It's easy to be overwhelmed by new finance terms when you're just getting started - I was. People throw acronyms and three syllable words around like confetti and if you've never heard of a "brokerage firm" and other words you'll never use in scrabble, you just want to give up. To make it worse, these terms are often in totally different categories that don't match up at all. If you ask a forum to explain the difference between a Roth IRA and an Index fund, they'll tell you that the two have nothing to do with each other, aren't the same at all, why are you asking this, go read a book, give up. So you give up! I'd hate to see that though, so here is my attempt to break down the categories, so you're a little less lost.
1) Where do you put your money?
Bank - you know banks, you drive by them. You set up an account. Maybe they pay you a little interest. Maybe they charge you!
Brokerage firm - Another place to set up an account. The big ones are Fidelity, Vanguard, and Schwab. The difference is that once you have an account with a brokerage firm, you get to buy and sell investments. You'll get to look at your account and it will show all your "positions" - stocks or funds you own that are going up and down.
2) What type of accounts do you have?
At a bank, you might get to choose between a checking and a savings account. Some banks offer "high yield" savings accounts that pay a little more interest, but they're all the same in that you put money in, and then you have no more choices to make. It does what it does.
At a brokerage firm, your first account is probably a basic brokerage account, sometimes called "taxable brokerage". That's because you'll pay taxes on the gains you make. You might be paying taxes on your savings accounts already too, if they pay enough interest. Do not freak out about this, at the end of the year you'll get a nice 1099 form from the firm that says how much you earned, you enter that in your tax software or hand it to your tax person and they'll do the rest. It is really common. And while you do have to pay taxes, you're only paying on the gains, so if you made $100 and have to pay $20 that's not bad. You're $80 ahead!
Some people make tons of money buying and selling stocks, so they are REALLY looking to reduce taxes, that's why you hear a lot about tax strategies in financial forums. So you might also see accounts like these available from a brokerage - this isn't a full list, just meant to get you started:
Cash management - a taxable brokerage where you can invest but also take money in and out easily, maybe even tie a debit card to it. That last bit makes me nervous but I do have a taxable brokerage account with some investments so I can take the money out any time.
Traditional IRA - an investment account that might let you write off what you put into it if your income is low enough. You can buy investments, and pay taxes on the gains years down the road when you withdraw funds from the IRA. I do not have this.
Roth IRA - an investment account that does not let you write off your deposits ("contributions"), but you never have to pay taxes on the earnings. They're a great deal. You can only put so much in per year, like $7K, so you hear people talking about "maxing out the Roth" and that's what they mean. The max changes every year. I do have a Roth IRA, but I have never taken money out of it, I try to avoid that. If your income is high enough, you can't make deposits into a Roth IRA.
HSA - Health Savings Account. You write off your contributions, never pay taxes as long as it's used for healthcare, never pay taxes on the gains, so we love these! I do have an HSA. I use it as an investment account, and I'm not using it for healthcare anymore. I figure someday down the road I will need it, maybe in retirement.
401K - an investment account that is funded with all pre-tax dollars. You pay taxes much later. These also have an annual limit, and a lot of employers match contributions to them, so they're another great deal. I have a 401K, too.
3) What do you own within the account?
Once your account is set up and you put money in it, it's probably sitting in a "cash" position. With a savings account at a bank that's it, you're done. They'll pay you some small amount of interest.
With investment accounts, you can make trades.
You can pick a stock, like Apple, Costco or Petsmart. Look up the symbol and buy a share, hope it grows! I am not good at this, so I don't do it very often. I bought Costco this year, but the vast majority of my investments are index funds.
Some people buy a stock every day and hope it goes up in a few hours. These are day traders. You can day trade with any account, but to me it feels like gambling, and people can lose a lot of money quickly, so I don't do it.
An Index Fund is traded like a stock, but it's like a thousand stocks in one. At Fidelity you might buy FZROX, at Vanguard you might buy VTSAX. These funds all contain thousands of stocks, so when you invest in it, it's like you just bought the whole market at once. I like these because I don't have to research companies, if one goes bankrupt it's no big deal because I own them all, and the stock market has historically, over time, gone up. Sometimes it goes down, but it has always recovered, I just keep my money in there and relax.
You might hear about ETFs - index funds that are priced throughout the day. For long term investing I do not care about little fluctuations during the day so I don't care about the differences between index funds and ETFs.
By default, Fidelity stores untraded cash in a money market fund like SPAXX. The interest (yield) on this is pretty good, better than a lot of HYSAs, so I leave a lot just sitting in the money market. But it won't grow as much as an investment. So once I have funds in my Roth IRA, I buy FZROX with it and let it grow.
Don't be intimidated by words you don't know around investing. Everything is googleable, you can ask in groups, you will learn! It's great to experiment with a few hundred dollars before you make big moves on anything. You'll read horror stories about people who save up a 401K for years, then lose it all day trading because they never took time to slowly learn about investments. Investments are a great thing to slowly learn about, like all money concepts. Do small things, see what works, and it will all be in your head eventually.
When I was in university, I took a Finance course, and there was one lecture that briefly covered the stock market, investing etc. Well, the poor professor was absolutely BOMBARDED with questions - to the point where he said - ok - we will spend today going over this, instead of moving on.
ReplyDeleteAnd he spent the hour explaining how stocks work, what "shorting" a stock means, what "going long" means and SO much of the jargon. He explained the difference between stocks, mutual funds and index funds - and briefly touched on "spyders" - ETF index funds were JUST starting to be a thing. He explained "dollar cost averaging" and showed us how individual stocks were subject to big fluctuations - but overall "the market" generally continued to rise over the years.
What I got out of that lecture - and what his recommendation was - is that if you don't want to spend a BUNCH of time researching individual companies and stocks and trying to time the market - the best thing to do is to buy index funds. And that's what I've done, basically - and I noticed my 401k statement this month - shows my "cost basis" is less than 50% of my current investment value - so it's been working for me!