With the U.S. economy booming and unemployment rates at their lowest level in decades, American disposable income has reached an all-time high of $16.45 trillion.
Younger earners who have never started investing before, Americans who have maxed out their 401(k) contributions or even retirees looking for a way to put excess cash to work have plenty of options of ways to invest some extra cash on the side.
Start Here First
The first thing most financial advisors will suggest prior to considering investing extra cash is to pay off any existing debts.
The stock market has historically generated an average annual return of around 10%. Yet the average interest rate on credit card debt is around 17.8%, according to Bankrate. Any interest you are paying on debt is simply eating into your investing returns.
Once debts have been paid, any Americans under retirement age should look to max out their 401(k) contributions first before considering investing on the side.
Not only do these 401(k) accounts have plenty of tax advantages, many employers also have matching programs, which are essentially free money. In 2019, the basic annual 401(k) contribution limit is $19,000. It’s almost always a good idea to max out that contribution with any excess cash before looking elsewhere.
Opening An Account
If you’re past the point of paying off debt and/or maxing out 401(k) contributions, it may be time to consider buying stocks and bonds. The first decision you will have to make is whether investing on the side is a responsibility you would like shoulder on your own or whether you would like a financial advisor's help.
Robo-advisors are a relatively new and low-cost alternative to managing your investments yourself. Top robo-advisors include Wealthfront, Betterment and SoFi.
If you’re taking on the challenge yourself, you will need to open an investment account. Online brokerages like Merrill Edge, TD Ameritrade and E-Trade are among the low-cost options with small account minimums and plenty of resources for new investors.
Stocks Vs. Funds
Once you have opened your investment account and understand the basics of buying and selling on the platform, you need to decide on an investing strategy based on your goals and risk tolerance.
Picking individual stocks to buy is one of the highest-risk routes with the potential for the highest returns. The more different stocks from different market sectors you buy, the more diversified your portfolio is and the less theoretical risk you will have.
Rather than buying dozens of individual stocks — and paying the associated trading fees — many investors prefer to buy low-cost exchange-traded funds or mutual funds. These funds typically own dozens or hundreds of different stocks, bonds or other assets and provide instant diversification.
Picking A Strategy
Finally, new investors should understand that investing can be as easy or as difficult as you want to make it. If your plan is to pick a handful of stocks and beat the market, it will require talent, knowledge, time and a lot of work.
If your plan is to simply sit back and let the market do the work for you, investors can buy a low-cost S&P 500 index ETF like the VANGUARD IX FUN/S&P 500 ETF SHS NEW (NYSE: VOO) and put their investment account on cruise control.
Despite a number of market booms and busts — World War II, the Great Depression, the Great Recession and any number of major economic disruptions — the 30-year rolling annual return of the S&P 500 has always stayed in a range between approximately 8% and 15%.
If your investment time horizon is shorter than 30 years, you need to make sure you understand and prepare for the potential for the risk of a major short-term market downturn like the one that occurred in 2008.
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