Investing in mutual and index funds
Mutual funds combine money from multiple investors and use it to invest in a variety of securities such as stocks, bonds, and other assets. This can reduce risk through diversification. Even if some companies in a fund decline in value, others could rise, offsetting each other. In addition, mutual funds can be a relatively low-cost and straightforward way to get into the stock market.
Mutual funds come in a range of flavors. One significant difference is whether fund management is active or passive. Active managers try to outperform the market. Actively managed funds tend to have higher expenses than passively managed funds, as you're paying for the manager’s expertise.
Index funds are a subset of mutual funds. Their goal is to mimic a stock index, such as the S&P 500. Because the fund managers aren’t trying to beat the market—in other words, they’re passive—they don't engage in as much research as active fund managers. As a result, index funds tend to be less expensive than actively managed funds.
“All the academic research suggests index funds outperform actively managed funds after fees and taxes,” Miller says.
Robo-advisors offer a newer way to invest in stocks, money market funds, and other assets. Instead of relying on a human to manage the fund, they use a computer algorithm to decide how to invest. You may not get as much human interaction as you might expect from a human manager, but the trade-off is typically lower management fees.
Investing in a retirement account
A significant goal for most investors is saving for retirement. Common ways to save for retirement are through 401(k) or 403(b) plans, which are offered by employers, and Individual Retirement Accounts, or IRAs.
Your investment options for your 401(k) plan are determined by your employer. Many offer a range of mutual funds. In deciding how to invest, compare the net expense ratio, says Mike Schupak, CFP, with Schupak Financial Advisors in Jersey City, New Jersey. Typically, you'll want to stick with reputable funds with lower expense ratios.
One red flag to look out for is if your employer offers the company's own stock in its 401(k) plan. In most cases, you don’t want to invest in your employer through your 401(k). “It’s great to believe in the company you're working for, but your future paychecks already are dependent on your employer,” Schupak says. If you also invest in your company through your 401(k), you risk both your salary and your retirement savings.
IRAs offer more flexibility than most 401(k) plans, Schupak says. You typically can invest in stocks, bonds, mutual funds and other types of securities. As a result, you should be able to find investments that fit your needs in an IRA. However, one of the downsides of IRAs is the lower contribution limits. For 2021, you can contribute up to $6,000 per year to a traditional or Roth IRA if you’re under age 50 or $7,000 if you’re over 50. In contrast, the 2021 annual contribution limit for a 401(k) or 403(b) is $19,500.
Investing in a brokerage account
In addition to investing in a retirement account, you can also buy and sell securities in a brokerage account. Brokerage accounts are similar to bank accounts in that you can transfer money in and out, but you also have access to stocks and other investments. Before you can buy securities, you’ll need to fund the account by transferring money from a bank account or another brokerage account. Alternately, you can fund it by mailing in a check.
The tax treatment is different for a brokerage account versus a retirement account. Unlike a retirement account, brokerage accounts carry no tax advantages. But you can usually withdraw money from a brokerage account without penalties. You’d need to wait until age 59½ to withdraw money penalty-free from most retirement accounts.