These days, people have to know more and more about investing due to the sharp decline in the number of companies offering pension plans and moving to 401(k) plans.  With these plans, the employee is often expected to choose the funds without the guidance needed to make informed decisions.

Because of this, you should know the difference between small and large cap mutual funds, or value versus growth funds.  You also must decide how much of your paycheck you want to contribute. 

Many employees elect to contribute very little — or worse yet, not at all — because they think they cannot afford to get money taken out of their paycheck.  However, they don’t realize that they are actually throwing money away to higher taxes.

Example:
Gross annual salary
$40,000
401(k) contribution
15%
Combined federal and state income tax rate
34%

Investing in a 401(k) instead of receiving the money as taxable salary would cut the annual income tax by $2,040 in this example —  a tremendous tax savings when it is compiled year after year.

In addition to maximizing your 401(k) contributions, you can contribute up to $3,000 per year to a Roth IRA. You don’t pay income tax on qualified withdrawals or even on the gains, dividends, and interest that build up. You can’t deduct a Roth IRA contribution from your taxable income, but it’s an excellent choice for future tax savings.

On average over the very long term, you can expect stock funds to appreciate about 10% a year.  This may not seem like much, but compared to bonds and other investments, it is a wise choice.

Where a lot of money can be lost or gained very quickly is through trading individual stocks, options, or commodities. Some think of it as essentially gambling, but that’s only true if you enter into it without the proper preparation.  A common suggestion is to put no more than 5% of your investment income towards individual stocks.  For a person making $40,000, this might be around $500 annually.

A person who wants to make money more quickly — which also makes it more of a risk — may want to start with a higher percentage. A good starting point is at least $3,000 for stocks.  Remember, a tax return combined with some savings accumulated throughout the year allows us to start a channel of income. 

The nice part about stock trading is you can ease into it.  If you don’t know anything about trading stocks, there are many good books, newsletters, and services available to choose from to get started.  One great way is to “paper trade” — trading without actually sending the transaction to a broker.  There are also software programs that simulate trading to help prepare you.

The returns from trading can be immense.  The key is to not be greedy and to take what the market gives you.  At the end of this ebook are links to our website that can help you get started in stock trading.

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