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There are quite a few investment options available. Check out the three most common ways to invest, so you can decide how to build wealth.
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Investing is one of the most effective ways to build wealth. If you save $500 per month for 30 years, you’ll have $180,000. If you invest that $500 per month and earn 8% per year, you’ll have $679,699 after those 30 years. That kind of return isn’t abnormal, either. The average stock market return is about 10% per year.
But how should you invest your money? Thanks to the 2022 Survey of Consumer Finances (SCF), we have data on the most common ways to invest. Here are the three top options.
1. Retirement accounts
Retirement accounts are by far the most popular way to invest. According to the SCF, 54.3% of Americans have retirement accounts. That makes them the second-most common financial asset, behind transaction accounts (any type of bank account).
There are retirement accounts you can set up yourself and employer-sponsored retirement accounts. The biggest benefit of retirement accounts is that they can help you save on taxes. However, they have annual contribution limits, which depend on the type of account. They also have early withdrawal penalties, which normally apply if you withdraw money before age 59 1/2.
Here are a few types of retirement accounts:
A 401(k) plan is an employer-sponsored retirement account. You can have contributions taken directly out of your paycheck, and contributions are tax-deductible.An individual retirement account (IRA) is an account any individual can open on their own. Contributions are tax-deductible.A Roth IRA is an IRA, but contributions aren’t tax-deductible. Instead, withdrawals are tax-free. That isn’t the case with traditional 401(k) plans and IRAs.
Because of the tax savings that retirement accounts offer, they’re a smart choice for just about anyone. It’s normally a good idea to invest through a 401(k) if you have one available through your employer. An IRA or Roth IRA is also worth having, either in addition to or in place of a 401(k).
2. Stocks
Stock ownership has been on the rise, as 21% of Americans now own stocks, compared to 15.2% in 2019. To be clear, this refers to direct ownership of stocks. Direct ownership of a stock means an investor has bought that individual stock. It doesn’t include stocks held as part of an investment fund.
Stock picking is popular among investors who want full control over their portfolios. One of the reasons it has gotten more popular is because of commission-free trading. Robinhood pioneered this, but it’s now a standard feature. You can buy and sell stocks commission-free with all the best stock brokers.
This approach isn’t right for every investor. Most investors are better off sticking to investment funds that do the work for them. Stock picking is time-consuming, and it’s rare to beat the market. If you want to do it, consider putting most of your money in safer investment funds, and do the stock picking with a small portion of your portfolio.
3. Pooled investment funds
In a pooled investment fund, a group of investors pool their money together. The fund manager decides how to invest that money. In the latest SCF, 11.5% of Americans owned shares of pooled investment funds. Note that this doesn’t include Americans who buy investment funds through their retirement accounts.
Some of the more popular types of pooled investment funds include:
Index funds: Investment funds that aim to follow the performance of a market index. For example, an S&P 500 index fund will aim to track the S&P 500. That’s an index of 500 of the largest publicly traded companies on U.S. stock exchanges.Target-date funds: Investment funds designed with a specific retirement year in mind. For example, a 2050 target-date fund is for investors who want to retire in 2050, and management of it will be based around that retirement year.Real estate investment trusts (REITs): Companies that own income-producing properties. Through REITs, everyday investors can invest in real estate.
Investment funds are a great choice, whether you buy them through retirement or non-retirement accounts. While there are a lot of fund options, index funds that invest in the S&P 500 or the total U.S. stock market provide a nice balance between long-term security and competitive returns.
Make sure to research any funds you’re interested in, and pay attention to fees. If an investment fund has much higher fees than similar offerings, that can cut into your returns.
How to invest your money
When you start investing, the first thing to decide is the type of account you’ll use. It usually makes sense to start with retirement accounts for tax savings. Many investors also have individual brokerage accounts, since these don’t have early withdrawal penalties like retirement accounts do.
Once you have your account (or accounts), you can choose your investments. This will depend on several factors, including your age, risk tolerance, and how hands-on you want to be with your portfolio. For most investors, pooled investment funds are the most appropriate option. If you’re interested in picking your own stocks, you can do that, too. But it requires a lot more time and effort.
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The Ascent does not cover all offers on the market. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.Lyle Daly has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Target. The Motley Fool has a disclosure policy.
