While most people with a 401(k) or IRA are likely to have money invested in the stock market, owning individual stocks is less common. Buying individual stocks certainly isn’t cheap, with some traditional brokerages requiring $5,000 or more upfront.
However, there are affordable ways to invest in the stock market, and some finance experts say it makes sense for investors to have money in securities outside of their retirement funds. “Interest rates are very low at the moment, and the stock market is one of the places where you can get a reasonable return on your investment,” says Dermod Sweeney, author of “Success in the Stock Market: Using the Power of the Internet .”
[Read: 7 High Return, Low Risk Investments for Retirees.]
Investing in the stock market doesn’t come without risk, but at a time when money in a traditional savings account will earn practically nothing in interest, it may be a risk worth taking.
Diversify your savings, not just your portfolio. Avi Lele, CEO of brokerage firm Stockpile, says people shouldn’t be too quick to put all their savings into a retirement fund. “There are lots of things that happen in life, and retirement funds aren’t going to help with those things.”
When the roof starts leaking or the car breaks down, taking money from a retirement fund could mean paying a 10 percent penalty in addition to income taxes on the withdrawal. Arian Vojdani, an investment strategist with MV Financial in Bethesda, Maryland, says people focus on having a diversified portfolio, but they forget to also diversify their savings accounts.
Vojdani suggests people think of their savings as several buckets that need to be filled. In addition to retirement savings, households need money for emergencies and long-term savings goals among other things. “Let’s say you’re saving $10,000 a year,” Vojdani says. “You need to start thinking about [splitting] it 50/50.” Put half away into a 401(k) or IRA and direct the remaining money to one of the other savings buckets.
Even for seniors, there can be a benefit to having money outside a retirement fund. Withdrawals taken after age 59 ½ from traditional 401(k)s and IRAs are subject to a person’s normal tax rate. However, money pulled from an individual investment account is taxed as capital gains, which can be a lower rate than what a person might otherwise pay.
Reduce risk with ETFs and mutual funds. While buying individual stocks is one way to invest outside of a retirement fund, it may not be the best option. “The danger with individual stocks is you put all your eggs in one basket,” Lele says.
Plus, researching and following specific company stocks can be a time-intensive and complex process. “It takes a surprising amount of work to manage an individual stock well,” Sweeney says. “I believe that for the average man or woman, investing in mutual funds is a better bet than investing in an individual stock.”
Mutual funds and exchange-traded funds — known as ETFs — are set up to include a variety of stocks, bonds and commodities. Then, rather than buying numerous individual stocks to diversify their holdings, investors can concentrate their money in a few funds that already contain diverse assets.
[Read: 5 Tips for Using Dividend Stocks to Pay for Retirement.]
Making stocks affordable. Despite the stability offered by ETFs and mutual funds, the idea of owning a specific company can be appealing. “There’s always an obvious benefit to investing in big, strong companies,” says Vojdani.
Unfortunately, the cost of many big-name stocks is prohibitive. For example, a single share of Google is selling for $791, as of this writing. For those who can’t afford that price, fractional shares offer the opportunity to buy into expensive stocks even if you can’t afford an entire share.
Some online brokerage firms, such as Sharebuilder, allow you to buy fractional shares. Firms including Folio Investing and Loyal3 specialize in allowing investors to buy a percentage of a single stock. And Stockpile sells gift cards in grocery stores to simplify the process even further.
Owners of fractional shares may receive dividends, although the amount is dictated by the share. “If you own half a share, you get half a dividend,” Lele says. Once a person has invested enough to own a full share, they may receive voting rights as well.
[See: How to Reduce Your Tax Bill by Saving for Retirement.]
Buying stocks can be risky, and investors should fully understand that before making any purchase. However, there are benefits to investing in the market outside of retirement funds. Lele likens it to having a well-balanced diet and suggests everyone consider spreading their money out over a variety of accounts and investment types.
More from U.S. News
How to Become a Millionaire by Retirement
Retirement Savings Tax Breaks for High Earners
How Your 401(k) Balance Stacks Up
Beyond the Retirement Fund: When to Invest in the Stock Market originally appeared on usnews.com
