider that money yours in retirement.

In many cases, vesting is graduated over time. For instance, you might be vested in 20% of your company’s match after one year, 40% after two years and so on until you are 100% vested after five years of employment.

If you separate from the company prior to becoming 100% vested, then you will lose the nonvested amount. Unfortunately, this is true whether you quit, get fired or get laid off. The good news is that your own contributions are completely vested, so any money you personally put away is yours to keep no matter what happens to the company match or your employment status with the company.

5. 401(k) contributions are pre-tax

While you crunch the numbers to determine how much you can contribute to your retirement account, don’t forget that your take-home pay will not be reduced by the full amount of your contribution. Since your contribution is taken from your pre-tax salary, contributions effectively lower your annual salary, which means your tax withholding for each paycheck also will go down. So for each $100 you contribute to your 401(k), you’ll see less than $100 deducted from your take-home pay.

6. 401(k) vs. debt vs. emergency fund: how to prioritize

Most people have a number of competing financial needs, making it difficult to understand how to prioritize where your money goes. Should you build your emergency fund, focus on maxing out your 401(k) contributions or pay down debt to avoid losing money on high interest rates?

“Your top priority should be building an emergency fund of three to six months’ worth of unavoidable expenses,” said Blankenship. “Unavoidable expenses means true bare-bones minimum: rent or mortgage, car payment, utilities and groceries. You don’t need to recreate your usual monthly spending, just the amount you would need to get by.”

Once that is in place, Blankenship recommended paying the minimum amount on your debt to prioritize getting the company match on your 401(k). Credit card debt or other high-interest debt should take priority over student loan debt; however, you can work on paying down your debt while contributing to your retirement account.

7. Review the details of your 401(k) plan

How much you contribute to your employer 401(k) may depend on how good the plan is. Blankenship recommended looking at the portfolios offered by your 401(k) to determine if it’s a good low-cost investing environment for your money.

“You should educate yourself on what makes for a good diversified portfolio, and there are a number of resources online that will help you do an analysis of your potential portfolio,” he said. In particular, Blankenship recommended Yahoo Finance.

Blankenship also recommended opening an individual retirement account (IRA) if your 401(k) isn’t up to snuff. You should keep contributing to your 401(k) up to your company match; however, any contributions beyond that should go toward your IRA to take advantage of lower fees or a more diversified portfolio.

8. Determine your desired retirement age

It can be hard to think about retirement when you’re in the thick of your career, but it’s a good idea to do some basic calculations to determine how much you will need, even if retirement is decades away.

Not only will you have a better sense of what you need to set aside to reach your goals, but thinking about what you want from your future makes those goals feel more immediate (which also makes it easier and more satisfying to save money).

The takeaway

The precise amount to send to your 401(k) will depend on a number of factors. Meeting your company match and creating savings goals that evolve over time will help ensure you have a robust retirement account when you need it.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Emily Guy Birken |

Emily Guy Birken is a writer at MagnifyMoney. You can email Emily here

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Investing

Here’s How to Buy Apple Stock

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

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When it comes to investing, many people think about purchasing shares of individual stocks, such as Apple. By purchasing shares of a company, it’s possible to outperform the market (if you pick a “winner”), and you have the opportunity to receive dividends when the company decides to share its profits with shareholders.

However, before you buy Apple stock or make any other individual share investment, it’s important to understand the risks. While you could do better than the market with an individual stock instead of an index fund or exchange-traded fund (ETF), you also run the risk of losing more if the stock tanks. For most beginning investors, it’s a good idea to consider investing in an index fund or another diversified investment before moving on to individual stocks.

If you do decide to buy Apple shares, or any other company shares, here’s a guide to help you increase your chances of success.

Research the company

Start by researching the company in question. For example, if you want to invest in Apple, you can begin by looking at how the company is managed and where its revenue comes from. You also can consider the following information to help you determine how strong a company is:

  • Company balance sheets
  • Earnings reports
  • Price history
  • Dividend payouts

Past performance isn’t a guarantee of future results, but you can get a feel for how a company like Apple does during a stock downturn and how well it recovers.

Some brokerages offer stock screeners that allow you to input your preferences and then suggest stocks that match your expectations. No matter how you do your research, you want to make sure the company you choose is strong now and likely to remain strong in the future.

Consult your portfolio

Next, look at your portfolio. Does it make sense to buy Apple stock?

Start with the asset allocation in your portfolio. This is the balance between stocks and other types of investments, such as bonds or real estate, in your portfolio. Your ideal asset allocation depends on your goals and your risk tolerance. For example, if you’re relatively young and won’t need to access the money in your portfolio for a decade or two, it’s often recommended to have more stocks than bonds in your portfolio.

You also should look at the types of investments you have. If you’re investing in a tech sector ETF, it might not make sense to buy Apple stock, as you may already invest in the company through your ETF. On the other hand, if you decide you want to buy Apple stock, you could sell your tech sector ETF shares, invest part of the proceeds in a different sector, such as utilities, and then buy Apple shares with the rest.

If you aren’t sure, consider consulting with an investment professional who can help you determine how much of your portfolio should be in individual stocks and help you avoid a lack of diversification.

How much money should you invest in Apple?

Once you know how much of your portfolio should be devoted to Apple stock, it’s time to figure out how much money you can spend.

The first rule is this: Don’t invest what you can’t afford to lose. Realize that your money might be tied up for years in Apple stock. Additionally, when you buy apple shares, there’s no guarantee that they’ll be profitable in the long run; you could lose money down the road.

Next, be realistic about how much money you can invest. For example, as of Dec. 4, 2018, Apple stock (AAPL) is trading at $176.69 per share. It’s an expensive stock, so you need a plan for investing. If you can set aside $200 a month to invest in Apple, you could buy one share per month.

It’s also possible to buy fractional shares. Some brokers will let you buy as little as one-eighth of a share if you sign up for an automatic investment plan. That allows you to buy a small portion of the stock at a time so you can make the most of your money; otherwise, you might need to set aside what money you can until you have enough to buy one share.

No matter how you do it, make sure your other investing needs are being taken care of. Only buy Apple shares if you’re on track with your retirement and other goals and if you have enough room in your budget to buy Apple stock.

Log in to your brokerage account (or open one)

In order to buy Apple stock, you need a broker. For many investors today, online brokerages make it easy to buy and sell individual stocks, mutual funds, ETFs and other assets. If you already have a brokerage account, log in and see how much money you have available in cash.

If you don’t have a brokerage account, open one. In many cases, you can open an account fairly easily online. You’ll need to provide basic identifying information and your bank account and routing numbers to fund the account.

You need cash in your account to execute trades; otherwise, you might need to wait for your account to be funded. A regular ACH transfer can take several business days. It’s possible to set up an automatic transfer so money regularly goes into your investment account and you have cash available for trades when you’re ready.

