LAST REVIEWED Dec 18 2020 10 MIN READ
By The Human Interest Team
Getting started with investing can seem daunting at first, but it doesn’t have to be. This guide will help make it easy for you to get oriented to the world of investing. Because your 401(k) is a tool to help you save for retirement, this guide is written to help you think about long-term investments.
What is investing?
Investing is the process of purchasing securities (think stocks, bonds, etc.) with growth, AKA returns, in mind. People choose to invest their money because they want to improve their life or the lives of their loved ones. For example, people invest money to help them become financially independent, to not have to work in retirement, and to enjoy a comfortable standard of living in their later years. That said, it’s not a linear path, nor is it a guarantee.
How do stocks work?
Thousands of companies make it possible for anyone to own tiny portions of a company, aka a stock. When the company grows, the value of the stock does, too, meaning that an investor’s purchase earns a return. There are thousands of stocks available for purchase, and each represents the price someone is willing to pay to own a portion of a given company.
Those stock prices go up and down depending on how many people want to own that specific company, which means money invested can grow or lose value. We’ll talk more about this shortly. Instead of purchasing a single stock, it is possible to purchase a group of stocks packaged together into what is called an “index fund” (a type of mutual fund).
An index fund is named because it tracks one of the tools we use to index or benchmark performance of the overall stock market, such as the Dow Jones Industrial Average (often referred to as “the Dow”). Since the Dow Jones represents what’s happening at big U.S. companies, an investment you have in an index fund linked to the Dow would increase in value when the overall U.S. economy does.
An advantage of an index fund is that they’re tied to a mix of companies, industries, sectors, asset classes, or other classifications. If something were to happen in, for example, the auto industry, the financial impact you’d see in an index fund would be less than if you had invested in a single automaker’s stock. This is also a way to achieve “diversification” in your portfolio. And, because picking a stock that will outperform the market is difficult, even for expert investors, index funds have a track record of performing better than a group of stocks most people put together on their own. Index funds also tend to have an advantage over actively managed mutual funds: they tend to have lower fees, meaning you would get to keep a larger portion of the growth.
The stock market: Short-term swings
If the stock market did well yesterday, it doesn’t guarantee another good day. Looking at the last year (see chart below, Google's recording of S&P 500 performance, February 2021-2022), you can see ups and downs in the market, including especially larger ups and downs since January 2022.
These ups and downs, also called market volatility, can be a lot to stomach, especially when you see your account balance drop during downturns. But before you pull your money out of the stock market, let’s remember the goal of your investing: your retirement.
The stock market: Long-term growth
Instead of looking just at the past year (or an even shorter timeframe), the stock market shows a different picture over the long haul.
The following chart shows the overall trend in the stock market from the mid-1980s through today. Despite large dips, for example, during the Great Recession in 2008 and in March 2020 during the start of the pandemic, the value of investments held in the stock market has grown over time (chart below).
Growth in a short- vs. a long-term investment
For example, if you had invested $5,000 in 2010, it would be worth more than $12,000 by the end of 2019, even after going through the dot com bust and the 2008 recession. If you had invested that same $5,000 in 1990, it would have been worth more than $54,000. In contrast, if you had put $5,000 in a savings account you wouldn’t have much more than $5,000 given the low interest rate during the last 10 years (under 0.1%). (Note this doesn’t even take inflation into account!) While past performance is no guarantee of future growth, the trend is that the longer you hold investments in the stock market, the more likely they are to grow.
What are the advantages of investing?
1. A greater chance at growing your money, especially over the long term.
Above, we compared how your balance would change if you had invested in the stock market vs. used a savings account. Both of these are better than not saving at all. One of the main reasons that people save or invest is because they know they need to be able to provide for themselves in the future.
2. Spending now could mean you'll pay for it later.
Money means choices. Because compounding interest can enhance the value of your savings, the pain of each dollar you save now can be greatly outweighed by the flexibility you gain in the future. Perhaps you'd rather spend your money on other things that are more fun than saving for retirement.
