How would you go about doubling $5,000 over 10 years? I recall talking to a woman whose strategy was to buy $10 worth of lottery tickets every week. Over 10 years, she “invested” $5,000 this way. I guess she wasn’t very lucky because after ten years, that $5,000 was gone.
I have never played the lottery because the odds of winning are so low. While some people think investing in the stock market is no different than playing the lottery or going to Vegas, I’m here to tell you that is simply not the case. Can you lose money investing in the stock market? Of course. But if you have a long time horizon and diversify your investments, your chances of ending up like the lottery lady are extremely low.
Do the Math
How long will it take to double $5,000? It depends how you invest the money. There’s a simple formula called the Rule of 72. You divide 72 by the average annual rate of return you receive on your investments, and that number is approximately how long in years it will take to double your money. For example, if you receive a 10 percent annual rate of return on your money, it will take 7.2 years to double.
Although the past is no guarantee of future performance, generally if you invest your money in a diversified stock fund that has very low fees, you can double your money in eight or nine years. In contrast, if you keep your money in a savings account or certificate of deposit earning one percent a year, it will take 72 years to double your money! So while the stock market carries more risk, at least you have the opportunity to grow your money.
From a tax perspective if you invest your money in a 401(k) or Roth IRA where your investment earnings can compound tax-deferred, you will double your money faster than if you invest your money in a brokerage account and have to pay taxes on investment earnings every year.
Open An Account
Your first step is to open an online IRA or brokerage account. There are many good online brokers, but I have been using TD Ameritrade for two decades (ever since I placed my first stock trade at age 24.) The online application takes about 10-15 minutes to complete.
Choose The Type of Account
Most online brokers allow you to open up a variety of accounts, so how do you know which one is best for you? For a beginning investor, here are the most common:
- Rollover IRA—Do you have an old 401(k) or 403(b) from a previous employer that is sitting gathering dust? Take this opportunity to open a Rollover IRA and transfer the money from your old plan into the new Rollover IRA account. There are at least seven reasons to do so and there are typically no fees or tax consequences if you complete the transfer in a timely manner.
- Roth IRA—If you are single and your annual income is less than $114,000 ($181,000 if married), you can contribute to a Roth IRA. Although you don’t get an immediate tax deduction, you won’t pay tax when you take out the money in retirement. Afraid of socking away money that you can’t access until retirement? With a Roth IRA, you can always take out your contributions without penalty (just not the investment earnings).
- Brokerage Account—This is the most flexible of accounts as your money isn’t tied up until retirement, although you do pay taxes each year on investment earnings.
Choose What To Invest In
I teach a class called, “How To Start Investing With Just $5,000.” In it, I identify commission-free and low-fee diversified mutual funds and exchange-traded funds (ETFs) that my students may want to consider in building a diversified portfolio. For a small investor, commissions and fees can have a huge impact on returns so it’s important to use an online broker that offers a wide variety of choices.
For most investors, I typically recommend a portfolio comprised of 80 percent diversified funds and 20 percent individual “fun” stocks. I say fun because it can be rewarding to invest in companies you are interested in following. Let’s say you and your friends love Coach purses or buy your cosmetics at Ulta—you might find it fun to become a shareholder and have partial ownership in these companies. Or perhaps you are interested in social media, solar power, or electric cars. As long as you keep the majority of your money in funds covering a wide range of assets classes and geographic regions, then investing a small amount of money in companies or industries you believe in can be fun and potentially profitable.
There are endless ways to invest, but hopefully this article has provided some basic issues to consider. While employees at online brokers are not generally permitted to give you specific investing advice, they can steer you to videos and tutorials that will help you identify the stocks, mutual funds or exchange-traded funds that are most appropriate for your personal situation. You can also find plenty of free online resources, and I list links to many of those free sites on my website.
How would you spend the money earned from investing? Tell me in a comment below!
DISCLAIMER: The information contained herein is strictly for educational and illustrative purposes, providing commentary, analysis, and opinions and should not be considered investment advice for any specific subscriber or portfolio or an offer to sell or a solicitation to buy any security.
Laurie Itkin is a member of the DailyWorth Connect program. Read more about the program here.