2022 is projected to be a volatile year for the financial market due to rising inflation, rising interest rates, supply-chain issues and ongoing COVID-19 related uncertainties. The current choppy US stock market may seem quite intimidating for beginner investors to tip their toes in.
Despite these uncertainties, investing is and will continue to be the best way to build wealth. Over the last two centuries, around 90% of the world’s millionaires made their millions through investing. For those who are starting their wealth building journey, there are 6 proven investments with little to no risk that you should consider.
401(k) and IRA
Having a comfortable retirement is one of the most important investing goals. This is exactly what 401(k), IRA (Individual Retirement Account) and other equivalent retirement savings accounts are designed for.
A 401(k) is a tax-deferred retirement account offered by employers to their employees. Employees contribute a percentage of their pre tax salary to this account, with their employers matching the contribution to a certain limit or percentage. The employees’ contribution will be deducted from their taxable income. In 2022, the maximum 401(k) employee contribution is $20,500.
The money is then deposited in various investments, typically mutual funds designed to meet a specific risk tolerance or investment goals. The typical annual growth rate of 401(k) funds is around 5% to 8%. The capital growth and investment incomes in this account is tax-free. Money can be withdrawn from 401(k) with no penalty as long as the account owner is over 59.5 or older. Withdrawals are taxed at the person’s income tax rate (that’s why it’s called tax-deferred).
Similar in many ways, IRA also allows tax-deferred contributions with no growth and income tax from its investments. The main differences are that IRA is not offered by employers, it has a lower yearly contribution limit, and it offers more diverse investment control and options.
Investing in 401(k) and IRA essentially allows tax-free investment capital gain, delayed and usually much reduced income tax, and free money/co-contribution from the employers for 401(k). Many Americans own both accounts to maximize the tax-free investment and compound growth.
Index Funds
The stock market, which has doubled since the low of March 2020, was the main source of wealth generation in America during the pandemic. The wealthiest 10% of Americans own around 90% of all U.S. stocks.
For those who want to invest in the stock market, but are worried about the market volatility or lack of stock-picking skills, Index Funds could be a beginner-friendly option.
“Don’t look for the needle in the haystack. Just buy the haystack” is a famous quote from John Bogle, who was credited with creating the first index fund. Stock picking is usually difficult and risky, that’s why investing in index funds might make more sense for beginners and average investors.
An index fund, or the “haystack” in Jack’s quote, is essentially a stock portfolio mimicking the profile of the stock market as a whole, or a broad segment of it. It matches the risk and return of the overall stock market or the segment. Investing in an index fund gives investors exposure to the overall growth of the economy or a particular segment of the economy, with reduced risks through the fund’s diversified stock holdings. This approach worked wonders for most long-term index fund investors.
As an example, over the past 30 years, the S&P 500 index has delivered a compound average annual growth rate of 10.7% per year despite the 2000 Dot Com bubble and 2008 US financial crisis. This performance beats most of actively managed funds and individual stock pickers.
Real Estate
Around 90% of millionaires in the U.S. invest in real estates. Many FIRE (Financial Independence, Retire Early) proponents advocate the importance of real estate investment. Real estate can be a great wealth generator when the property price increases, it also generates consistent passive income when rented out.
It may take a bit more time and accumulation to start investing in real estate compared to investing in index funds, but the benefit of having a part of investment diversified away from the stock market provides an extra layer of security to your wealth. This is especially important in a volatile stock market.
Once the real estate investment becomes cash-flow positive, meaning the rental income surpasses the costs (mortgage, maintenance, etc), the excess money can be redeployed to other investments, or support living expenses. Once a portfolio of rental properties is established, living off passive income entirely without actively working, i.e. FIRE, won’t be too far out of reach.
Quality Blue Chip Stocks
Blue chip stocks are offered by huge companies with a long history of excellent reputation and financial results. Companies like Apple, Microsoft, P&G and Berkshire Hathaway are all in this basket.
Although individual stocks are more volatile compared to an index fund or an index tracking ETF, the blue chip stocks are considered safe investments overall due to the solid foundation and long winning history of these companies.
Investors might consider investing in some of the blue chip stocks, especially when they are going for a higher return potential with slightly elevated risks. Think about this as owning a very small part of these great businesses.
Your Other Income Sources
Dave Ramsey, a famous author and personal financial advisor, once said: “Your most powerful wealth building tool is your income”. This is indeed the case, especially for those who just started their wealth building journey. Most beginner investors mainly rely on salary from their day jobs to fund life expenses and investments.
A healthy investment portfolio is well diversified, the same goes to income sources. Overly relying on one income stream (e.g. salary from a day job) exposes one to great risks when the unexpected happens (e.g. job loss). While it is important to be good at what you do at your day job and maximize salary, it is also important to always be open to exploring and growing other income sources through side hustles.
Side hustle is not only a good way to boost your income, provide extra income protection if anything happens to the day job, it’s also a perfect opportunity for you to start working on something you are truly passionate about, something you truly care about. Mastery comes from working on something consistently for a long period of time. This is why much sustainable success is achieved from passion projects and obsessions. Who knows, maybe your passion project could one day become your main source of income. Now that’s the type of dream job we are talking about.
Yourself
The great Warren Buffett once said: “The best investment you can make is an investment in yourself… The more you learn, the more you’ll earn.” Anything that generates income requires some sort of knowledge or skills. The more knowledge and skills you acquire, the broader your opportunities. No matter if it is to further improve on the day job, or having the knowledge and ability to set up and grow side hustles.
Health is another investment anyone should prioritize, this includes both physical and mental health. You can only do your best at income generation when you are in tip-top shape. You are only able to truly enjoy your success and life in general when you are healthy. Look after yourself.