Place your order

When you’re ready to buy Apple stock, place your order. Most brokerages will let you go to the trading page and enter the ticker symbol — in this case, AAPL — and show you how many shares (and fractions of shares) you can buy with the money in your account. Remember that you’ll likely have to pay a transaction fee, so the broker will subtract the fee from your available cash.

You may choose to place a market order. With a market order, your transaction executes immediately at whatever the current market price is.

Some brokers let you set different parameters for your order. You might be able to set up a limit order, which means the broker will execute the trade only if Apple shares drop below a certain price of your choosing.

You also might be able to set up a stop-loss order on your Apple stock. That is when you say you want to sell your shares if Apple drops below a certain price in an effort to limit your losses if Apple is trending heavily down.

For most investors, though, it makes sense to go through with a market order. If you feel like Apple is a solid company with long-term staying power, you can hold it through the tough times and reap potential rewards later, during a recovery.

Continue to monitor your investment

Keep tabs on your portfolio by checking in on occasion. For most investors, it doesn’t make sense to obsess about daily stock prices. The stock market can be volatile in the short term, so trading anytime there’s a small change can get expensive since you pay trading fees each time you buy or sell.

Instead, consider looking at your portfolio a few times a year to see if owning Apple stock still makes sense. Check quarterly reports and follow the news to get a feel for how Apple fares compared to similar companies in the same sector.

In many cases, it doesn’t make sense to make huge changes to your portfolio unless there’s been a fundamental change to a company.

How to buy stock in Apple: the bottom line

Buying Apple shares isn’t just a matter of adding a popular stock to your portfolio and expecting to meet your goals. Before you move forward, consider your portfolio and your long-term investing goals. What do you hope to accomplish when you invest in Apple?

Be clear about your goals and make sure you have appropriate diversity in your portfolio. That way, if you’re wrong about Apple, it won’t completely derail your plans. Investing in individual stocks like Apple can help your portfolio performance, but make sure it’s part of an overall plan.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Miranda Marquit
Miranda Marquit |

Miranda Marquit is a writer at MagnifyMoney. You can email Miranda here

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Investing

How to Buy and Sell Stocks

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

Maybe you haven’t invested in stocks yet. Maybe you have a 401(k) or IRA. Perhaps you have a micro-investing app with steadily increasing gains. No matter where you are in your investing journey, the process of how to buy stock and how to manage your own portfolio can seem daunting.

While there’s definitely a learning curve when it comes to investing, it’s never been easier to buy your first stock. Robo-advisors, micro-investments, and simple web platforms that allow you to buy, trade and sell stocks on your phone have made investing in the stock market effortless.

Why invest in the stock market?

Just because it’s easy to buy and sell stocks doesn’t mean the process is a no-brainer. First, it’s important to understand why you want to invest in the stock market. Why buy stock as opposed to, say, putting your hard-earned money in a savings account? The answer is that unlike other options, such as savings or bonds, stock shares likely have higher potential returns than stocks or bonds. But of course, with high returns comes risk: The volatility of the stock market means while you hope your investment gains value, there’s no guarantee it will do so.

Once you own stock shares, you literally own a small percentage of a company. If the company does well, not only does the stock gain in value, but you may receive what’s known as a dividend — a portion of the company’s earnings, usually paid on a quarterly basis. If the company continues to do well, the share continues to pay dividends, which a stockholder may reinvest in the stock market or withdraw as passive income.

Alternatively, a stock investor may decide to sell all or some shares of their stocks to maximize the gains they made. If the share price has increased in value, an investor can sell those stock shares at a profit.

A beginner’s guide to stocks

The concept of buying and selling stocks is simple. But, in reality, words and phrases like “ETF”, “blue chip”, “index” and “yield” may make you feel like you’re learning a foreign language. So how do you get started?

First, forget about stocks for a second and focus on your financial goals. While investing in the stock market can be a smart financial strategy, experts generally agree that it’s important to focus on paying down debt and establishing an emergency fund before investing extra cash. That’s because while stock returns on long-term investments can be good — the average annual return of the S&P has been around 10% since 1928 — interest rates on debt can be higher.

Once you feel comfortable with your finances, think ahead to your goals to decide on the right investment strategy for you and your family. Do you want to buy a house? Save for retirement? Have money set aside for a rainy day? These answers will affect how to buy and sell stocks, and what your stock portfolio may look like.

A portfolio represents the entire range of assets you own. You may buy shares or securities for specific companies, but it’s common — especially for beginner investors — to invest through a mutual fund, exchange-traded fund (ETF) or index fund. These funds can have any number of stocks, as well as commodities, real estate, foreign investments and bonds that are diversified to protect investors from potential risk. You may choose investment options that range from conservative to aggressive, with aggressive funds generally being chosen if you’re hoping for big gains — and are okay with potentially having a big loss.

While you can withdraw money in the stock market at any time, it’s often best to think of money you invest as relatively untouchable. That’s because it takes time for money to grow, and also because the nature of the stock market is to ebb and flow — if you withdraw all your investments as soon as you see share prices start to fall or your portfolio lose value, you may miss future gains.

Your goals, as well as your comfort with risk, will influence how you buy stock. Many beginner investors don’t buy stock alone: Research, investment advisors, robo-advisors, and portfolio recommendations can all come into play to help you come up with the best investing options for you. It may be that you want to actively monitor your stocks, or you may want to set a strategy and check in once or twice a year.

How to buy and sell stocks

If you’re looking to invest, there are several places to consider as you decide where to buy stocks, with pros and cons to each. It’s also important to note that it’s easier than ever to buy stocks online. That said, different platforms have different fees, limitations and considerations.

A traditional brokerage firm

A few decades ago, the only option to buy stock would be a brokerage firm. Even today, with plenty of online platforms to aid investors, brokerage firm can be a good option if you’re planning to invest in individual stocks. Major brokerage firms include TD Ameritrade, Edward Jones, Charles Schwab and Fidelity. In addition, many banks have brokerage services.

Some brokerages have a minimum amount required to open an account, and may charge fees for any buys, sales or trades. Brokerage firms also have stockbrokers on staff who can work with you to select stocks. A brokerage firm is an ideal option if you want to be hands-on with stock selection.

Online-only broker

Is there a way to avoid a fee for buys and trades? While the U.S. Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) charge a fee for all stock sales orders regardless of brokerage, commission fees can range between brokerage options. Some traditional brokerage accounts have fee-free options for ETF sales or trades, and some online startups, like Robinhood, charge no commission fees for any stock buys, sells, and trades (though fees from third-parties may apply).

Some online-only brokers have the option of working over the phone with a live broker, which can be an option if you wish to buy and sell individual stocks. In general, being aware of any fees — regardless of which option you choose — is smart, since over time, fees can eat into your hard-earned capital.

