One of the most intimidating aspects of personal finance when you are just starting out in your career or beginning to get ahead is choosing an investment strategy that works. Unfortunately, we are all bombarded with "get rich quick" investment products and messages on almost a daily basis. It muddies the water and distracts from the reality that building wealth is a process that just doesn't come easily.
No matter what path you choose in investing or what anyone else tells you, the ultimate factor is time. You want your money to be subjected to the incredible force of compounding interest for as many years as possible.
What you choose as the vehicle to build your wealth is up to you, and honestly there are a lot of ways to do it. In our last investing article, we detailed some of the most basic investment terms and vehicles to create a foundation to build on.
This article is going to dive into the actual process of picking a strategy that works the best for your career and life.
Here are four important factors to consider while choosing an investment strategy:
1) What are your goals?
Just a few decades ago, the biggest reason for the average person to invest was pretty simple. You worked for a set amount of years while putting money into investment accounts, with the hope that you would be able to retire at the end of your career and live off of your various investments.
Today, things have changed drastically. Millennials in particular are rewriting the definition of what retirement actually means. Young people are wanting to retire earlier, work less and enjoy their families more, and also are willing to cut back on lifestyle costs to put more money away.
So, before you decide anything, you need to look at your life and career and decide what you want it to look like.
Do you want to retire early? Then you'll need to grow your retirement accounts as aggressively as possible and make sure your money isn't locked up in IRAs until you are 59 1/2.
If you want to take the traditional route, there are a range of investment options available to you. Your biggest goal would be to make sure you maximize your returns over time and make educated guesses on when you think you'll realistically want to retire.
2) See what options are readily available first
Of course, before you jump into any type of plan to build wealth through investing, you need to fully understand what options are available to you through your career path.
Does your company have an attractive 401(k) match? If so — that's essentially free money that you'll want to max out first before applying investment funds elsewhere. Also, how limited are the investment options within that 401(k)?
You might be working with a company that has an annuity-based retirement system, where you have no control over the funds that you contribute to retirement every month. If that's the case — there's a good chance that you'll want to supplement your retirement plan with an IRA that allows you to buy ETFs (exchange-traded funds), mutual funds, or individual stocks and bonds as you please.
If you're self-employed, you really have a wide range of options depending on your business income. The best strategy here would be to hire a great accountant that can guide you on what type of account(s) will work best to keep your taxable income low.
How much debt do you have? It's no secret that getting a degree in the mental health profession isn't cheap. Many mental health professionals have high student loan debt loads. When you are deciding what to do with money that you've set aside for investing, how do you know that you shouldn't apply it to your debt instead?
The answer is fairly simple: What's the interest rate on your loans?
If you have a higher interest rate at 6% or more, you might want to consider putting your money there first. Any time you pay off higher interest debt, you are keeping a lot of money that would have gone to interest in your pocket. So, paying off your debt is almost a guaranteed return.
If you look at stock market average returns over history, they have averaged anywhere from 7–12% (depending on the source you're reading). If you feel confident that you will outperform your student loan interest rate in the market, you might want to put your money there.
Just understand — investing is never guaranteed and there is a risk of losing your money, so make sure you take that into consideration when dealing with the debt vs. investing question.
3) Taxes have a huge impact!
Taxes are rarely on people's minds at the beginning of their careers, but if you ignore them, they can eat a hole into your investment returns.
That's why it's typically a good idea to use a "tax advantaged" investing strategy. Most commonly, that means putting money into designated retirement accounts like a Roth or Traditional IRA.
Very quickly, here's the difference between those two popular IRA choices:
Roth IRA: Money is taxed at your current income tax rate when you contribute money to the account, and then grows tax free until you take the money out at retirement.
Traditional IRA: Money is not taxed when you contribute to the account, but when you take it out at retirement it will be taxed at whatever tax bracket you fall into later down the road.
Why is this important? It has a ton to do with your investment strategy! When you are young, you generally are in a lower tax bracket, so the investment funds may be better served in a Roth IRA. That means that those funds will be taxed at a lower rate and then grow over the course of your career tax free.
If you opt for a traditional IRA, you are essentially betting that your tax bracket will be lower in the future than it is now.
It's always important to consult with a tax professional when making these choices, but know that even the best accountant can't predict future tax rates. You'll have to make the best informed decision you can and hope for the best.
4) Are you paying too much in fees?
You need to be aware that fees can eat away at your returns over time in a drastic way.
Every time you make a trade in your investment account, you'll have to pay a commission. Those $4 to $7 dollar fees might seem small, but they can slowly pile up to a huge amount over 30-plus years of investing. Buying and selling too often and based on impulse within your accounts is a good way to lose a large sum of money over time.
There are also management fees to consider. Mutual funds in particular are often packed with fees that you may not even know about, and your investments will suffer over the long term.
The popular personal finance site NerdWallet recently conducted a study that showed even a 1% fee could cost a young investor up to $590,000 over a 40-year investment period.
Bottom line—pay attention to the fees.
5) Do you want income, or growth?
This is a huge debate in the personal finance world right now. Buying dividend-producing stocks is a popular investment strategy because particular equities with a high-dividend yield (or amount paid to you quarterly in the form of cash) can essentially produce a passive income. That sounds great, right?
The rub is that historically, dividend stocks don't produce quite as much growth as other equities that don't pay a dividend. Some argue that while dividend income is nice, they would much rather own companies that reinvest those potential dividends back into the company so it can grow larger and more valuable (and in turn make your stock more valuable).
Like everything in investing, there isn't necessarily a "right" answer. Everything is based on your financial goals and what you are most comfortable investing in and understand the most.
Finally and above all else—never invest in a vehicle that you don't fully understand. You can create all of the goals and strategies that you'd like, but if you don't know what you're actually buying with your investment funds, you're probably going to lose money.