- Many new investors are considering signing up with Robinhood, the buzzy investing app.
- But financial planners say you should have adequate savings and a retirement fund first.
- You should also know your risk tolerance and the tax implications of your trades.
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If there’s one thing the internet does well, it’s set trends. And investing with Robinhood is the latest craze.
If you’ve been mulling over the idea of signing up for a Robinhood account, it’s important to do your homework before deciding whether it’s the best approach for you. While investing through a brokerage account can be a great way to build wealth, it can also be unpredictable — and Robinhood might not be right for everyone.
We talked to two financial planners who shared a few important things every first-time investor should consider before signing up.
1. Have adequate short- and long-term savings set aside
Nickolas P. Sanchez, financial planner at Financial Architects, Inc., says that before investing in a taxable brokerage account from Robinhood or any other investing app, you should have adequate liquid savings set aside in a bank savings account. He recommends saving six to 12 months of your gross income.
This money serves two purposes, an emergency fund and an opportunity fund. The recommended amount will cover you in the event of a job loss or other financial emergency, and also ensures you have capital on hand if an opportunity arises, such as a real estate investment or market downturn.
It’s also important to have a retirement savings strategy in place before investing with an app like Robinhood. Your long-term retirement savings should be invested using a 401(k) or other workplace retirement account, or an IRA.
Before opening an account with Robinhood, be sure your savings account is full and you’re on track for retirement. Any money invested with Robinhood should be cash you can afford to lose.
2. Know your risk tolerance
Financial planner Michael Schwartz, CEO of Magnus Financial Group LLC, says it’s important for a first-time investor to understand how much risk they are able to handle emotionally and mentally.
Knowing your risk tolerance before embarking on your investment journey is not as simple as it sounds. You may assume you can tolerate losing a certain amount of money, but when it happens, you may feel differently.
When Schwartz first works with a client, he asks them theoretical questions based on three or four different scenarios to help him gauge their risk tolerance. It’s something he recommends every first-time investor do before jumping in.
For example, take the money you plan to invest; if it’s $10,000, ask yourself how you’d feel if it turned into $20,000. Then, ask yourself how you’d feel if that same amount turned into $2,000. If that creates too much anxiety for you, then a high-risk strategy probably isn’t your best bet.
Apps like Robinhood can make investing look and feel like a game by using colors and push notifications that encourage a user to make quick and frequent trades. It’s easy to forget your limits because the process can become addictive, like gambling. That’s why it’s important to be clear with yourself about your financial limits and risk tolerance well before joining Robinhood.
3. Don’t base your investing decisions on hype
Many first-time investors are signing up for Robinhood because of the hype around certain stocks. But Sanchez warns against investing in stocks based on market trends and popularity alone.
The price of a stock is not always linked to a company’s underlying financial value. A company’s stock price could go up simply because of an online trend, or because of news that suggests its value may grow. But even if it’s based on positive news, the increased demand may drive the stock price above its value.
“When the hype dies down and the stock comes crashing back to earth, people that got in late could lose a significant amount of their investment. It’s not a game,” Sanchez says.
If you’re considering a particular stock, you should base your decision on your own research or understanding of a company’s value or growth potential. Better yet, invest in low-cost ETFs and index funds, giving you broad exposure to the market and mitigating your risk.
Bottom line, “If you can’t afford to lose the money, then it shouldn’t be in an investment account,” Sanchez says.
4. Don’t forget about taxes
Before trading with Robinhood, Sanchez says you should familiarize yourself with how these investments are taxed. A good place to start is by understanding the difference between long-term and short-term capital gains tax. For example, money made on stocks sold within a year is considered short-term capital gains and may be taxed higher than money made on stocks held for a year or more. When tax season comes around, you’ll need to be prepared to pay taxes on those gains.
Once you’re familiar with what your tax implications may be, Sanchez suggest asking yourself if you’d be better off investing your money in accounts that offer tax-free growth, such as a Roth IRA.
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