10 More Investing Questions Explained in Plain English

  • By Karen Carr, CFP, Society of Grownups
  • May 11, 2016

Our first basic investing primer was hugely popular, and for good reason: Investing seems largely out of reach to many people (and Wall Street has especially shut out women). But investing doesn’t have to be inaccessible or scary if you have basic knowledge to bolster your confidence. Here, we build on what you learned in our first installment of basic investing questions so you can start growing your net worth.

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1. What are blue-chip stocks?
Blue-chip stocks are stocks from public companies that have strong reputations, often household names like Microsoft and General Electric. Blue-chip stocks come from companies with demonstrable ongoing success that typically deliver good returns for their shareholders over time. But don’t let that fool you into thinking that these companies are infallible or unaffected by the market at large. They, too, can have bad quarters or bad years. But overall, blue-chip stocks are often seen as solid bets.

2. What’s day trading? Is it for me?
Day trading is pretty much what it sounds like: buying and then selling stocks (or other financial instruments, like bonds or mutual funds) in the same day. In general, day traders make their money by investing large sums and taking advantage of small fluctuations in stock prices. These investors are also called “speculators,” since their primary goal is to turn a quick profit.

Day trading is risky and not for the faint of heart. For a long time, it was primarily something done at big financial firms or by full-time, professional speculators. Today, with the rise of electronic trading, more and more hobbyists are giving it a go. That said, it’s probably not the right place for a beginner investor to get started — and it also comes with big tax implications. Whatever you do while investing, don’t be lured by the idea of “beating the market.” Studies show that it’s essentially impossible.

3. What is hedging?
Sometimes people talk about hedging as a form of “insurance” for an investment (think of the expression “hedge your bets”). A perfect hedge would take 100 percent of the risk out of a portfolio, but in the real world, that’s more of an ideal than something that can actually be achieved.

One of the ways that people go about hedging is by buying derivatives, which are investments designed to balance risk. An investor might put some of their investment into derivatives to balance out the risk of their portfolio. If you’re concerned about your level of risk, you can bring this up with your financial advisor.

4. Should I pay off my debt before I invest?
The paying off debt vs. investing question comes into play only if you have extra cash on hand. That means you’re paying at least the minimum on your debts, covering your other expenses, and still have money left over.

If you do have extra money, first consider how much your debt is costing you by finding exactly how much you owe and what the interest rates are. Use a debt repayment calculator to crunch the numbers on how much interest you will pay over time on your debt. And consider whether you’ll receive a tax deduction for paid interest that saves you even more, like in the case of student loans and mortgages.

Next, decide if the potential return on your investment outweighs the cost of your debt. For example, investing money in your 401(k) that you project to earn a 7 percent return makes investing more attractive than paying off a student loan at 4 percent interest. You still come out ahead if the investment return you’re expecting comes to fruition. However, the credit card interest — which is likely much higher — pales in comparison.

5. I have some money to invest. Where should I start?
When getting started with investing, it’s a good idea to educate yourself on the options available and narrow down your goals. If you work at a company with a 401(k) or 403(b) or similar retirement plan, you should strongly consider investing in these first. This is especially true if your company offers a match of any type, since that’s free money.

It’s smart to max out these types of accounts before you start to consider other types of investment accounts. In 2016, the max you can contribute to a 401(k) is $18,000 ($24,000 if you’re 50 or older). Then consider an IRA, since like a 401(k), these types of accounts have special tax incentives attached to them (read: they can save you money). The max you can contribute to an individual IRA in 2016 is $5,500 ($6,500 if you’re 50 or older).

6. How do I evaluate an investment?
The basic goal of an investment is to make money, right? So you want to look for opportunities where the upside (aka potential to make money) is as high as possible, while balancing risk. You always have the option to pick individual company stocks or bonds, but that can be tricky. One common tool to get around that trickiness is a mutual fund or an exchange-traded fund (ETF). They offer portfolios with a bunch of investments that you might not be able to buy on your own given your resources. So, rather than buying one share of Apple stock, you can invest in one share of a fund that invests in a much larger portfolio of large U.S. companies (including Apple). This means you don’t have to be a stock-picking genius who can spot the next big thing. You spread your investments around a lot more and temper your risk.

When evaluating a mutual fund or ETF, take a look at a site like Morningstar.com, an independent research tool for investments. Consider the fund’s Morningstar Category to get a better idea of what type of investment you are looking at.

Next, look at the fees associated with this investment. The annual fees, also known as an expense ratio, are expressed as a percentage of your total investment. For example, an expense ratio of 0.50 percent means you will pay $5 annually to invest $1,000 in this fund.

Lastly, consider the past performance of the fund you’re looking at. Even though past performance isn’t a perfect indicator of what will happen in the future, it can give you a sense of how the value of the fund has grown or fallen over time and what the overall trends look like.

7. Where can I go for investment advice?
The investing world can be a noisy one, with lots of different advice and opinions coming from every direction. If you’re looking for more help and advice on how to invest, you may want to consider a “robo-advisor,” which uses sophisticated algorithms to automate the investing process. These digital tools evaluate your tolerance for risk, design an investment strategy accordingly, and rebalance your portfolio for you. They offer a hands-off approach to investing for people who don’t want to manage everything on their own — and they tend to be much more affordable than a traditional money manager. If you want some face time with an actual human, check out the National Association of Personal Financial Advisors to find an advisor. Not sure what to ask? Start here.

For more advice, read up on how to invest when you don’t have much to invest, how to build wealth at every stage of your life, and what to do when the stock market crashes. Find out why “boring” investments aren’t a bad thing and what socially responsible investing is.

8. What is the minimum amount of time I should plan to let my money sit in an investment account?
A balanced portfolio held over the long term often outperforms frequent trading, so it’s important to let the market take its course and not make knee-jerk decisions.

You also want to consider the tax consequences of selling any investments held in taxable, non-retirement accounts. If you sell an investment you’ve held for one year or less, any gains on that investment will be taxed at your ordinary income rate. But if you hold on past the one-year mark, the gain is taxed at the capital gains rate of 15 percent, which is much less for most people.

9. How do I know if I’m ready to invest? Is there a financial threshold you should aim for?
No, there’s no magic number that you need to hit to know you’re ready to invest. As long as you can cover your necessary expenses comfortably and have some sort of cushion or rainy-day fund, it’s a great idea to put as much into these types of retirement accounts as you possibly can (up to the yearly limits). There’s no hard-and-fast rule about how much money you should have before you start to invest, but as long you’re meeting your day-to-day needs and have a way of dealing with any major emergencies that may arise, putting your money to work for you is a great idea.

10. Should I invest in increments, or all at once?
A lot of people find that it can be a little uncomfortable to start investing money if they’re used to bringing home a certain amount each paycheck. To get started, you might want to dedicate, say, 5 percent of your income to investing. Over time, you can increase that number. A good retirement calculator will give you a sense of how much you need to be investing on a monthly or yearly basis in order to reach your goals. You don’t have to go from zero to 20 percent overnight, but the earlier you start to save, the more you’ll benefit over the long run.

The information in these materials is only intended to provide general education. It's not legal, tax, or investment advice, and may not apply or be useful to your specific financial situation. If you need recommendations geared to your personal financial situation, schedule time with a financial planner. Any third party resources or websites referenced above are not under Society of Grownups’ control. We cannot guarantee and are not responsible for the accuracy of the resources, websites, or any products or services available through such resources or websites.

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How to Invest When You Don’t Have Much to Invest
How to Build Wealth at Every Stage of Your Life
What Is Socially Responsible Investing?