Step 1: Meeting Investment Prerequisites-Before one even thinks of investing, they should make sure they have adequately provided necessities, like housing, food, transportation, clothing, etc. Also, there should be an additional amount of money used as emergency cash and protection against other various risks. This protection could be through life, health, property, and liability insurance.
Step 2: Establishing Investing Goals-Once the prerequisites are taken care of, an investor will then want to establish their investing goals, which is laying out financial objectives they wish to achieve. The goals chosen will determine what types of investments they will make. The most common investing goals are accumulating retirement funds, increasing current income, saving major expenditures, and sheltering income from taxes The Info Blog.
Step 3: Adopting an Investment Plan-Once someone has their general goals, they will need to adopt an investment plan. This will include specifying a target date for achieving a goal and the amount of tolerable risk involved.
Step 4: Evaluating Investment Vehicles-Next up, evaluates investment vehicles by looking at each vehicle’s potential return and risk.
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Step 5: Selecting Suitable Investments-With all the information gathered so far; a person will use it to select the investment vehicles that will compliment their goals the most. One should take into consideration expected return, risk, and tax considerations. Careful selection is important.
Step 6: Constructing a Diversified Portfolio-In order to achieve their investment goals, investors will need to pull together an investment portfolio of suitable investments. Investors should diversify their portfolio by including several different investment vehicles to earn higher returns and/or be exposed to less risk than just limiting themselves to one or two investments. Investing in mutual funds can help achieve diversification and also have the benefit of it being professionally managed.
Step 7: Managing the Portfolio-Once a portfolio is put together, an investor should measure the behavior about expected performance and make adjustments as needed.
Considering Personal Taxes
Knowing current tax laws can help an investor reduce the taxes and increase after-tax dollars available for investing.
Basic Sources of Taxation-There are two main types of taxes to know about: those levied by the federal government and those levied by state and local governments. The federal income tax is the main form of personal taxation, while state and local taxes can vary from area to area. In addition to the income taxes, the state and local governments also receive revenue from sales and property taxes. These income taxes have the greatest impact on security investments, in which the returns are in the form of dividends, interest, and value increases. Property taxes can also have a significant impact on real estate and other forms of property investment.
Types of Income-Income for individuals can be classified into three basic categories:
1. Active Income-This can be made up of wages, salaries, bonuses, tips, pension, and alimony. It is made up of income earned on the job and other forms of noninvestment income.
2. Portfolio Income-This income is from earnings produced from various investments, which could be made up of savings accounts, stocks, bonds, mutual funds, options, and futures and consists of interest, dividends, and capital gains.
3. Passive Income-Income gained through real estate, limited partnerships, and other forms of tax-advantaged investments.
Investments and Taxes-Taking into tax laws is an important part of the investment process. Tax planning involves examining both current and projected earnings and developing strategies to help defer and minimize the level of taxes. Planning for these taxes will help assist investment activities over time to achieve maximum after-tax returns.
Tax-Advantaged Retirement Vehicles-Over the years, the federal government has established several types of retirement vehicles. Employer-sponsored plans can include 401(k) plans, savings plans, and profit-sharing plans. These plans are usually voluntary and allow employees to increase the amount of money for retirement and tax advantage of tax-deferral benefits. Individuals can also set up tax-sheltered retirement programs like Keogh plans and SEP-IRAs for the self-employed. IRAs and Roth IRAs can be set up by almost anyone, subject to certain qualifications. These plans generally allow people to defer taxes on both contributions and earnings until retirement.
Investing Over the Life Cycle
As investors age, their investment strategies tend to change as well. They tend to be more aggressive when they’re young and transition to more conservative investments as they grow older. Younger investors usually go for growth-oriented investments that focus on capital gains as opposed to current income. This is because they don’t usually have much for investable funds, so capital gains are often viewed as the quickest way to build up capital. These investments are usually through high-risk common stocks, options, and futures.
As the investors become more middle-aged, other things like educational expenses and retirement become more important. As this happens, the typical investor moves towards higher-quality securities, which are low-risk growth and income stocks, high-grade bonds, preferred stocks, and mutual funds.
As the investors get closer to retirement, their focus is usually on preserving capital and income. Their investment portfolio is now usually very conservative at this point. It would typically consist of low-risk income stocks and mutual funds, high-yield government bonds, quality corporate bonds, CDs, and other short-term investment vehicles.