Example: You could spend $1,000 a year now on something you want - travel, dining out, clothes, or items for your home. That would be fun! Or, you could put that $1,000 into your 401(k) every year starting at age 30 and keep doing this until you reach retirement age (65). In the first case, you’d have spent $35,000 for $1,000 of fun every year for 35 years, but if you invested it, assuming a 7% return, you’d end up with a fun fund for your retirement that’s 4x bigger — roughly $149,000.
3. Government programs are unlikely to give you enough to retire on.
While many people talk about relying on Social Security in their later years, it won’t be enough. Social Security payments will likely be too low and (and too unreliable) to retire without any other source of retirement income. The average amount that people get from Social Security is less than $18,000 per year. Do you think that will be enough to cover all of your expenses in retirement? There’s also greater cause for concern. For years, people have talked about Social Security running out of money. The latest estimates suggest that the program will run out of funds as soon as 2034.
How do I get started with investing?
Your employer-sponsored 401(k) is a great tool to get started! Through your 401(k), you’ll have access to a variety of investments.
1. Choosing investments
If you have access to a 401(k) through your employer, you can automatically contribute a portion of your paycheck to your account. You will need to select investments aligned with your goals and risk tolerance (a process often referred to as asset allocation).
Depending on your company’s 401(k) provider, this can be a daunting process, especially if you’re not an investment expert. Some providers, like Human Interest, provide employees with a selection of ready-to-go portfolios (aka model portfolios) that automatically invest your money in a diversified mix of low-cost funds so you don’t have to hand-pick from the tens of thousands of options that are available on the market.
Frequently asked question
1. How does Human Interest help me select a portfolio?
We use an online questionnaire to gather relevant information from you including your age, your intended retirement age, along with your comfort with tolerating ups and downs in the market (aka risk tolerance) and existing savings.
Our proprietary algorithm constructs your portfolio, or bundle of investments, tailored to your situation. We have 20 different model portfolios and we’ll recommend one most suited to you. As you get older, we’ll automatically optimize the investments in your portfolio so that they have a lower risk of losing value close to your intended retirement date. We also give you the choice to design and manage your own portfolio, if you prefer (though this is only recommended for experienced investors).
2. Building an investment habit
Just like saving is a habit that can get easier with practice, investing is, too. Since you’re investing using your 401(k), you’ll need to figure out how much money you want to put in during a year and how to break that up across each paycheck. Read more in our Guide: What is a 401(k) and how does it work?
One practice consistent with building the habit is called dollar-cost averaging. This is a strategy that requires steadily investing the same amount of money at regular intervals. It’s an intuitive way to invest (versus trying to figure out the ideal time when the market is low) and can help ensure that you’re not always buying when prices are high.
3. Investing for the long-term (a.k.a. “letting it be”)
You’re using your 401(k) to save for retirement. Focusing on a milestone, like retirement, that is likely years (or decades) away, you’ll need an investment strategy that aligns with your long-term goal. Covid has taught us one strategy that you can apply to investing for retirement: Think of your 401(k) like your face. Don’t touch it.
Even though the market (and therefore your 401(k) balance) may go down some days, it’s more important to focus on how the market is doing over a 10-year period. While it may be tempting to try to sell investments when they lose value (or when you think they’re going to lose value), it’s nearly impossible to do this successfully even for expert investors. Timing the market, also called performance chasing, has been less successful to date vs. simply holding investments in the market for the long term. Just remember: focus on time in the market, not timing the market.
But what if I lose money?! Before you think about pulling money out of the stock market (or avoid investing in it all together), read more about how to handle market volatility, i.e., what to do (and not do) when your 401(k) loses value.
Is investing for people like me?
52% of households in the U.S. - 65 million of them - own stocks, the majority through a 401(k). Data from Pew, in the chart below, show that investing is still more common today among certain demographic groups (white and affluent households). However, when given the chance to invest through a work-based retirement plan, people invest regardless of their income. Employees who earn between $30,000 and $60,000 per year are putting away roughly 6% of their earnings into a 401(k). Those who earn between $200,000 and $210,000 are investing closer to 8%.
