Once you get the hang of investing, you may get into a nice groove and come to the wonderful realization that it's actually not such a hard thing to do. But when you're first starting out, it can be daunting and challenging. If you're not sure how to go about it, you may want to make one important move — sign up for your employer's 401(k) plan.
How a 401(k) can help you break into investing
One of the greatest things about 401(k)s is that investing in one is seamless. All you need to do is decide how much money you want to contribute from each paycheck toward your retirement savings. From there, your payroll department will deduct those funds so you don't even have to think about them. And that way, you'll also be less likely to chicken out and stop investing at times when the stock market gets volatile.
But here's another thing you should know about 401(k)s — they don't allow you to choose individual stocks. Now for many people, that's actually a bad thing. Getting to select individual stocks helps you put together a truly customized investment mix that help you meet your personal goals. But if you're new to investing and really have no idea what you're doing, then you may not want to buy individual stocks. Rather, until you're able to boost your knowledge base a bit, a better bet may be to start off with index funds-and 401(k)s generally have a decent selection of those to choose from.
Index funds are massively managed funds that aim to track the performance of the market indexes they're associated with. An S&P 500 index fund, for example, will have the goal of performing as well as the S&P 500 itself.
Index funds really take the pressure off for new investors — namely, because they're the perfect “set it and forget it” type of investment. And since 401(k)s work the same way — you fill out some paperwork with your payroll administrator and then let them take care of the rest — it's a simple, easy formula to kick off your investing career.
Now one thing you should know is that 401(k)s generally offer a mix of actively managed mutual funds and index funds. The difference between the two is that index funds are passively managed — they don't employ fund managers to hand-pick investments, and as such, they don't have to pay the high salaries that such experts generally command. As such, index funds charge very low investment fees (which are called expense ratios), whereas actively managed mutual funds charge a lot more because you're getting access to experts who are choosing your investments for you.
But worry not — index funds are not second-tier investments. In fact, index funds routinely outperform actively managed mutual funds despite costing a lot more.
If you're nervous to start investing, or you've been putting it off for far too long, your company's 401(k) plan could be a great way to begin. Plus, many employers that offer 401(k)s also match worker contributions, so if you begin funding one, you could be entitled to free money that allows you to grow even more wealth over time.
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