A robo-advisor

In the past decade, robo-advisors have become popular for those interested in buying stocks online. These providers offer automated portfolio management. Algorithms, as well as the information you input regarding financial goals and risk tolerance, will create a customized portfolio.

Robo-advising services are offered by many traditional brokerages, but companies such as Betterment, Wealthfront, Wealthsimple and Ellevest are devoted to robo-advising. This can be a good option if you don’t wish to actively be involved in your investments, as these providers also tend to automatically recalibrate your portfolio if there’s any dramatic shift or change.

In general, robo-advisors specialize in algorithmically created portfolios and may not give you the option of buying individual stock. The fees may be lower than traditional brokerages, and may be based on a percentage of your overall portfolio.

A micro-investing platform

These providers take small amounts of money — in some cases, just a few pennies — and invest in ETFs and mutual funds. Micro-investing platforms may be exclusively on an app, and can be a good way to dip your toe into the stock market without a big commitment.

Acorns, Clink, and Stash are three examples of robo-advisors that have micro-investment options. These investment options — which tend to charge a monthly fee of around $1 — can be a good way to watch your money grow, but depending on fees, it may make sense to move the money gained in these accounts into another investment vehicle that offers more robust services. That’s because some micro-investing platforms switch from a flat monthly fee to a fee-based percentage once the account reaches a certain threshold, and it may make more sense to compare fees and choose a lower-fee account once your account reaches that point.

Choose your investment strategy carefully

Your investment portfolio is personal, and while there’s no “right” or “wrong” reason to buy a stock, there are some general best practices. Like so many skills, one of the best ways to learn how to invest is to learn by doing. Brokerages and robo-advisors, in addition to sites like MagnifyMoney, are great for learning common terms and strategies. But you can simultaneously learn and invest, and robo-advisors, brokers and financial planners can give you options for the type of portfolio that makes sense to you based on your financial goals.

For example, a retirement portfolio may look different than a portfolio meant to help you buy a house in the next five years because of the way assets are allocated. Aggressive assets have a bigger risk of loss but potentially bigger rewards; conservative assets may have the lowest risk and lowest potential of return. A customized portfolio will contain some of each in the attempt to help you reach your goal with as much money as possible.

A huge differentiation for new investors to realize is that investing in a portfolio through a robo-advisor or brokerage is very different than, say, actively buying and selling individual stock in the hopes of maximizing return. For example, investing in cryptocurrencies, initial public offerings (IPOs) and even individual stocks is very different than investing in a diversified portfolio meant to grow your money over the long term.

If you do wish to choose individual stocks, it’s smart to research a company and look at their quarterly or annual financial report with an eye toward positive cash flow. You may also wish to invest in stocks simply because you like the company and its mission, you’ve seen a proven track record of the company’s success, or it’s a company that you’ve followed over the years. That said, investing a small amount and watching the performance of the stock can help you suss out a strategy or make a decision whether you’d like to buy more.

How to buy stock today

You’ve done your research, opened a brokerage account and are ready to make your first stock investment. Once you’ve decided what stock to buy and how much money you want to invest, the next step to buying stock is to figure out how many shares to purchase.

Instead of focusing on shares, one common strategy for investors is to use is called “dollar cost averaging.” This strategy focuses on buying shares based on the money you wish to invest, not the number of shares you want. To use dollar cost averaging, simply purchase the same dollar amount of stock at regular intervals. For example, if you wish to buy $100 of stock and Company X is trading at $10 a share, you can buy 10 shares this month. Next month, when Company X is trading at $12.50, you can afford just 8 shares.

This strategy can help can help mitigate risk, since you purchase more shares when prices are low and fewer shares when costs are high. New investors can also learn to ride the ups and downs of the stock market by sticking to a strict budget and purchase schedule.

No matter what investment strategy you choose, the purchase experience varies across platforms. In general, you may be prompted to opt for a market order — which means the stock will be purchased at current market price — or a limit order, which allows you to name a target price at which the shares will be bought. It’s also important to be aware of any fees or commissions that may come from the purchase, and be aware of any limitations on purchases — some brokerage accounts have a cap on the number of buys, sells or trades made in a day.

While it’s smart to research the company you wish to invest in, it’s important not to get overly bogged down on any “best day of the week to buy stock” advice. If you’re planning to invest for the long term, it doesn’t really matter if the stock you buy is slightly lower a day or two after you’ve bought it; what matters most is long-term patterns and movement.

When to sell stock

Is it ever a good idea to sell stock? That depends. In general, money in a retirement account like a 401(k) or a Roth IRA has penalties and tax implications for withdrawals before a certain age, so many financial advisors would suggest those portfolios are left untouched.

But what if you opened a brokerage account or have bought individual stocks? There’s no wrong reason to sell stock — for example, you may need that money to be liquid for an emergency fund or an unexpected bill. Other reasons to sell stocks include diversifying your portfolio, moving away from a company with haphazard performance results, or simply feeling like the time is “right.” Some investors sell stock when the price has appreciated rapidly, using the money to invest in a less expensive stock. Other investors look closely at the valuation of the company. Working with a personal investment advisor can help you figure out smart strategies to sell stock, and your own experiences and research can help you become more familiar with common points at which investors consider selling stock.

In general, it’s usually not a good idea to sell stocks based on emotion alone — seeing a stock dip may make you nervous, but it could be smart to ride out an initial dip or look for larger trends over time.

How do you sell a stock when you’re ready? Platforms vary, but in order to sell a stock, an investor triggers what’s called a sell order. A sell order can be a market order (the stock is sold right now), a limit order (a seller names the minimum price they’ll accept), or a stop order (the sale will be stopped when the stock dips beyond a price limit) Again, it’s smart to be aware of any sale fees or limits within your investment platform.

Investing is an art and a science

There’s no limit to the number of investment strategies, tips and techniques you can try, but one of the best ways to learn to invest is to simply practice. With so many platforms offering investment opportunities for the cost of a latte, it’s never been easier to buy stocks. Keeping track of your long-term investment goals, your capacity for risk, and making sure you’re never investing more than you can afford to lose can help grow your money — and your confidence.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Anna Davies
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Anna Davies is a writer at MagnifyMoney. You can email Anna here

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Retirement Plan Options When You’re Self-Employed

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

Self-employment is a dream for many who crave the flexibility and sense of autonomy being your own boss provides. No more worrying about taking those long lunches or running out of vacation days. On the flipside, it also means you’re on your own when it comes to saving for retirement. There are no company-sponsored plans or matching funds, and no human resources department to consult about your best options — it’s all up to you.

The good news is there are a host of great investment tools to help you plan for your future and build a solid nest egg for retirement, many of which have similar benefits as employer-sponsored plans. Here are six of the most common retirement plans for self-employed individuals.

