The first thing to consider when it comes to investing is what your goals are. You have to know what you’re investing for in order to form a strategy. Are you investing for a large purchase in the near future such as a house, car, or a boat? Are you putting money away so you can retire in 20, 30, 40+ years? Each of those objectives should have different philosophies. Think of it like a track team; if you’re running the 400 meter dash you’re not training the same way as someone running the 3200 meter run because the race isn’t as long. If your goals are short term you don’t want to take as much risk in case the stock market falls and you lose the money you have invested. If they’re longer term you have plenty of time to make up for these drops. If you’re young, you’re probably in the latter situation and have many years to invest.

Before making any investing decisions it’s important to have a basic understanding of how investing works. The first thing is understanding what makes an investment go up or down. Just like every other market, supply and demand drive a price up or down. There are infinite variables that can influence supply and demand, but the most important thing to know is that said supply and demand are what drive a price.

Next, you need to know what it means to invest in the first place. Investing is simply buying a piece of ownership in a business. When you buy a share of Amazon stock you’re buying a piece of ownership in Amazon. If a lot of people want to own part of Amazon it will push the price up and if less people want to own part of Amazon it will decrease the demand and drive the price down. Arguably the most well known investor, Warren Buffett, has iterated this many times throughout his career. Keeping this simple understanding of what it means to invest has helped him become one of the most successful investors ever.

After understanding what it means to invest you’ll need to know how to go about doing this. There are different types of accounts you can invest in. There are retirement accounts and non-retirement accounts.

For retirement accounts there are employer sponsored retirement accounts and individual retirement accounts. The employer sponsored accounts can only be opened if your employer offers it, the most common being a 401(k). With a 401(k) you defer some of your salary, invest it, and it grows tax-deferred. This means whatever you defer (put into the account) gets invested and grows without having to pay taxes on it. Since the Internal Revenue Service (IRS) allows you to deduct these contributions from your income they require you to distribute them from the account later on (currently, when you reach age 73) so they can collect their share of tax just as they have to do with any money you earn. The deduction is nice now but remember that it’s a “deferral” and not an “avoidance” and it must be paid in the future if it isn’t paid now.

A 403(b) is essentially the same where the only difference is they’re offered to government employees. A Thrift Savings Plan (TSP) works just like a 401(k) or 403(b) but is only offered to military members. With each of these, you employer may choose to “match” by contributing a certain amount to your account for every dollar you put in. There are limits for how much you can put into these accounts for any given year with the 2023 limit being $22,500.

Other common retirement accounts are called Individual Retirement Arrangements, or IRAs. The two most common types of IRAs are Traditional IRAs and Roth IRAs. A Traditional IRA works similar to the 401(k) where you can deduct the amount you contribute to your account from your current income, the growth is tax deferred, and it’s taxable as ordinary income when it’s withdrawn. With a Roth you can’t deduct any of your contribution from current income but it grows tax free and can be withdrawn 100% tax-free. Since it’s a retirement account that means you’ll have many years to make contributions and let the contributions grow tax free, so this can be a powerful wealth building tool.

Roth IRAs have strict limits on who can contribute and how much one can contribute. The contribution limit for 2023 is $6,500. If you file your taxes as a single filer your income must be under $138,000. After $138,000, the amount you can contribute is phased out until you reach $153,000 where you can’t contribute anything. If you file Married Filing Jointly you can contribute the full $6,500 (per person, meaning both you and your spouse can contribute up to $6,500) if your income is under $218,000 and gets phased out until you and your spouse’s combined income reaches $228,000. It’s important to know these limits because the IRS will require you to take your contribution out for the amount over the limits, and pay an additional penalty.

For retirement accounts you have to wait until age 59 and a half to take money out or the IRS will hit you with a 10% early withdrawal penalty on anything taken out. This is why you want to take a long term approach when investing in retirement accounts.

The other type of investment account is called a brokerage account. A brokerage account is a non-retirement account that has no restrictions on when and how much can be contributed. With this absence of restrictions comes different tax consequences. Retirement accounts all come with certain tax benefits whereas brokerage accounts do not. However, just because there aren’t current tax advantages to invest in a brokerage account they are taxed at a more generous rate than the retirement accounts.

When you make an investment in a brokerage account, the amount you purchase a stock for is called “cost basis”. When you sell your stock in a brokerage account you pay taxes on the difference between the amount you sell it for (your proceeds) and the amount you bought it for (cost basis). The difference between the two is your taxable gain (referred to as capital gain). As mentioned previously, this taxable gain is taxed at more generous rates than normal tax rates (ordinary income tax rates). It’s important to understand the difference in tax treatment of each of the accounts so you can maximize your wealth.

One of the most important rules in investing is to diversify. Diversifying means investing in different things to reduce risk, which is the possibility of your investment losing money. The best way to do this is to buy “baskets” of stocks called stock funds. Stock funds take shares of hundreds or thousands of different companies and basket them into a single fund so you can participate in the gains the underlying stocks experience, but you don’t have to worry about one or two of them losing money. For example, if you were to only buy shares of Apple and Apple does poorly you’ll lose your money. But, if Apple does poorly you still have hundreds of other stocks in there to reduce the impact of Apple’s losses. And if Apple does well you still get to capture the upside.

Individual stocks carry a lot of risk so you’re better off investing in the baskets of these stocks which are called mutual funds, index funds, or exchange traded funds (ETFs). Mutual funds, index funds, and ETFs all have the same premise where it’s a collection of different stocks, but each vary slightly in the way they’re put together. The biggest factor when it comes to choosing between these funds is the cost. Just like any business, fund managers have to get paid for their work. The cost of funds is known as the expense ratio which can be found with a simple Google search. Mutual funds tend to be the most expensive with index funds and ETFs being the cheapest. There’s no real evidence of either fund providing superior returns to the others so index funds and ETFs are often a good choice.

Another crucial aspect of diversification is geographical diversification. As humans we have the tendency to stick with things we’re familiar with so it’s easy to only want to invest in US companies/funds. While the US stock market has a track record of great performance it only captures roughly 60% of the investable universe. Evidence has shown that any given country’s stock market can outperform the US market in any given year so it’s important to employ global diversification in your investment strategy. For example, if you look at the past 20 years of returns (ending in 2022) the Denmark stock market has the best annualized returns of any country followed by New Zealand, Australia, Sweden, Switzerland, and the US at number 6. We know that any of these countries can perform better than the rest in any given year but it’s impossible to tell when and that’s why it’s important to have a globally diversified investment portfolio. The investment Gods don’t care where you live.

Perhaps the most important thing to understand when investing at a young age is that you have many years to invest and take advantage of the compound interest the stock market offers. The stock market is prone to temporary declines but history has proven these declines ALWAYS come back up. So you have to ignore short term drops and stay invested. It’s a proven formula. No one knows when stocks will go up or down but we know that stocks go up over the long term.

So do your research when it comes to investing, invest in low-cost funds, have a globally diversified investment portfolio, take advantage of tax advantaged accounts, and have a long term approach to your investment philosophy. These are proven ingredients for success in the greatest wealth building tool ever offered.