By starting to save early and building short-term savings — even paying off medical student loans and handling other expenses — you’ll be investing in a secure retirement and creating peace of mind.
But starting early doesn’t in itself guarantee you a comfortable retirement. You also need a basic knowledge of investing, including an understanding of the most common investment options. Following are several basic terms and concepts.
Your investment horizon is extremely important. This is the length of time in years you invest before you start using the money. For example, if you invest in your pension for 25 years, your investment horizon is 25 years. Your investment horizon is also called your time horizon.
Your investment horizon will be affected by your retirement age – when you expect to use your retirement savings. For example, if you retire in 25 years and live for another 30 years, the investment horizon is 25 years, but you need to live for another 30 years from the retirement investment, so your retirement period is 30 years.
As a rule of thumb, the longer your investment horizon, the more aggressive you can be as an investor because you have more time to recover from periodic price drops.
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Combining your investment horizons with compound interests can be a powerful force in helping you achieve your retirement goals. Compounding occurs when the money you save earns interest, which is added to the amount already saved and that new sum earns interest.
By compounding your contributions and interest over 40 years, you can save a significant amount of money for retirement. Get help estimating your required savings using this retirement calculator.
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Having a basic understanding of investment risk can help you make wise asset allocation decisions. Simply put, risk tolerance is the willingness to accept investment risk—in other words, the chance that your investment will lose value—in order to achieve higher returns.
For example, if you are an aggressive investor, you are willing to accept the risk of losing some of your investment capital.
If you are a conservative investor, you are not willing to accept high risk because keeping the principal invested is a priority.
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There are many accounts specifically designed for building retirement savings, and most such accounts, described below, allow you to deposit money directly from your paycheck before taxes.
Contributions to a 401(k) plan are taken from your paycheck before taxes, so your pre-tax dollars include your 401(k) plan. If you contribute, your employers can match a certain percentage of your salary to your 401(k).
Early withdrawals from a 401(k) — meaning money taken from a plan you’re currently contributing to before the plan’s normal retirement age, usually 65 — are generally subject to taxes and penalties. However, if you have a 401(k) plan from a previous employer, you can start taking those contributions without penalty at age 59 1/2. The rate of return in these schemes varies depending on the scheme invested. A 401(k) calculator can help you see how monthly salary contributions can add up over the course of your life.
An Individual Retirement Account (IRA) is a tax-deferred retirement fund, which means you don’t pay taxes on your earnings until you withdraw your money. Withdrawals are taxed at standard income tax rates, not lower capital gains rates. If you qualify, some or all of your current IRA contributions may be tax-deductible.
This differs from a traditional IRA in that it offers no tax deduction on current contributions. Instead, it offers a complete exemption from federal taxes when you use money to pay for retirement or a first home. A Roth IRA can be used without penalty for certain other expenses, such as education or unpaid medical expenses; Any withdrawals are subject to income tax unless you are over 59 1/2.
Roth IRAs have stricter income limits than traditional IRAs. Taxpayers who participate in corporate retirement plans and do not qualify for traditional IRA deductible contributions can often benefit from a Roth IRA.
A Simplified Employee Pension (SEP) plan is a special Keogh-individual retirement account. SEPs were created so that small businesses can set up retirement plans that are easier to administer than traditional pension plans. Both the employee and the employer can contribute to the SEP.
Learn about Social Security, the US federal government’s Social Security program that provides income to eligible retirees and their families.
A security is a tradable financial instrument. Several common types are discussed below. You should consult a professional financial advisor or broker for advice on investing in securities.
A mutual fund combines investors’ money, or pools, and then uses that money to buy different holdings. Some mutual funds are actively managed by professionals, and some track the returns of a stock market index such as the S&P, Dow Jones or NASDAQ. Pay attention to the mutual fund future, which offers its investment objective and various fees.
Called “fixed income,” the amount of income the bond generates each year is fixed or fixed, when the bond is sold, bonds are issued by governments or corporations rather than banks. Bonds have different risks depending on whether you are investing in US Treasuries, corporate bonds or junk bonds.
Shares, also known as stocks, are a way for individuals to acquire part of a business. A share of stock represents a proportionate share of ownership in a company. As the company’s value changes, the company’s shares rise and fall. Weigh your risk tolerance to determine if stocks are the right investment vehicle for you and what type of stock best suits your investment style and time horizon. There are many types of stocks, including value stocks, growth stocks, income stocks, and foreign stocks.
Because the value of securities fluctuates with the market, the balance in your account will fluctuate as well, and this may include gains or losses on your original investment.
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A capital gain is the profit made on the sale of an asset purchased at a lower price. The most common capital gains are realized from the sale of stocks, bonds, precious metals and real estate. Short-term capital gains and long-term capital gains have different tax characteristics.
- Short-term capital gains are gains made when the asset is sold within a year of its purchase. Currently, these benefits are taxed at the income tax rate of the owner.
- Long term capital gains It is the profit made when an asset is sold more than one year from the date of purchase.
Disclaimer: This information is provided for informational purposes only and should not be construed as financial or investment advice. Consult a professional regarding your particular situation.
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