1. Traditional Individual Retirement Account (IRA)

How it works

There are several types of Individual Retirement Accounts (IRAs) you can establish if you’re self-employed. First up is a traditional IRA, which allows you to deposit money in an investment account before paying taxes on it. Your funds then grow — tax-deferred — over the years until you reach retirement, at which point you will have to pay taxes on the funds as you withdraw them.

IRAs are more flexible than 401(k)s in that you can withdraw money from them at any time without paying a penalty to cover certain costs, including higher education, buying your first home and medical costs. You will, however, need to pay taxes on the funds in the year in which they’re withdrawn with a traditional IRA. You also can’t leave your funds in an IRA forever. Required minimum distributions begin at age 70 and a half.

Contribution limits

You can invest up to $6,000 in a traditional IRA in 2019 (an increase of $500 in 2018). If you’re over the age of 50, you can contribute an additional $1,000 a year ($6,500 in 2018 and $7,000 in 2019) as “catch-up” contributions. Note: This is the total yearly limit for all Roth and traditional IRA contributions.

Some additional limitations may apply depending on your income and you or your spouse’s participation in other work-sponsored retirement plans.

How it’s taxed

A traditional IRA allows you to invest the maximum amount for growth (as opposed to paying taxes up front, which is the case with a Roth IRA) because the funds aren’t taxed until after they’re withdrawn.

Your contributions may also be fully or partially tax deductible in the year in which you make them, so that may also decrease your taxable income.

Who it’s best for

Typically, traditional IRAs are a good option if you’re currently in a higher tax bracket and expect to be in a lower one when you retire. They’re also an attractive option if you want the ability to access funds before retirement for certain expenses without paying a penalty.

2. Roth IRA

How it works

A Roth IRA works much like a traditional IRA, but there’s one big difference: when you actually pay taxes. With a Roth IRA, you pay taxes on your contributions in the year in which they’re made. Those funds then grow tax-free over the years until you reach retirement. When you’re ready to withdraw them — as long as you’ve reached the age of 59 and a half — they’re yours, tax-free.

IRAs are more flexible than 401(k)s in that you can withdraw money from them at any time without penalty to cover certain costs, including higher education, buying a home and paying for medical costs. There are no required minimum distributions.

Contribution limits

You can invest up to $6,000 in a Roth IRA in 2019 (an increase of $500 from 2018). If you’re over age 50, you can contribute an additional $1,000 a year ($6,500 in 2018 and $7,000 in 2019). Note: This is the total yearly limit for Roth and traditional IRAs combined.

How it’s taxed

Contributions to a Roth IRA aren’t tax-deductible, so you don’t get a tax break in the year they’re made. However, because you pay taxes up front, those funds are not counted as taxable income when you retire.

Who it’s best for

In general, Roth IRAs are a good option if you’re currently in a lower tax bracket and expect to be in a higher one when you retire. They’re also good if you want the ability to access your funds before retirement for certain expenses without paying a penalty or paying taxes on the funds when needs arise.

3. Solo-401(k)

How it works

A solo-401(k), also referred to as a one-participant 401(k) plan, works much like a traditional, employer-sponsored 401(k); however, it’s designed for individual business owners or the owner and their spouse. It allows you to invest funds in a retirement savings account that then grows tax-deferred — traditional solo-401(k) or tax-free (Roth solo-401(k) — over the years until you withdraw them at retirement.

Penalties apply for early withdrawal if the account is less than five years old and you haven’t reached the age of 59 and a half. However, you may be able to take out a loan from your 401(k).

Contribution limits

Like a traditional 401(k), you can contribute up to $19,000 in 2019 ($18,500 in 2018). If you’re over the age of 50, the limit increases to $25,000 in 2019 ($24,500 in 2018).

One notable upside to this plan is you’re allowed to contribute additional funds because you act as both the employer and employee when you’re self-employed. Total contributions can’t exceed $56,000 for 2019 ($55,000 for 2018), unless you’re over the age of 50, when there are allowances for “catch-up” contributions.

How it’s taxed

Like IRAs, you can choose either a Roth or a traditional solo-401(k). With a traditional solo-401(k), taxes are deferred on the money you contribute to your account until you withdraw funds in retirement.

If you choose to designate some of your funds as Roth contributions, however, you will pay taxes on them up front, with tax-free withdrawals in retirement. Contributions to a traditional solo-401(k) aren’t counted as taxable income in the year they are made, while Roth solo-401(k) contributions are.

Who it’s best for

A solo-401(k) is a good option if your income surpasses the IRA limits and you want to invest more for your future.

4. Savings Incentive Match Plan for Employees (SIMPLE) IRA

How it works

Traditional and Roth IRAs are funded entirely by employee contributions, whereas SIMPLE IRAs allow contributions from both the employer and employee, which means you’re playing both roles if you’re self-employed.

Like with other IRAs, there are penalties for early withdrawal (before the age of 59 and a half), and there are exceptions for many expenses, including education, health care costs and buying a first home. If you withdraw funds before your plan is two years old, however, that withdrawal is subject to a hefty 25 percent tax penalty.

Contribution limits

You can contribute up to $13,000 in 2019 (an increase of $500 from 2018) to a SIMPLE IRA, but not more than the amount you earn. Additional “catch-up” contributions up to $3,000 can be made if you’re 50 or older.

As the employer, you can also contribute dollar-for-dollar matching funds up to 3 percent of your net earnings or make an additional non-elective contribution equal to 2 percent of your income, up to $280,000 in 2019 (an increase of $5,000 from 2018).

How it’s taxed

Contributions to a SIMPLE IRA aren’t taxed in the year in which they are made, but they are taxed when they’re withdrawn in retirement. Contributions are also tax deductible by the employer in the year in which they are made.

Who it’s best for

A SIMPLE IRA is a good option if you want to contribute funds in excess of the limits of traditional and Roth IRAs. They’re also worth considering if you have 100 employees or less, as they’re easy to set up and don’t come with the same startup and operating costs that other plans may have.

5. Simplified Employee Pension (SEP) IRA

How it works

Like other IRAs, a SEP IRA allows you (as the employer) to invest funds, tax-deferred, until you need them in retirement. There are penalties for early withdrawal (before the age of age 59 and a half) and there are minimum distribution requirements.

There are two primary differences that set the SEP IRA apart from others:
1. A SEP IRA has higher contribution limits than traditional and Roth IRAs, and;
2. If you have employees who meet certain qualifications, you must make contributions to their SEP IRA in equal amounts for all employees. Contributions are only made by the employer (which is you) if you’re self-employed.

Contribution limits

You can contribute up to 25 percent of your net earnings to a SEP IRA, up to a certain limit. In 2019, the limit is $56,000, an increase of $1,000 from the prior year (2018). There’s no extra allowance for catch-up contributions as there is with other retirement accounts.

How it’s taxed

Contributions to a SEP IRA are tax deductible, as funds are taxed when they’re withdrawn in retirement. There’s no Roth option to pay taxes up front, as the contributions are made by the employer.