Women and investing
We talk a lot about the “gender pay gap,” the fact that a woman earns 80-something cents for every dollar a man earns. That’s a 20-cent differential. In retirement, that gap is magnified: as a result, a woman’s retirement income could be hundreds of dollars less every month. That’s a huge difference in the quality of life that they could face in retirement — not to mention that a woman’s retirement savings likely will need to last longer, based on women’s longer life expectancy.
Let’s look at the gender retirement savings gap, and how it is much larger than the gender pay gap. A review of more than 20,000 of our customers shows that men and women small business employees are contributing a similar percentage of their salary to their 401(k) — 7.9% and 7.5%, respectively. While these differences seem small at first, they are quite significant when you consider how these add up across the course of someone’s life, especially when taking compound interest into account.
Here’s an example with Marc and Kim, who each earn an average salary for their gender*:
*The projections in this scenario are for illustrative purposes and are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Results may vary. Assumptions include: the man and woman each earn the average salary for their sex (as of January 2020), in round numbers $52,000 and $43,000, across their working years, that retirement age is 65, and that their investments yield 5% annual returns.
Put your money to work
Money is a tool that you can use to help reach your goals, and investing is a key long-term strategy that puts your money to work for your future. If instead of investing, you leave your savings in cash, it could cost you. You might be able to grow your money by only 1% per year in a savings account (it’s been lower than that in recent years) but by 7% if invested, based on historical returns.
Over one year, that’s $100 vs. $700, respectively for a $10,000 nest egg, but it’d be much more over the course of years – or decades – ahead of you before retirement.
What else do you need to know? Taking a long-term view is just what we do. Rather than chasing short-term gains (which usually doesn’t work), we focus on growing your nest egg using a long-term strategy. Read more about our investment philosophy.
Investing terms glossary: Help to get you going
Here’s a glossary of common investing terms to help you get familiarized with basic investing concepts:
Asset allocation: A method of investing which includes a range of different investment classes − such as stocks, bonds, and cash alternatives or equivalents − in their portfolios.
Bond: A debt security that represents the borrowing of money by a corporation, government, or other entity. The borrowing institution repays the amount of the loan plus a percentage as interest. Income funds generally invest in bonds.
Bond fund: A fund that invests primarily in bonds and other debt instruments.
Dollar-cost averaging: An investment strategy where you invest a consistent amount of money over time, e.g. $500 every two weeks, in the same group of assets. The goal of this strategy is to help you stick to an investment strategy rather than responding to the ups and downs in the market, which are really difficult to predict (and trying to time the market tends to be a less effective strategy).
Exchange-Traded Fund (ETF): An exchange-traded fund is a type of security that involves a collection of securities—such as stocks. Similar to a mutual fund except that they can be bought and sold throughout the trading day whereas mutual funds can only be traded at market close.
Mutual fund: An investment company registered with the SEC that buys a portfolio of securities selected by a professional investment adviser to meet a specified financial goal (investment objective). Mutual funds can have actively managed portfolios, where a professional investment adviser creates a unique mix of investments to meet a particular investment objective, or passively managed portfolios, in which the adviser seeks to parallel the performance of a selected benchmark or index.
Portfolio: A collection of investments such as stocks and bonds that are owned by an individual, organization, or investment fund.
Rebalance: The process of moving money from one type of investment to another to maintain a desired asset allocation.
Risk: The potential for investors to lose some or all the amounts invested or to fail to achieve their investment objectives.
Risk tolerance: An investor's ability and willingness to lose some or all of an investment in exchange for greater potential returns.
Stock: A security that represents an ownership interest in a corporation.
Stock fund: A fund that invests primarily in stocks.
The Human Interest Team
We believe that everyone deserves access to a secure financial future, which is why we make it easy to provide a 401(k) to your employees. Human Interest offers a low-cost 401(k) with automated administration, built-in investment education, and integration with leading payroll providers.