Starting to invest money in the stock market can be an intimidating endeavor. With so many companies vying for your investment, it can be confusing to choose a company to invest with, not to mention choosing your investments once you find a trustworthy partner.
This comprehensive guide to getting started investing will help you understand how to begin, from asking the right questions to developing an investment strategy, the various types of investments available, and how to make your first purchase. Let’s dive in.
In this article, you’ll learn:
- Questions to ask before you start investing
- Types of Investment Accounts (retirement, children’s education, etc.)
- Various kinds of investments (stocks, index funds, mutual funds, etc.)
- How to make your first investment
- Basic principles for first-time investors
Start Learning About Investing
The amount of information that exists about investing is overwhelming. The best place for any new investor to start is by looking inward. There are certain questions only you can answer about why to invest, how much to begin with, and risk aversion. Any new beginner should start with the following fundamental questions:
Why Do I Want to Invest?
A clear answer to this question can help drive your investing decisions.
- Were you discussing investing with friends, and it sparked a curiosity?
- Are you contemplating early retirement, and you’re looking for ways to get ahead financially?
- Did you attend a meeting at work with your 401K specialist and feel compelled to understand more and begin investing for retirement?
- Do you want to save for your child’s education by putting away money into a taxable brokerage account or 529?
No matter the reason, determining why you want to get into the investing game should be step one.
How Much Money Do I Have to Start?
If you’ve never looked at your cash flow, meaning the amount of money you have coming in vs. that which goes out, now would be a good time to do that. It’s critical to understand the amount of money that you have freed up to invest. Otherwise, you may find yourself in a position where you’ve dumped so much money into an investment that you need to retrieve it at an inopportune time, potentially taking a loss.
Be realistic. If you only have an extra $5 a week to spare, that’s great, and that’s enough to get you started. You can always increase or decrease your investments over time as your priorities shift and life circumstances change.
How Do I Feel About Risk?
This is perhaps the most critical question for any new investor. Certain types of investing can be a bit like gambling, and if you’re not able to stomach the ups and downs of a volatile investment, you may want to lean towards something a bit more conservative.
Types of Investment Accounts
Before we look at the types of investments available, it’s critical to understand the account in which the underlying assets will be held. Some investment accounts use post-tax money and are accessible to the investor at any time. Others hold funds until a certain age or circumstance, meaning investors will get hit with a penalty if they try to pull money out prematurely.
Employer-Sponsored Retirement Accounts
Retirement accounts enable investors to save money, often with some pretty significant tax incentives, to use at a set age in retirement. Common employer-sponsored retirement accounts are the 401(k), 457, and 403(b). There are similar options for self-employed individuals like a Solo 401(k), SEP IRA, and SIMPLE IRA.
If you’re interested in investing for retirement, it’s critical to review the types of accounts available through your company and make sure you understand the contribution limits and restrictions and penalties for withdrawals before signing up.
You’ll also want to ask questions about investment options to determine if you can choose or if the plan offers managed model portfolios or target date funds..
A significant benefit of employer-sponsored retirement accounts is that the money is often routed to the investment of your choice before you ever see it in your paycheck. Since you don’t ever see the money go out the door, you’re less likely to miss it. But a major downside is that sometimes the available investment options are limited, or the accounts assess higher maintenance fees.
Individual Retirement Accounts (IRA)
There are also retirement accounts that are not explicitly tied to an employer, like a traditional IRA or Roth IRA. The critical difference between a traditional IRA and Roth IRA account is that a Roth account allows for post-tax contributions and tax-free growth. In contrast, a traditional account allows for pre-tax contributions and tax on the back-end post-retirement (when many people are in a lower tax bracket).
These IRAs are subject to some income and tax-free contribution limits. Even still, they are a great tool to add to a well-balanced retirement plan.
A taxable brokerage account is an investment account opened by an individual that uses after-tax dollars to purchase investments. These accounts are subject to capital gains taxes on growth. But they have loads of advantages, including no income requirements or limitations, no contribution limits, no mandatory distributions, and no withdrawal penalties.