Who it’s best for

A SEP IRA is a good option if you’re self-employed and want to save a large amount of money for retirement. It’s also a good option if you have 100 employees or less and want to establish a retirement plan without the associated costs of other plans.

6. Defined benefits plan

How it works

Like an employer-sponsored pension, an individual defined benefits plan lets you put away a certain amount of money for a guaranteed return in retirement. The amounts are based on a formula that takes into account the number of years you’ve worked and how much you earn. You must enlist the help of an actuary to help determine your contribution and benefits.

Contribution limits

The amount you may contribute is based on a formula and will vary from person to person. Generally, however, the annual benefit can’t be more than the highest salary they were paid for three years in a row, or surpass the annual limit of $225,000 in 2019 (a $5,000 increase from 2018).

How it’s taxed

Taxes are deferred up front and paid on the funds when they’re withdrawn during retirement. The contributions are tax deductible in the year in which they are made.

Who it’s best for

A defined benefits plan may be a good option if you’re a high earner and want to save aggressively for retirement.

How to open a self-employed retirement plan

To open any of these retirement plans, there are numerous online brokerages that can help, or if you prefer a more personal approach, you can seek out a financial advisor in your area. Banks can also help you establish some of these accounts as well. It may also be wise to work with an accountant to make sure you file the proper forms and pay the correct amount of taxes.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Julie Ryan Evans
Julie Ryan Evans |

Julie Ryan Evans is a writer at MagnifyMoney. You can email Julie here

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Investing

6 Ways to Invest in Real Estate

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

home with change stacked in front of it
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In the United States, the housing market is booming. According to the U.S. Census Bureau, the average sales price of a new home was $395,000 as of October 2018. That’s a 44% increase from the average sales price of a new home just 10 years prior.

If you want your money to work harder for you and are looking to invest, putting your money in real estate could be one option to consider.

6 ways to get started in real estate investing

Real estate investing — where you use a portion of your savings to purchase property in some form — can be a lucrative way to grow wealth. According to Stefany Marcelino, co-founder and managing partner of Orlando City Corporate Housing, it can be an excellent source of income as you age.

“Investing in real estate can have a huge advantage for you financially,” she said. “When it comes to planning around your retirement and around old age, having real estate investments and having assets will help in that aspect of your life. It’s something that allows you to be more financially independent.”

If you’re not sure how to begin, it’s important to know there’s more than one way to invest in real estate. And you can get started without having hundreds of thousands in the bank.

Here are six ways you can invest in real estate.

1. Buy a rental property

When you invest in a rental property, you buy a house or condo with the intention of renting it out to someone else and collecting rent.

To do so, you usually need to be able to qualify for a mortgage and have enough money for a down payment as well as a cash reserve for repairs and maintenance costs.

“As a landlord, you have to plan ahead for unexpected expenses,” said Marcelino. “You’ll get maintenance requests like ‘My appliance broke’ or ‘I need a new AC,’ so you do need to to have a bit of an emergency fund in your bank account to be able to fix those unexpected things.”

You’re also responsible for finding and vetting tenants, collecting rent, and doing the necessary repairs yourself (or hiring out for the job), so it can be a significant time investment. And if a tenant falls behind on rent, you need to be prepared to handle the eviction process.

Investing in rental properties can be rewarding, but it’s not for everyone. You need to make sure you have the time and cash cushion to handle it.

2. Flip homes

Made popular by reality television shows, flipping homes is a common type of real estate investing. With this approach, you purchase a run-down home with the intent of fixing it up and reselling it for a profit.

While the profits can be large, so are the expenses. You’ll likely need an army of contractors to make the house sale-ready, which requires a significant upfront investment. And if you took on debt to purchase the home, you’ll need to continue paying down your loan until the home sells, which can take months.

Flipping homes is not for the faint of heart. You need to have a large reserve of cash, the knowledge and ability to do at least some of the work yourself, and a high comfort level with risk.

3. Invest in REITs

Investing in real estate on your own can be expensive and time-consuming, but real estate investment trusts (REITs) can be a great solution. A REIT is a company that owns and manages profitable real estate, such as apartment buildings, shopping malls or storage facilities.

Many REITs are publicly traded on the stock market, so you can buy shares of a REIT like you would any other type of stock.

For beginning real estate investors, REITs can allow you to dip your toes into the investing pool without having to invest a ton of money. Instead of needing thousands to buy real estate yourself, you can get started by buying just one share. And you don’t need to worry about day-to-day operations, as the REIT manages that aspect for you.

However, because you are only a shareholder, you have less control and little say in the investment. If you prefer a hands-off approach, that can be an asset, but it’s an important point to understand before you invest your hard-earned money. You’re also subject to the stock market’s volatility.

4. Consider real estate investment groups

A real estate investment group is an organization that buys properties and then sells them to investors as rental properties. They take the hard work out of running a rental property yourself; you provide the capital, and the real estate investment group handles the work for you.

Usually, you pool your money with a small group of other investors. When it’s time to make decisions, you work together to come up with solutions.

A real estate investment group can require a larger investment and more time than a REIT. And because you are involved in the decision-making, it’s important to have some foundational knowledge of real estate and renting.

5. Use an online platform

Crowdfunding is another way to invest in real estate. Rather than having to come up with hundreds of thousands of dollars yourself to invest in high-value real estate, you can pool your resources with other investors.

Online real estate crowdfunding platforms allow normal people to invest in real estate instead of limiting it to the super rich. You don’t need tons of money to get started; some online platforms have initial investments as low as $500. Here are two online platforms to consider.

  • Fundrise: You can invest as little as $500 with Fundrise, and you can choose from a diverse range of investment opportunities, from manufacturing buildings to single-family homes.
  • Prodigy Network: Get in on New York’s booming real estate market with as little as $10,000 with Prodigy Network. Investments include commercial buildings and hotels.

If you opt to invest in an online platform, you’re one of many investors, so you have less control over what happens to the property. It’s a hands-off approach that can be helpful for beginning investors but may be frustrating for more seasoned ones.

6. Buy a home

When you think of investing in real estate, you might think of buying properties other people live or work in. But buying a home for yourself is a form of investing too.

“Investment in real estate can be for anyone,” said Marcelino. “Even purchasing your own home to live in means you’re an investor because one day it will gain equity and you’ll sell it.”

Over time, your home can grow in value, so you can make a nice profit a few years down the line. And becoming a homeowner can be more affordable than you might think. Some mortgages require just a 3.5% down payment, making homeownership more accessible.

When it comes to investing in real estate, there’s a strategy for every type of investor and every budget, from beginner to advanced. By researching your options, you can diversify your portfolio and invest wisely, building another source of income.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Kathryn Tretina |

Kathryn Tretina is a writer at MagnifyMoney. You can email Kathryn here

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Investing

What is a Roth 401(k)?

