Let’s look at some of the most well-known investment options.
- Real estate
- Retirement accounts are tax-advantaged accounts.
Stocks are good investments for nearly everyone
Stocks are a must-have for almost everyone. Stocks have been the best option for building wealth over the long term. Over the past 40 years, U.S. stocks have provided better returns than savings yields and bonds. Over the past 100 years, stocks have outperformed all other investment types.
Why are U.S. stocks such good investments? You own a company and your stockholder status means that you can make more money. Many times, shareholders also receive a dividend.
The past dozen years can be used as an example. The S&P500 has provided better returns than bonds or gold, even during two of the worst recessions in history.
Stocks should be the foundation of most portfolios.
A person in their 30s who is saving for retirement could ride out market volatility for decades and own nearly all stocks. A person in their 70s should have some stocks to grow; an average American 70-something will live until their 80s. However, they should invest in bonds and hold cash to protect the assets they will need over the next five years.
Stocks come with two major risks:
- Volatility Stock prices are subject to large swings in very short periods. If you have to sell your stock within a short time, this can pose a risk. Learn more about market volatility.
- Permanent losses. Stockholders can be considered business owners. Sometimes businesses fail. Bond owners, vendors, suppliers, and contractors will get the most repaid if a company goes under. Stockholders receive whatever, if any, is left.
Understanding your financial goals will help you limit your risk.
You should not be trying to maximize growth if your child is going off to University or you are retiring in the next few years. Instead, you should protect your capital. It is time to move the money you will need over the next few years from stocks into bonds and cash.
You can avoid volatility if your goals are years away. Stocks delivered amazing returns to investors who held them, even though the two worst market crashes in history.
Permanent losses can be avoided
A diversified portfolio is the best way to avoid permanent loss. You shouldn’t have too much wealth in one company, industry, or end market. Diversification will limit your losses to just a few poor stock picks. However, your top winners will more than compensate for them.
Consider this: If you have the same amount of capital and 20 stocks fail, your maximum loss is 5%. Let’s suppose one of these stocks rises in value by 2,000%. This would double your portfolio. You can avoid permanent losses while diversification will allow you to be exposed to wealth-building stocks.
Why bonds are a good investment
Growing wealth over the long term is the most important thing. Once you have built your wealth and are closer to your financial goals, bonds can help you keep it. These loans are to a government or company.
There are three types of bonds.
- Corporate bonds are issued by companies.
- Municipal bonds are issued by the state and local governments.
- Treasury Notes, Bonds, and Bills issued by the U.S. Government.
This is an example of how bonds can make good investments. It uses the Vanguard All Bond Market, which owns both short- and longer-term bonds, and also the IShares 1-3 Year Treasury Bond, which owns the most stable Treasury bonds, in comparison to the S&P500 Trust:
How and why to invest in property
Furthermore, like great companies, having high-quality, productive property can be a great way to build wealth. In most recessionary periods through history, commercial realty is anti-cyclical to downturns. It is often considered a safer and more stable investment than stocks.
The most accessible way to invest is through publicly-traded REITs (or real-estate investment trusts). Just like all public companies, REITs trade on stock exchanges. Here are some examples.
- American Tower manages and owns communications sites, including cell phone towers.
- Public Storage has almost 3,000 self-storage properties in the U.S.A. and Europe.
- AvalonBay Communities is one of America’s largest multifamily and apartment property owners.
REITs make excellent income investments since they don’t have to pay corporate taxes and pay at least 90% in dividends.
It is now easier than ever to invest in commercial real-estate development projects. Legislation has made it legal for real-estate developers to crowdfund capital for their real estate projects. Individual investors who want to invest in real estate development have raised billions of dollars.
Crowdfunded real estate requires more capital. Unlike public REITs, where you can buy and sell shares easily, you might not be able to touch your capital once you have made your investment. There is also the possibility that the developer will not execute and you could lose your money. The potential income and returns from real estate are attractive, but they have been difficult to access until recently. Crowdfunding is changing this.
You can reduce your taxes by investing in brokerage accounts
As important as having the right investments to help you achieve your financial goals is where you invest. People don’t think about the tax implications of their investments which could lead to financial failure.
A little tax planning can make a big difference. These are just a few examples of the different types of accounts that you might want to use in your investment journey. Your investments will grow tax-free in each account, except for the taxable brokerage.
401(k)Taxes today are reduced by pre-tax contributions Employer-matching contributions are possible. In retirement, distributions are subject to regular income tax. Early withdrawals are subject to penalties. Limit of $19,500 for employee contributions in 2020
SEP IRA/Solo 401(k)Taxes today are reduced by pre-tax contributions You can contribute more than you can in an IRA. In retirement, distributions are subject to regular income tax. Early withdrawals are subject to penalties. In 2020, the total contribution limit is $57,000
Traditional IRA You can transfer 401(k), from your former employer. Contribute to retirement savings beyond 401(k). In retirement, distributions are subject to regular income tax. Early withdrawals are subject to penalties. Limit of $6,000 for 2020 contributions
Roth IRAs retirement, distributions are exempt from tax. Contributions can be withdrawn without penalty. Contributions are not subject to pre-tax. There are penalties for early withdrawals of gains. Your income determines your contribution limits.
In a brokerage that is tax-deductible, you can contribute any amount to your account with no tax consequences or benefits. You can withdraw money at any moment. Even if you do not withdraw the proceeds, taxes are calculated based on realized events. You may be liable for taxes on realized capital gains, dividends, and taxable distributions
Coverdell ESA has more control over your investment options. Tax-free withdrawals for qualified education expenses. Limit of $2,000 per year for contributions; additional limits are based on income. Nonqualified withdrawals are subject to taxes and penalties
529 College Savings For qualified education expenses, withdrawals. Contribution limits are very high It is more complicated and varies by state. There are fewer investment options. Nonqualified withdrawals are subject to taxes and penalties.
This is the most important lesson. You should choose an account that matches your investment goals. Take this example:
- 401K – To help you save for your retirement.
- SEP IRA/Solo 401(k) – For self-employed retirement savers
- Traditional IRA – To help retirement savers
- Roth IRA – To help retirement savers
- Taxable brokerage To help savers who have additional cash to invest beyond their retirement/college savings accounts limits
- Coverdell ESA For college students
- 529 College Savings For college students
These are just a few of the things you should keep in mind depending on why you are investing.
- Maximizing employer-based 401 (k) plans is an easy task.
- You can build up tax-free income in retirement if your earnings permit you to contribute to a Roth IRA.
- The Roth-like Roth benefits of the Coverdell or 529 college savings plans reduce the tax burden and allow you to have more money for education.
- A taxable brokerage account can be a great tool to help you achieve other investment goals or additional cash beyond your retirement account limits.
Everyone’s situation will be different. To make the best investment decisions to achieve your financial goals, you must take into account your investment time horizon, expected return, and risk tolerance.