1. Your style – How much time do you want to put into investing your money?

The investing world has two major camps when it comes to the ways to invest money: active investing and passive investing. We believe both styles have merit, as long as you focus on the long term and aren't just looking for short-term gains. But your lifestyle, budget, risk tolerance, and interests might give you a preference for one type.

Active investing means taking time to research investments yourself and constructing and maintaining your portfolio on your own. If you plan to buy and sell individual stocks through an online broker, you're planning to be an active investor. To successfully be an active investor, you'll need three things:

  • Time: Active investing requires lots of homework. You'll need to research investment opportunities, conduct some basic analysis, and keep up with your investments after you buy them.
  • Knowledge: All the time in the world won't help if you don't know how to analyze investments and properly research stocks. You should at least be familiar with some of the basics of how to analyze stocks before you invest in them.
  • Desire: Many people simply don't want to spend hours on their investments. And since passive investments have historically produced strong returns, there's absolutely nothing wrong with this approach. Active investing certainly has the potential for superior returns, but you have to want to spend the time to get it right.

On the other hand, passive investing is the equivalent of putting an airplane on autopilot versus flying it manually. You'll still get good results over the long run, and the effort required is far less. In a nutshell, passive investing involves putting your money to work in investment vehicles where someone else is doing the hard work — mutual fund investing is an example of this strategy. Or you could use a hybrid approach. For example, you could hire a financial or investment advisor — or use a robo-advisor to construct and implement an investment strategy on your behalf.

How investments can earn you money

When the value of your investments goes up

You can earn money when your investments increase in value. For example, a stock’s market price won’t stay the same price forever — ideally, the company grows and makes money, and it becomes more valuable overall. Then, because that total value gets spread across all the company’s shares, the market price per share usually goes up.

For example, let’s say the market price of company X’s stock is $5, and you buy ten shares of it. The value of your investments is 10 x $5 = $50. But then let’s say company X performs well, and its stock is now selling for $6. Well, you still own ten shares of it. That means the value of your investments is now 10 x $6 = $60.

You only paid $50 originally, so if you were to sell those shares, you’d have $10 more than you started with. That means you’ve earned $10 in returns.

When you get paid because you own the investment

You can also earn money from an investment by collecting payments. For stocks, those payments are usually dividends.

For bonds, you get those interest payments we mentioned. Let’s say you buy a bond for $100 that pays 3% interest for 10 years. Each year, you’d be paid $3. At the end of ten years, you’d get your $100 back and have received a total of $30 in interest.

Then, the money you’ve made could make you even more money

That’s thanks to compounding returns, which have historically been super powerful. Basically, when you invest your money, it hopefully earns returns, and then the returns you’ve earned can also earn returns of their own. This can also go the other way during down markets, but over the long term, markets have historically trended upward. Here’s a more in-depth explanation of how compounding works.

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Your Investment Style

Before you dump $1,000 (or any other sum) into an investment, spend time thinking about your investing style. For the most part, your investing style is determined by considering:

  • Timeline to invest
  • Whether you need easy access to your money
  • Appetite for risk
  • General interest in learning about investing

If you want a third party to do most of the work for you, then there’s a good chance a robo-advisor, like Betterment, is what you need.

After all, Betterment charges low fees, yet uses technology to make smart investment decisions for you. You can open a Betterment account, set it up to be funded regularly, and (mostly) leave it alone. If you’d rather spend your time and energy on your career or your hobbies, going this route is a good choice.

That said, some people prefer the do-it-yourself option. This can make sense if you want to learn more about investing by being hands-on so you become a better investor over time. It’s also a sensible path if you just want to understand the inner workings of common investment strategies. If you think you’d be better off as a DIY investor, then investing in ETFs, managing a BlockFi account, or investing with Fundrise might be better options.

Where to Start Investing

One of the most important steps to getting started with investing is deciding where you’ll actually invest. Today, there is no shortage of brokerage firms where you can start investing quickly. NextAdvisor recommends online brokers like Vanguard, Fidelity, and Schwab because they make it easy to open an account online and have a wide variety of investments to choose from.

For investors who prefer a more hands-off approach, a robo-advisor is also something to consider. When you sign up for a robo-advisor like Betterment, Wealthfront, or Ellevest, an algorithm chooses investments on your behalf based on your financial goals and time horizon. This option might be well-suited to investors who don’t know what to invest in and are allowing analysis paralysis from allowing them to take the next step.

Just as it’s important to talk about what company to open an account with, we should also talk about what type of account to open. While a taxable brokerage account is a great option, experts agree that investors take advantage (and max out) all their retirement accounts first, to take advantage of the tax breaks associated with them. For example, a Roth IRA.

“I do recommend that, especially for young people, that they consider their first investment to be in a Roth IRA account,” Berkowicz said. “They provide for tax-free distributions, both during the lifetime of the contributor and for their heirs.”

A Roth IRA can be a great option for everyone from the teenager working a few hours per week to earn money to the professional who is ready to take investing more seriously. And for those who make more income than the Roth IRA allows, a traditional IRA also allows investors to save for retirement in a tax-advantaged way.

Rate of Return

Photo credit: © iStock/Farknot_Architect
Photo credit: © iStock/Farknot_Architect

When you’ve decided on your starting balance, contribution amount and contribution frequency, your putting your money in the hands of the market. So how do you know what rate of return you’ll earn? Well, the SmartAsset investment calculator default is 4%. This may seem low to you if you’ve read that the stock market averages much higher returns over the course of decades.

Let us explain. When we figure rates of return for our calculators, we’re assuming you’ll have an asset allocation that includes some stocks, some bonds and some cash. Those investments have varying rates of return, and experience ups and downs over time. It’s always better to use a conservative estimated rate of return so you don’t under-save.