Child Education Accounts (529)
A 529 college savings plan is an option available to those who want to save money for a particular child’s education (your own, a family member, or a close friend). The benefit to the investor is a tax deduction. And the benefit to the eventual recipient is that money in the account grows tax-free if utilized for a qualifying education expense.
Types of Investments
Stock market investments can be broken down into several broad categories:
Stocks are the most common type of investment. When you invest in a single company stock, you’re buying into that organization’s success or failure. You will profit if share prices go up, and you could potentially lose everything if a company goes under. Individual stock investing tends to be riskier, but also offers incredible returns if you manage to choose the right company and get in at the right time.
In the old days, you’d have to buy a full share of a company stock. For some larger companies, this was a pretty expensive endeavor. But thanks to the rise of fractional share investing, you can buy $5 or $10 worth of a share instead of the entire thing. That means you could become an investor in Tesla, Apple, or Google for a fraction of the cost of purchasing a whole share, and take part in the growth as well!
Bonds have traditionally been viewed as the quiet and steady that allow investors to hedge risk by ensuring some of their investment is protected. An investor can purchase bonds that act as loans to governments or corporations in return for the peace of mind that the borrower will repay with interest at the fixed rate over time.
While returns on stocks can be practically limitless, bonds are fixed-income investments that offer much lower risk and return profiles.
Exchange-traded funds or ETFs are baskets of investments, sometimes containing hundreds or of individual assets. ETFs increase broad exposure compared to individual stocks or bonds, while adding diversification benefits to a portfolio.
ETFs may track a broader market index (S&P 500), a specific industry (energy, real estate), or a commodity (natural gas, precious metals). These funds offer exceptionally low fees and greater tax efficiency than mutual funds due to their passive management style and low overhead.
Similar to an ETF, index funds are portfolios of stocks or bonds that track a broader market index. Index funds differ from ETFs in that they can have a minimum investment amount to make a purchase (sometimes at least $3,000), and they only trade once per day based on net asset value. In contrast, ETFs trade in real-time much like an individual stock.
Index funds are passively managed. This means there is very little overhead for companies to offer index funds to investors. Therefore, many index funds offer their products to investors for minimal costs.
Since index funds track a broad market index, the securities that exist within an index fund only change when the index components change.
Mutual funds are the actively managed counterpart to ETFs and index funds. A mutual fund is overseen by a fund manager responsible for the fund’s performance and uses more frequent buying and selling of fund assets to beat a predetermined benchmark (the S&P 500 for example).
Since active management takes more human resources and oversight, mutual funds tend to have some of the highest internal expenses and are also less tax-efficient than ETFs and index funds.
While cryptocurrency is not a traditional investment, it’s worth mentioning as it continues to grow in popularity. Operated on a distributed ledger technology called blockchain, cryptocurrencies have various uses and are beginning to make their way into mainstream institutional and retail portfolios.
How do I Begin to Invest?
There are relatively few barriers to entry for investments these days. If you have a legitimate identity, a bank account, and a phone, you’re ready to get started. The below steps take you through beginning to invest from account creation to re-balancing.
- Choose a Company, ETF, or Mutual Fund: Beginner investors can download an app like Robinhood and begin purchasing fractional shares of stocks, bonds, or cryptocurrency in as little time as it takes to link a funding source. If you’d like to take a more traditional route, you can sign up for an account with a reputable brokerage company like Vanguard, Schwab, or Fidelity.
- Link to a Funding Source: Many people set up a direct ACH from a bank account to quickly transfer funds for investing. If you’re choosing to opt-in to a company retirement account, reach out to your human resources department to set up recurring paycheck deductions.