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

You’ve probably heard of a Roth Individual Retirement Account (IRA) and are at least somewhat familiar with 401(k) plans, but what about a Roth 401(k)? Here’s what you need to know about this increasingly popular hybrid option some employers offer to help their employees save money for retirement.

What is a Roth 401(k)?

Roth 401(k)s get their name from former U.S. Rep. William Roth of Delaware, who’s credited with establishing Roth IRAs as part of the Taxpayer Relief Act of 1997. In 2006, as an extension of that legislation, employers were able to begin offering Roth 401(k)s, which follow the same tax principals as Roth IRAs — you pay taxes on contributions up front so you have access to tax-free funds during retirement.

Roth 401(k)s operate much like traditional 401(k)s. The difference lies in when you pay taxes on the contributed funds. With a traditional 401(k), the money you put away is taken out of your paycheck before you pay taxes on it. Of course, taxes are unavoidable and you’ll have to pay taxes on the withdrawals you make later in life when you’re retired.

On the other hand, if you contribute to a Roth 401(k), you pay taxes on the funds during the same year in which you contributed. That means when you eventually withdraw money from the account during retirement, you’ve already ripped off the financial Band-Aid so to speak, and you have access to tax-free funds.

Roth 401(k) eligibility

Employers aren’t required to offer any 401(k) plan. They’re an optional benefit businesses of any size can choose to provide, but there are no laws requiring employers to participate. If an employer does offer a Roth 401(k) option, they must also offer a traditional 401(k) plan. If both are offered, employees may split their contributions between the two options.

According to a retirement study by the Transamerica Center for Retirement Studies, 65% of U.S. workers have access to a 401(k) plan through their employer, with large companies (92%) being more likely to offer them than small businesses (59%). Of those companies offering a 401(k) plan, 45% offer the Roth 401(k) option. When offered the option of a Roth 401(k), approximately 28% of employees choose that option, with millennials choosing a Roth 401(k) option 63% of the time.

If your employer offers a 401(k) plan, it doesn’t automatically mean you’re eligible to participate. It’s up to each employer to determine which employees are eligible based on varying criteria. For example, only 41% of employers who offer a 401(k) plan offer it to their part-time workers. Other companies may require certain employment thresholds to be met before they can enroll (like being employed for a year).

Roth 401(k) deductions

Once enrolled in a Roth 401(k), a portion of your salary (usually a set percentage) is deducted automatically from each of your paychecks. For example, if you make $4,000 a month and decide to contribute 10% to your 401(k), then $400 will be deducted from each of your monthly paychecks.

Determining how that money is invested is up to each individual employee. Beyond the Roth option, in some cases, you will be presented with a variety of investment options including managed accounts and asset allocation suites. There may be a fee associated with some of them, which must be disclosed to employees by the plan’s administrator.

How much can you contribute?

There are no income limitations for participation in a Roth or traditional 401(k). However, there is a limit as to how much you can contribute, which is adjusted yearly. For example, in 2018, the limit is $18,500, while the limit for 2019 will be $19,000. If you’re over the age of 50, you can contribute an extra $6,000 per year as a “catch-up” contribution. You don’t have to contribute the entire amount, but you can select to have any amount up to that limit deducted.

As much as 85% of companies who offer 401(k) plans also provide matching funds up to a certain amount (yay, free money!), while others may contribute to your 401(k) regardless of whether you do or not. It’s important to note that any funds your employer contributes won’t be put in your Roth 401(k), and instead placed in a traditional 401(k). You will be responsible for paying taxes on the amount they contribute.

In some cases, employer contributions vest immediately, which means they belong to you right away, protecting your retirement in the event you quit or leave the company. In other cases, employer contributions are vested over time. That means if you quit before a certain amount of time, you only get to take a portion of the employer-contributed funds with you. The amount you get to keep typically increases each year, according to the employer’s vesting schedule, until you’re fully vested and get to keep the entire amount.

Roth 401(k) withdrawal rules

You’ve made the wise financial choice to invest in your future — so when do you get to use some of that money?

The money you’ve contributed, along with any vested employer contributions, technically belongs to you and you can withdraw it at any time. The catch is that unless you meet certain requirements, you’ll have to pay a penalty. To withdraw funds penalty-free, 59 and a half is the magic age. Once you’ve contributed to a plan for five taxable years and you hit your half birthday in your 59th year, you can withdraw from your fund without penalty.

If you do choose to withdraw funds from your 401(k) early, you’ll face a 10 percent early withdrawal fee on the amount, plus taxes. With a Roth 401(k) it’s a little bit different. Since you’ve already paid taxes on your contributions, you’re only responsible for paying the penalty tax based on the increase in the value of your funds since you opened the account. There are also exceptions for death or disability.

Some plans allow you to take out a loan from your Roth 401(k), but there are tax repercussions for doing so. You’ll pay interest on that amount and if you don’t repay the loan, the funds may be considered a non-qualified distribution, requiring you to pay taxes on that, too. In some cases, if you leave your job, you’ll be responsible for paying the loan in full at that time.

It’s important to note that you can’t leave the funds in a Roth 401(k) forever. The IRS requires that you take distributions from your plan no later than age 70 and a half, unless you’re still working.

Roth 401(k) vs. traditional 401(k)

In general, experts say the two most important factors to consider when deciding between a Roth and a traditional 401(k) is your age and the tax income brackets you’re currently in (and expect to be in later on). The more years between you and retirement, the more likely your Roth will pay off. That money has years to grow tax-free, and you won’t pay taxes on it no matter how much that money grows.

On the other hand, people who anticipate their tax rate will be lower in retirement may prefer to keep the extra income now and pay taxes in retirement. It’s not a cut-and-dry decision, and you must take into account your effective tax rates, expected earnings and various other factors that are unique to your situation.

If you can’t decide between the two, you can always split your contributions between both options to diversify your savings.

 TaxesContribution Limits (2019)Penalty-free Withdrawal

Traditional 401(k)

Paid on funds when they’re withdrawn in retirement

$19,000 per year ($25,000 if you’re over 50)

After 5 years and at age 59 and a half or older (exceptions made for death and disability)

Roth 401(k)

Paid in the year funds are contributed to the plan

$19,000 per year ($25,000 if you’re over 50)

After 5 years and at age 59 and a half or older (exceptions made for death and disability)

Roth 401(k) rollover

As the saying goes, all good things must come to an end, and when you’re ready to move on from your job, you have some options when it comes to the funds you’ve been socking away.

One option is to leave it be and start a new 401(k) plan with your next employer. Many people, however, choose to transfer or “roll over” those funds into another account. While you can roll over your Roth 401(k) into a Roth IRA, you can’t roll it in into a traditional 401(k). On the flip side, you can roll over a traditional 401(k) into a Roth 401(k) or IRA, but you will owe taxes when doing so.