Sure, you could count on a 10% rate of return if you want to feel great about your future financial security, but you likely won’t be getting an accurate picture of your investing potential. That, my friend, would lead to undersaving. Undersaving often leads to a future that’s financially insecure.

Risk and Returns

Photo credit: © iStock/HAKINMHAN
Photo credit: © iStock/HAKINMHAN

The closer you are to retirement, the more vulnerable you are to dips in your investment portfolio. So what’s an in investor to do? Conventional wisdom says older investors who are getting closer to retirement should reduce their exposure to risk by shifting some of their investments from stocks to bonds.

In investing, there’s generally a trade-off between risk and return. The investments with higher potential for return also have higher potential for risk. The safe-and-sound investments sometimes barely beat inflation, if they do at all. Finding the asset allocation balance that’s right for you will depend on your age and your risk tolerance.

#4: Open a Roth IRA

Risk level: Varies

A Roth IRA is a type of investment account that lets you invest after-tax dollars for retirement. From there, your money can grow tax-free, and you can withdraw your funds without having to pay income taxes once you reach retirement age. For 2022, the maximum contribution amount across IRA accounts is $6,000 for most people. However, individuals ages 50 and older can contribute up to $7,000.

How It Works: Income caps limit who can contribute to a Roth IRA, but note that contributions are phased out completely for single filers who earn more than $144,000 and married couples who earn more than $214,000.

Where to Get Started: Eligible investors can open a Roth IRA with any brokerage account that offers this type of account. Some of the most popular brokerage firms that offer Roth IRAs include Betterment, Stash, M1 Finance, and TD Ameritrade.

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Who It’s Best For: Investing in a Roth IRA makes sense for anyone who’s saving for retirement or a future goal. This type of account is also ideal for anyone who wants to set up a tax-free income source for their retirement years.

Pros
  • Your money grows tax-free and you can withdraw funds without paying income taxes in retirement
  • You can withdraw contributions (not earnings) at any time without penalty
  • Most brokerage firms make opening a Roth IRA a breeze

ConsLow annual contribution limitsIncome caps limit who can use this accountYou invest with after-tax dollars, meaning you cannot deduct your contributions the year you invest

What should you invest your money in?

Here's the tough question, and unfortunately there isn't a perfect answer. The best type of investment depends on your investment goals. But based on the guidelines discussed above, you should be in a far better position to decide what you should invest in.

For example, if you have a relatively high risk tolerance, as well as the time and desire to research individual stocks (and to learn how to do it right), that could be the best way to go. If you have a low risk tolerance but want higher returns than you'd get from a savings account, bond investments (or bond funds) might be more appropriate.

If you're like most Americans and don't want to spend hours of your time on your portfolio, putting your money in passive investments like index funds or mutual funds can be the smart choice. And if you really want to take a hands-off approach, a robo-advisor could be right for you.

What is the $1,000 per month rule?

The $1,000 per month rule is a simple metric used by financial planners to determine how much money an investor needs to have in savings to generate a pre-tax income of $1K per month for 20 years during retirement.

Assuming a deduction rate of 5%, savings of $240,000 would be required to pull out $1,000 per month:

  • $240,000 savings x 5% = $12,000 per year or $1,000 per month

While the rule is easy to use, it’s based on a couple of assumptions that may or may not be correct. 

First, the rule assumes the savings amount doesn’t change at the same time deductions are being made. For example, there’s volatility risk to consider if the funds are held in the stock market. If the stock market drops by 10% in 1 year, savings would decline to $216,000. 

Secondly, $240,000 will last 20 years (ignoring interest) if $12,000 is deducted each year. After 20 years the money runs out, and so does the $1K per month in income, assuming that the savings balance doesn’t increase. 

But what happens if an investor wants to have his or her cake and eat it too? In other words, is there a way to generate an income of $1,000 per month without tapping into a nest egg? 

Happily, the answer is “Yes!” In the next section, we’ll discuss 5 strategies that may help you make $1K per month while still keeping those hard earned savings intact.

And here’s the good news

Stocks go up and stocks go down — like really up and really down. The “stock market” is is just the collective value of all the stocks investors own, so it goes up and down, too. In fact, the market’s biggest one-year gain since 1928 was 52.6%, and its biggest one-year loss was -43.8%. But. (And this is a big but.) The market has, on average, returned 10%. 10-year government bonds have returned an average of 4.8%. In comparison, the average savings account currently pays 0.09% per year. That’s why investing can help investors get to their goals faster than saving alone.

Ready to get started?

Invest in Rental Properties

Buying rental properties is a popular real estate investment strategy used to generate passive income.

For rental properties, the rate of return will depend on your specific area, vacancy rate, whether you are taking out a mortgage to buy the property, and many other factors. In general, most real estate experts agree that the expected yearly return in rent will be around 10% of the property’s value in the USA.

We then have to take into consideration maintenance costs, so let’s assume that apart from the maintenance costs, you make a yearly net profit of 8%.

In this case, you’ll need to invest roughly $450,000 in a few properties to make $3,000 a month. Here’s how we calculated this number:

  • If we want $3,000 a month, then we want $36,000 per year ($3,000 x 12 months).
  • If we invest $450,000 in rental properties that generate 8% annual returns, then we can get that $36,000 per year (8% of $450,000 is $36,000).

On top of the rent that you’ll be collecting each month, your properties could continue to appreciate in value, so if you decide to sell them in the future, you would also make a profit on the sale.

Alternatively, you could buy properties with mortgages, paying less upfront. That means you also generate less profit, as you have to pay for your mortgages. The upside here is that someone else is paying your mortgage for you – your tenant. A good strategy to consider in this case would be house hacking – investing in a larger property, keeping one part of it for yourself to live in, and renting out the remaining space.

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