How to Choose Your Investments

Investing is the only way to build enough of a nest egg for your retirement. Saving alone isn’t enough - it’s better to invest what you have.

How often do we avoid doing something because it seems complicated? Maybe it’s the new computer you’ve neglected to set up or the new pressure cooker you’re afraid to use. Maybe it’s the home improvement project that you’ve been promising to start for a year. But inevitably, once you get started, you’re able to find your way.

So why aren’t you investing?

It’s understandable. Investing has always been seen by the public as black magic, best left to the wizards in advisory positions and Wall Street offices. Maybe that’s why one in four workers don't have enough saved for retirement. In a world where the future of Social Security is in doubt, that’s a very, very worrying statistic.

But here’s the honest truth: choosing investments is only as complicated as you make it. It’s a lot like exercise. You can research kinesiology and perfectly tailor your workout routine to shape and tone your body to its fullest potential - or you can just jog a few times a week. Both options will make you healthier, and both are leaps and bounds better than staying on the couch.

So whether you’re looking to become the next Warren Buffett or just grow your finances modestly, read on for a guide on choosing the right investments for you.

Which investment vehicle to choose

IRAs

When it comes to saving for retirement and investing, there are two main vehicles: 401ks and IRAs.

IRAs are Individual Retirement Accounts that anyone can open and fund with earned income, up to $5,500 a year. Those 50 and older can contribute an extra $1,000 each year. The two types of IRAs are Roth and traditional. A traditional IRA is one that allows users to deduct the annual contributions on their taxes for that year.

When the retiree is ready to withdraw from their traditional IRA, they’ll be taxed on that income. You can open a traditional IRA if you’re 70.5 years of old or younger and have income earned from employment. Traditional IRAs also require minimum distributions, which must be taken starting at age 70.5.

A Roth IRA provides no current tax benefits, but withdrawals can be made tax-free. Roth IRAs are also not subject to required minimum distributions

401Ks

The 401k is an employer-sponsored retirement plan that can only be opened once your workplace determines that you’re eligible for one. Not every company provides a 401k, but it is a common benefit. Nonprofits offer 403bs as their retirement plan, but these function similarly to a 401k. Like IRAs, 401ks also come in traditional and Roth options. There is a $18,000 annual limit for 401k contributions, not including what the employer may add.

A 401k is popular because some companies match their employee’s contributions, essentially giving them free money for retirement. Company policies vary widely, from 100% matching on all contributions up to the annual limit or 0% matching. If you’re eligible for a 401k and have not opened one, talk to your HR department about your matching options

Be sure to ask when the employer’s contributions will be vested. A vesting schedule explains when you’ll receive partial or complete access to your employer’s money. For example, a five-year graded vesting schedule means you’ll get 20% of the employer contributions for each year you stay with the company until you reach 100% in five years.

How to choose

Employer matching is one reason why 401ks are so popular, but there’s a hidden side to 401ks: they often have high fees and a poor selection of funds to choose from. Your company has to provide a list of funds that are available in the 401k, including information about their fees, so do your research.

In general, many experts recommend choosing a Roth IRA or 401k if you’re young and anticipate having a higher income during retirement. Remember, the amount you withdraw from your retirement account is classified as income. You won’t see the tax break now, but you’ll be grateful for it when you’re older.

However, if you’re already in your late 30s or 40s, you might be better using a traditional IRA or 401k. If you find yourself getting a huge tax refund because of the traditional IRA or 401k deductions, use that windfall to bolster your retirement accounts even more.

Which investments to pick

People who barely know anything about investing might hear about Snapchat going public or Amazon shareholders earning thousands. Don’t be fooled - owning individual stocks is not for the novice investor. People in this situation are better off buying a mutual fund or ETF.

It’s risky to own an individual stock, even if it’s a famous company like Apple or Microsoft. A company can collapse at any point, so you’re not protected if you have thousands of dollars tied up in one firm.

That’s why most personal finance experts recommend having a diverse basket of funds in your retirement account, like a low-fee index fund specializing in large US companies. An index fund might hold hundreds of companies in one share, providing you the kind of diversity you can’t get with one Tesla stock.

In general, an index fund follows one index, such as the S&P 500. It tries to track that index as much as possible, and the index serves as a benchmark.

Billionaire Warren Buffett has repeatedly come out in favor of index funds, citing their reliability, low fees and diversity. He even once bet a Wall Street firm that his index fund would outperform their actively managed investments over the course of a decade. Buffet is currently winning that bet.

Before buying up the first index fund you find, look at the fees it charges.

In general, you never want to pay more than 1% in total fees. While 1% might seem like a small sum to pay in exchange for investing, the index fund you choose might only earn between 5-8% total in returns, so paying 1% is actually giving up 20% of your total earnings. Not worth it, right? Firms like Vanguard and Schwab often have funds with low fees with good reputations, so you won’t be paying extra for a quality investment.

How to get help

If reading about stocks and mutual funds isn’t your idea of a good time, you might be ready to hire afinancial planner. A fee-only financial planner can look over your budget, provide financial advice and manage your retirement accounts. You can find a licensed, reputable planner through the National Association of Personal Financial Advisors

If you’re getting a recommendation from a friend or coworker, ask if the financial advisor charges a set fee or a percentage of your assets. A fee-only planner is more likely to be a fiduciary, which means they’re obligated to choose the funds that work best for you - not the ones that will earn them more money.

Another option is to go with arobo advisor, like Betterment or Wealthfront, which will determine which investments make the most sense for your goals, age, salary and risk tolerance. Many robo advisors have a low minimum threshold, and most have fees that are comparable to other investments. Plus, robo advisors are designed for the app-friendly millennial generation and are easy to set up.

Investing in the abstract

Research shows that people, especially millennials, are afraid of investing. Having grown up during the tech-stock crash of the early 2000s and the Great Recession, millennials have seen the stock market crash more than any generation since the 1930s. That’s a shame, because the power of compound interest ensures that those who invest earliest end up seeing the biggest returns.

A lack of knowledge about investing is a big reason for this trend. Personal finance is already intimidating, and investing is even scarier. To become comfortable with investing, you have to accept that the market will go down at some point during your life. However, it will also rebound.

The best investors aren’t the ones who buy a stock before it becomes huge, but the ones who stick with their investments even when newscasters are predicting doom and gloom.

“All of the math and logic on the Internet won't help you stick with your plan if your emotions make you sell out every time the market drops 15%,” said early retirement expert Doug Nordman of The Military Guide.

The bottom line

Before you start investing, remember that there will be times when the market will decline and it will seem as if your entire life savings has been destroyed. But people who keep their money in the market during the slow times will eventually recover and do better than if they had withdrawn.

If you think you’ll have trouble maintaining a level head in dicey market situations, consider hiring a financial advisor. Not only can you trust them to choose the best investments, but they can calm your fears and remind you to embrace a long-term outlook. There’s nothing better for calming anxieties than talking to an expert who’s been around the block a few times.

Talk to a financial advisor about your situation to see if you’re doing enough with your IRA or 401k. They’ll also be able to help you pick investments and make sure you’re on the right path.