So, if you’re fortunate enough to work for an employer that offers a 401(k) plan, take a close look at your options. If Roth is one them, it’s worth considering to help secure your financial future.

This article contains links to LendingTree, our parent company.

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Julie Ryan Evans
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Julie Ryan Evans is a writer at MagnifyMoney. You can email Julie here

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Investing

How to Invest in Index Funds

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

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Few investment products become popular enough to make it into the general lexicon, but everyone seems to be talking about index funds these days. Index funds have doubled their share of asset management dollars since the financial crisis of 2008 ended, and they could surpass actively managed mutual funds in popularity as soon as 2024, according to Moody’s Investors Service. Even Warren Buffett, one of history’s most successful active investors, regularly touts index funds as the only strategy the average investor really needs.

Despite the buzz, index funds are not the most exciting investments at first glance. They are passive and powered by a computer model — without a manager attempting to pick winning holdings or to get rid of losers when they are down. Instead, an index fund tracks the performance of a set group of companies included in a major market index and produces returns in line with that benchmark.

An S&P 500 index fund, for example, provides exposure to the 500 largest publicly traded companies in the U.S. that make up the S&P 500. It’s like buying the performance of the benchmark U.S. stock market — and at a very low cost. With an index fund, you generally won’t outperform or underperform a given market, as you own the market.

Why investing in index funds has become so popular

While they may not be the kinds of investments you brag about, index funds consistently outperform hot-shot actively managed mutual funds over time.

Here are four reasons passive investing is winning out.

Index funds are low-cost

“One of the major factors to investing success is fees,” said Joseph A. Carbone Jr., a certified financial planner with Focus Planning Group in Bayport, New York. Lower fees help boost performance in any market because you are losing less of your investment to the cost of the fund. Without an expensive fund manager to pay, index funds charge an average annual expense ratio of 0.09%, compared to an average of 0.59% for actively managed mutual funds, according to the Investment Company Institute. At the extremes, Fidelity, the giant broker typically known for its actively managed mutual funds, offers no-fee index funds. Actively managed funds can charge as much as 2.5% in annual expenses, not including added sales charges.

Index funds are consistent

Mutual fund managers are sometimes guilty of “style drift,” or diverging from intended investment categories, which can impact the fund’s underlying asset allocation and risk profile. With index funds, the investments are set, so there is no risk of drift.

Active management isn’t adding value

For the past 15 years ending in June 2018, 92.43% of large-capitalization mutual fund managers, 95.13% of mid-cap managers and 97.70% of small-cap managers failed to outperform index benchmarks on a relative basis, according to midyear data from SPIVA. With those odds, why pay a stock or bond picker in an attempt to beat the market?

There are tax advantages to investing in index funds

“Passively managed investing is a lot more tax-efficient than actively managed,” said Carbone. Managers are able to buy and sell assets to take advantage of market opportunities, but that trading creates taxable capital gains, which can be a drag on performance. Because indexes generally shift infrequently, trading within index funds happens a few times a year at most.

What are the downsides to index funds?

Plenty of professional investors will tell you that index funds have their downsides. Here are a few of the most common arguments.

Index funds aren’t strategic

Many of the strategies that fuel market success stories — stock picking, concentrated positions, value investing, hedging — are not as easy to index.

They don’t weather downturns

Unlike a mutual fund, an index fund is not able to react when markets turn volatile. This should help actively managed funds handle downturns better than nonreactive index funds.

According to a 2018 analysis by Morningstar, the odds of an active U.S. equity fund beating its benchmark are almost twice as good during “down” market periods, regardless of asset class. It also found that funds that beat the benchmarks during down periods do so by a wider margin than in “up” markets. However, that performance was not sustained, and those funds that did well during a single three-year period tended do badly the following period.

Index funds may not be best for every asset class

OK, so maybe a manager can’t add value in the large domestic stock market, which is so well covered by analysts that there’s virtually no way to have an edge on other investors. But what about, say, small-cap international stocks? Surely there are managers who can uncover something there or in similar markets we don’t know much about.

For some years, this is true. In 2017, 55% of managers in foreign large-cap blend and diversified emerging markets funds beat their benchmarks, up from 36% in 2016, according to Morningstar. Active U.S. small-cap managers did well in 2017 too, with 48% of them beating their benchmarks, up from 29% in 2016. “In theory it makes sense, but the numbers don’t bear this out,” said Carbone. Over the long term, however, asset managers lag significantly in most asset classes.

They can be boring to some people

If your idea of fun is buying individual stocks in the hope of finding the next Apple or Netflix, index funds probably are not your speed. On the other hand, some financial advisors prefer index funds because they feel like less of a gamble than other investments.

Index funds vs. mutual funds vs. ETFs

Mutual funds are actively managed, while index funds are passive. Otherwise, the two investments are fairly similar. Then there are exchange-traded funds (ETFs), which are index investments that trade on the stock exchange.

How to make sense of it all? Here’s a chart to help you compare the differences.

 Mutual FundIndex FundETF

What is it?

A pool of money through which large groups of investors can own a variety of stocks, bonds or other assets strategically selected by an asset manager or management team.

A pool of money through which large groups of investors can track the performance of a stock or bond market index. An index fund is a type of mutual fund without a manager.

A security that tracks the performance of a stock or bond market index or selection of assets. Think of an ETF as an index fund-stock hybrid.

How often can you trade?

Once a day at net asset value (NAV) or daily share price.

Once a day at net asset value (NAV) or daily share price.

All day at intraday share price.

Where can you buy it?

Purchase directly from a mutual fund company or through a broker.

Purchase directly from a mutual fund company or through a broker.

Trade shares on the stock exchange through a broker or online brokerage account.

How do you pay for it?

Through an ongoing expense ratio or percentage of assets. The average expense ratio for equity mutual funds is 0.59% per year. Some mutual funds have sales loads or commissions paid when you buy or sell shares.

Through an ongoing expense ratio or percentage of assets. The average expense ratio for index equity funds is 0.09% per year.

Through an ongoing expense ratio or percentage of assets. Index equity ETF expense ratios average between 0.20% and 0.50%. There are also trading fees when you buy and sell.

What’s the minimum investment?

Typically $500 to $3,000. Fidelity has no minimum investment funds.

Typically $500 to $3,000. Fidelity has no minimum investment funds.

None, other than the cost of a share plus the cost to trade it.

Source: 2018 Investment Company Fact Book

Carbone uses ETFs to build portfolios for clients but doesn’t always recommend them for the individual investor. “There’s a lot less that can go wrong when you’re purchasing a mutual fund or index fund versus an ETF.” said Carbone. “A mutual fund is much more user-friendly.”

How to select an index fund

Ready to invest in an index fund? These three steps can get you started.

1. Find a fund company

You can purchase an index fund directly from a mutual fund family, such as Vanguard, the company that pioneered index funds. Firms such as Schwab and Fidelity offer index funds and are large enough to offer products to handle all your investment needs. Keep in mind that index funds don’t really vary from firm to firm. So look for a provider with a good reputation for offering low-cost, no-load funds.

