By Paula Pant
Investing books may not sound like a thrilling beach read – it's no spy thriller or comedic novel – but you may still want to peruse a few investments books or articles while you're sitting on the deck or patio during these warm summer nights.
Investing, after all, has the power to change your life. You can't say the same about your favorite detective series.
Before you take a few finance books to the ocean this summer, check out this broad overview that gives you an introduction to the world of investments.
How Much Should I Invest?
Most people invest in order to reach certain goals. These could be general, such as "build wealth" or "preserve existing capital (from inflation)," or the goals could be specific, like retire by age 60, pay for your children's college, or save for the down payment on a home.
The amount you should invest depends on your specific goal. As a general rule of thumb, many financial experts recommend investing 10 to 15 percent of your income towards retirement. This may seem like a lot, but remember that any employer match that you receive counts towards this goal. If you save 10 percent of your income and your employer matches 5 percent, for example, you'll reach the 15 percent goal.
(Remember, also, that this is only a broad rule-of-thumb. Your specific savings target should reflect your age, timeline, risk tolerance, portfolio goals and other unique factors.)
Beyond retirement, the amount you should save for other goals also depends on these unique factors. If you're investing for your child's education, for example, you know your target withdrawal date. You also have a decent idea of how much tuition and housing will cost. You can make predictions about returns based on historic averages. Based on these factors, you'll get an idea of how much you'll need to save each year.
How can you calculate this figure? Diving into detail is a complex topic, so we recommend that you read books, use online calculators, and speak with a financial advisor to identify your unique goal.
What are the Limits?
In 2015, the annual contribution limit to most 401(k), 403(b) and 457 retirement plans is $18,000, plus an additional $6,000 if you're age 50 or older. As long as you turn 50 anytime this year, even if your birthday is New Year's Eve, you qualify for the additional limit.
Eligible individuals can also contribute up to $5,500 this year into either a Traditional or Roth IRA, plus an extra $1,000 if you're 50 or older.
These rules change annually, so keep watching for 2016's limits, which will most likely be announced in the fall.
Various Types of Investments
What types of investments can you select from? Here's a quick overview:
Individual stocks – You could purchase shares of a publicly-traded company, which means you're a partial owner of that company. These are further broken down into:
Large-cap: Huge, established enterprises like Coca-Cola, Nike and Home Depot.
Mid-cap: Companies that strike a balance between small and large, like Urban Outfitters and Dick's Sporting Goods.
Small-cap: Companies you may not have heard about yet. Since they're smaller, they might grow faster – or they might fail.
Bonds – These are loans issued by investors (like yourself) to governments, companies and other entities. These are broken down into:
Government bonds – Loans that you give to the U.S. government. These include:
Bills – Mature in less than one year.
Notes – Mature in 1 to 10 years.
Bonds – Mature in more than 10 years.
Municipal bonds - Loans that you issue cities or towns. These are often tax-free for residents.
Corporate bonds – Loans that you issue companies.
Mutual funds – These are baskets of stocks, bonds and other investments selected by a fund manager or team of managers, who charge a fee for this service.
Index funds – These are mutual funds that mirror a generalized trading index, such as U.S. large caps or Emerging Markets. Since these aren't actively-managed, the hold a much lower fee than active mutual funds.
There are quite a number of other investment types, such as commodities, real estate trusts, and more, but for the sake of length and complexity, we'll stop here.
How to Understand Risk and Return
Generally speaking, risk is tied to reward. That means some investments are more likely to be volatile – they may swing between highs and lows – while other investments are more likely to show stable, steady performance. (Of course, we can't predict the future. These are simply patterns we've observed in the past.)
Most investors build their portfolio with a mix of risk profiles. One slice of their portfolio might get slated for higher-risk investments, like small-cap stocks or frontier market funds, while another slice might be devoted to bonds or cash equivalents.
You should slice the pie based on your timeline, age, risk tolerance and other factors. Everyone's asset allocation is unique; there's no one-size-fits-all formula. Strengthening your financial education – through some combination of books, articles, calculators, and unbiased advice – will help you find the allocation that's right for you.
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