If you’re still in the early stages of a career you enjoy, you’re certainly in a good place. But if you’re earning a high income, what should you do with that money?
The financial world can be confusing – so here are a few questions and answers that you may find helpful.
1. What’s the difference between saving and investing?
Although the concepts of “saving” and “investing” may sound similar, there are some important differences.
When you put money in a savings or checking account, you can safely assume the money will always be available to you. The Federal Deposit Insurance Corporation (FDIC) insures accounts up to $250,000 per depositor, per insured bank. Also, your money typically won’t decline in value, though it will likely only earn a low, fixed-interest rate of return that may not keep up with inflation.
Because the money will be there when you need it, a savings account is valuable for use as an emergency fund or for short-term goals, such as a sizable purchase you plan to make.
Investing, on the other hand, should be looked at in a much different light. When you invest in stocks, bonds, mutual funds and other securities, you want your money to grow or produce more income – or attain both growth and income. To achieve these objectives, though, you must assume some risk – there are very few guarantees in the investment world. You assume this risk because you want your investments to help you reach your long-term goals, such as a comfortable retirement.
2. Is there a way to reduce the risk associated with investing?
If you were to own just one type of financial asset, such as growth-oriented stocks, your investment portfolio might be significantly affected when the financial markets are volatile. But you can reduce the impact of this volatility by diversifying your investment dollars among domestic and international stocks, bonds and other fixed-income vehicles, mutual funds and government securities. (Keep in mind, though, that while diversification can ease the effects of volatility, it cannot guarantee profits or protect against all losses.)
Another way to help reduce investment risk is to buy quality investments and hold them for the long term. Short-term market declines are inevitable and a normal part of the investment landscape, but the longer you hold your investments, the greater your chances of “smoothing out” your returns.
3. How should I divide my investment dollars between stocks and bonds?
There’s no one right “formula” to determine the optimal investment mix for everyone. Ideally, when building a portfolio, you should take into account your life stage, your goals, your risk tolerance and your time horizon. These factors should help you determine the percentages of your portfolio devoted to stocks, bonds and other securities.
4. Should my investment mix stay the same throughout my life?
Over time, you may need to change your investment mix from its original composition. As you get closer to retirement, you might choose to scale back on the amount of investment risk you’re taking on, a choice which might lead to fewer growth stocks in your portfolio. However, even during retirement, you’ll want some growth potential in your holdings to help keep you ahead of inflation.
5. How can I balance investing with paying off my debts?
Investing and debt repayment should both be key parts of your overall financial strategy. But it can be challenging to balance these two activities. As a basic strategy, though, consider this suggestion: If you have already established an emergency fund and you’re already contributing enough to a 401(k) or a Health Savings Account (HSA) to at least receive any employer match available to you, start whittling away at your high-interest-rate, non-tax-deductible debt – like credit cards. If your debt has relatively low interest and is tax deductible, such as a mortgage or student loans, consider investing any extra money instead.
6. How much do I need to invest to retire comfortably?
There’s no easy answer to this question because it’s based on where you are in your financial journey – and your goals for retirement. First, think about when you want to retire. The earlier your projected retirement date, the more you may need to invest each year. Next, consider what you want to do in retirement. Will you travel the world? Stay close to home and pursue your hobbies? Or will you continue working in some capacity, such as consulting or running a small business of your own? All these options, and any others you might choose, can greatly affect how much you need to invest for your retirement years.
7. Work toward milestones – and get some help
As you travel along your financial journey, you may find it helpful to mark your arrival at certain “milestones,” such as reaching a point where you’re confident in your ability to handle short-term cash needs while still being able to invest for the future.
Finally, you don’t have to go it alone. By working with a financial advisor, you can get the help you need to keep making progress toward all your goals.