You also can purchase an index fund through a broker, and some discount brokerages will trade mutual fund shares without a transaction fee. If you still can’t decide, compare a couple of options and pay attention to things such as the expense ratio, minimum initial investment and account minimum. Vanguard and Schwab both offer a wide range of low-cost index products with relatively low minimums. Fidelity offers a handful of no-fee, no-minimum accounts, but the fund giant still makes its money through active investing.

2. Select your index

A recent finding by the Index Industry Association found that there are almost 3.3 million stock indexes around the world.

Where is a good place to start? Buffett recommends a simple S&P 500 index fund for the average investor. Or you can get even broader exposure through the total-market Wilshire 5000. Looking for just small caps? The Russell 2000 represents the smallest U.S. stocks. Looking for global exposure? The MSCI global equity index is popular with international investors.

You also can choose between equal-weighted and market-weighted index funds. Market weighted means the companies are represented according to their market value, with the largest companies representing a greater portion of the index. With an equal-weighted index, all companies are represented equally. Each strategy has its benefits: Market weighting tracks more closely to the market’s performance, but equal weighting helps reduce your risk and tends to outperform over time.

3. Balance your assets

Should you buy just one, or is it better to buy multiple index funds? For investors who want to keep things simple, a single broad domestic index fund, such as an S&P 500 fund, is a good start. But if you’re ready to diversify, you can build a world-class equity portfolio with as few as three index funds, said Carbone.

Start with an S&P 500 and add an international equity stock index, such as MSCI, he said. “This gives you global diversification.” For a bond portion, Carbone recommended a Barclays investment-grade bond index fund, a common benchmark for bonds.

How much you put into each fund will depend on your own goals and risk tolerance, but the three components represent all the diversification you need at a combined cost of less than one percentage point.

Bottom line

Any active manager or investment trader will tell you that outperforming the market is not easy to do. Take fees into account, and an active manager has to work even harder to beat a passive investment. So why not consider jumping on the index fund bandwagon? This is one popularity contest investors can win.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Melissa Phipps
Melissa Phipps |

Melissa Phipps is a writer at MagnifyMoney. You can email Melissa here

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Investing

Mutual Funds vs. Stocks: Which is Right for You?

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews or recommendations expressed in this article are those of the author’s alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

As you explore ways to invest your money, you’ll face a slew of options. There are stocks, bonds, mutual funds and a host of other places to park your cash.

When it comes to mutual funds vs. stocks, though, which one is right for you? Here’s a breakdown of each and what you should consider before you choose one.

Mutual funds vs. stocks: At a glance

Mutual funds are like group investments. Multiple people pool their money together to invest in a collection of stocks, bonds or other securities.

Stocks are ownership shares of a company. You can own one share or many, depending on the price and how much you can afford. The more shares you own, the more ownership you have of a company.

Here’s a breakdown between mutual funds and stocks.

 Mutual FundsStocks

Good for

Beginners or those who want to spread their cash between a few different investments

Micromanager investors or those who are well-versed in when to buy specific stocks

Typical expenses

Fund managers, account fees, expenses based on passive or active accounts

Broker fees, possible commission fees, trading costs

Common risks

Relatively low, but still have the chance to lose money based on how the market performs

Putting all your money in one or a few stocks means a poor-performing company can lose you money

Common benefits

Diversification — investing in a range of companies to lower risk

Dividend-paying stocks allow for payouts monthly, quarterly or annually; buy low, sell high

Where to buy

Robo-advisors for long-term, low-risk investors

Online brokerages

What is a mutual fund?

Mutual funds consist of multiple different types of investments. You buy and sell mutual funds through a broker or manager. There are four main types:

  1. Money market funds. These are relatively low-risk for investors. Interest rates are usually higher than savings accounts. Maturity is short, which reduces your risk from major market fluctuation.
  2. Bond funds. Bonds can carry a higher risk than money markets. When the interest rate rises, bond prices drop. When interest rates drop, bond prices rise. They’re similar to stock investments.
  3. Stock funds. These funds invest in corporate stocks; different funds focus on different types of stocks. Subcategories of stock funds include growth funds, income funds, index funds and sector funds.
  4. Target date funds. Otherwise known as lifestyle funds, these are for those who know when they’re going to retire. It’s a mix of stocks, bonds and other investments that shift over time based on when you’re going to retire.

Brokers come in the form of online brokerages, where you can manage your investments yourself, or through robo-advisors. Robo-advisors are good if you’re interested in letting your investments handle themselves, and good for both passive and active investors.

Costs vary depending on the broker you choose, but you might have:

  • Annual fees. Many companies have some sort of annual fee. It keeps the business running.
  • Transaction fees. Any time you buy or sell, you may get a transaction fee tacked on.
  • Advisory fees. If you use an online broker, someone is likely managing your account for you. A financial advisor earns their paycheck a few different ways, but fee-only advisors usually have your best interests in mind.

You can expect fees to be anywhere between 0.25% and 2% of your portfolio, depending on how much you invest and what type of investor you are. You can use the Fund Analyzer by FINRA to see how much fees can cost you over the life of your mutual fund investments.

Mutual funds are a great idea for quick diversification. By putting your money into a wide range of different types of investments, you lower your risk of losing a lot of money.

What is a stock?

Stocks are shares of a company owned by investors. You’re not the owner of a company, but rather, a small part-owner as a shareholder.

Compared to a mutual fund, stocks aren’t as diversified. This means that if you put all your money into one or a few companies, your risk for losing money is higher. However, if a company’s stock rises, so does your bank account.

If you’re looking to invest in stocks, it’s helpful to use an account that gives you the ability to pick and choose stocks that interest you. An online brokerage can provide this, but keep in mind that extensive knowledge of the market and trading are really important for handling stocks. If you’re just getting into the game, investing in individual stocks is a gamble.

Fees vary widely based on the broker you work with and how often you plan on making transactions. For brokerage accounts, you can expect fees for simply having an account, making transactions and someone managing your account. Some firms require account minimums, so make sure your account is padded before you sign up.

There are other ways to put your money in stocks, even for the most active investors. Since mutual funds consist of stocks, bonds and other types of securities, this is a great way to get introduced to stocks.

Which investment is right for you?

When you’re evaluating mutual funds vs. stocks, consider what type of investor you are. If you’re new to the game, mutual funds can carry less risk. If you’re an active investor and you watch your portfolio closely, it might be time to move up to something more aggressive.

Don’t be afraid to change your mind if you don’t feel you’re doing as well as you would’ve hoped. Investing is a long-term affair and you may need to adjust your strategy as your preferences and lifestyle change.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

Dori Zinn |

Dori Zinn is a writer at MagnifyMoney. You can email Dori here

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