For many Americans, an employer-sponsored 401(k) is their first investment vehicle, with 65% of U.S. workers offered one or a similar plan. But to build wealth, you also may want or need to invest outside of that plan.
Here are five investing strategies beginners can use to get more involved in the stock market:
1. Open an IRA
After an employer-sponsored retirement plan, the next stop for any stock market strategy is to invest in other tax-advantaged accounts, such as a traditional or Roth individual retirement account. You can open an IRA at an online broker — many brokerages don't require an account minimum, and you won't be investing any of your money until you're ready to do so. These days, brokerages are pretty similar to banks. The major difference is that with brokers, you'll have access to the stock market when you're ready to invest.
You can contribute up to $6,000 a year ($7,000 if you are 50 or older) to an IRA, either to one account or a combination of both these types of IRAs. Each has different tax advantages, so check out which IRA is best for you. And if you max an IRA out for the year, you can always continue investing in a taxable brokerage account — these are also opened at an online broker, but they don't offer the tax perks of an IRA.
» Ready to start? Find the best IRA providers
2. Only invest cash you won’t need for five years
One big drawback of traditional and Roth IRAs: There can be penalties and tax ramifications if you withdraw funds before the age of 59 ½. Roth IRAs are more forgiving on early withdrawals — you can pull out contributions at any time, but you may be penalized or taxed if you pull out investment earnings early.
But that restriction might be OK because there’s a key rule of thumb to keep in mind with any stock market strategy: Don’t invest cash you'll need within five years. Patience pays when investing — you need to give your assets time to weather the market's ups and downs.
“A key rule of thumb to keep in mind with any stock market strategy: Don’t invest cash you'll need within five years.”
If 59 ½ feels too far away, a taxable brokerage account won’t penalize early withdrawals, but it also won’t offer the tax advantages of an IRA or employer-sponsored account (most brokers offer both taxable and tax-advantaged accounts).
Opening a taxable brokerage account may be the next step if you're already maxing out a 401(k) and an IRA, and you have idle cash sitting in your bank account. However, the following strategies can be applied to both retirement and brokerage accounts.
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3. Explore passively managed index funds
Ideally, you want to create a balanced portfolio while keeping costs down. Most investors lean on mutual funds, index funds and exchange-traded funds to do that. Rather than betting on any one company stock, these funds pool multiple stocks together, balancing out the inevitable losers and winners.
And these funds are built on passive management strategies. Passive investing seeks only to match wider market gains, as opposed to active investing that tries to outperform the market by frequently buying and selling stocks. And while having an expert pick and choose stocks for you may sound appealing, in the five years leading up to Dec. 31, 2019, 80% of large-cap funds underperformed the S&P 500. In other words, if you’d invested in a low-cost index fund that closely tracks the S&P 500, there’s a good chance you would have seen better returns than in the average mutual fund.
» Learn more about passive vs. active management
Passive investing also brings fewer of the fees that can erode long-term investment growth. In 2019, the average passively managed fund had an asset-weighted expense ratio of 0.13%, compared with 0.66% with actively managed funds. This cost difference has sparked a growing array of robo-advisors that automate portfolio management, which allows these companies to charge much lower fees than actively managed accounts.
» Looking for investment research? Read our review of Morningstar
4. Limit active stock trades to 10% of a portfolio
If you want to buy stocks, try to keep these to 10% or less of your total investment portfolio. Again, actively managed stock market strategies that seek to beat the market regularly underperform passive strategies.
If you throw all of your money into one or a few companies, you’re banking on success that could quickly be halted by a single regulatory problem, new competitor or public relations disaster. If you still have a strong interest in actively trading with a portion of your portfolio, some stockbrokers offer educational tools and simulators that allow you to practice trading before you dive in. (Need some guidance? Check out our list of the best-performing stocks this year.)
» View our picks for the best brokers
5. Use dollar-cost averaging
Active investors race to buy low and sell high, but that’s easier said than done. A better strategy, experts say, is to make new investments at regular intervals, a process known as dollar-cost averaging.
Successful investing is less about timing the market than giving a broad portfolio of investments the time it needs to grow. Unlike the frenzied image you may have of stock market trading, slow and steady typically wins the investing race.