- Decide on a Cadence: Do you plan to invest weekly, monthly, one lump sum annually? Dollar-cost averaging, which is the strategy of dividing up an annual investment at regular predetermined intervals throughout the year, has been shown to reduce risk. When you invest a set amount on the first of the month, you spread the risk of market volatility evenly across the calendar year. That means you might buy at a peak some months and in a valley others, which is likely to even out over the long term to result in a net gain.
- Pick a Portfolio Allocation: Some investors say to hold bonds in your portfolio as a percentage equivalent to your age. For example, a 30-year-old’s portfolio would be 30% bonds, 70% stocks. But that’s not a hard and fast rule. If you’ve got a long time horizon before you need the money, you can afford to be a bit more aggressive and stay the course through potential market volatility.
- Set it and Forget it: Once you’ve developed your investment strategy, automate it and don’t touch it until you need it. It can be tempting to jump back in and buy or sell based on if the market is up or down, but often that can result in missed opportunities, not to mention frustration and heartache.
- Re-balance Regularly: Annual re-balancing is typically a good practice. As investments change in value and dividends get reinvested over time, your asset allocation can fall out of balance. For example, let’s say your portfolio had 30% bonds and 70% stocks at the beginning of the year. If the stocks saw incredible returns and tons of dividends, you may now be looking at a ratio of closer to 20% bonds and 80% stocks. When you re-balance, you’d either sell off some stocks to purchase bonds or simply set your investments to buy more bonds over the first few months of the year until you get back to your preferred allocation.
Basic Investing Principles
New investors can be inundated with information that makes it tough to decide on an investment and get started. These basic investing principles cover what a beginner investor needs to know before dipping their toe into the stock market waters.
Do Your Research
You wouldn’t buy an expensive product without checking out reviews first, and you shouldn’t start to invest without doing your research first, either. Now that you understand the types of investments available, you can begin to consider where you may want to distribute available funds.
The most important element of research is to make sure that you understand potential investments before you jump in. Sometimes the best way to do that is to compare several options in which you’re most interested.
Some people prefer to track the pros and cons of potential investments on paper or a spreadsheet. These options enable you to do a side by side comparison of fees, historical returns, and projected returns. There are also plenty of tools online that will allow you to research stocks if you want to take a more hands on approach. .
Build a Diversified Portfolio
While it can be tempting to allocate all of your funds towards a particular investment that sees great returns, diversification is a major principle of investing. Through diversification, or spreading the risk of your portfolio across different assets, you essentially buffer your portfolio against the elements of a market downturn.
Holding a portfolio that exists entirely of large-cap technology stocks is extremely risky if something happens in the tech sector. To create a diversified investment portfolio might mean that in addition to large-cap technology stocks, you also invest in small-cap stocks, international ETFs, bonds, etc.
Timing the Market vs. Time in the Market
Savvy investors know that the secret to long-term success in the market is not excessive trading but following a steady, dedicated plan over the long term. Generally, investors who try to time the market miss out on growth.
Waiting for the perfect opportunity to buy an asset at the lowest price possible or sell it when it peaks is a guessing game at best. By selling when you think something is at its peak and removing yourself from the game, you miss out on long-term growth and are less likely to put your money back in once you’ve taken it out. Slow and steady investors tend to win the stock market race.
Keep Fees Low
Some investments, like mutual funds, assess higher fees in return for active management. Remember that any fees you pay when buying or selling your investments mean less money in your pocket when all is said and done. Passively managed ETFs have come into favor mainly because of their low fees and easy entry for beginner investors.
If your investments or the accounts in which they reside assess fees, make sure you understand how much you’re paying and what you’re getting in return. One of the worst things you can do with an investment is to continue to pay high fees and not receive a benefit.
There is no time like the present to get started investing. While nobody knows what the market may do today, allowing your money to compound over decades is one of the best paths available to build wealth.
Stick to the Plan
If you fail to plan, you plan to fail. Nothing could be more accurate than when it comes to investing. While some investors may seem like they’re throwing around money with no rhyme or reason, most understand their risk aversion, monetary limitations, and how they will react or not react given certain market circumstances.
The market has been known to fluctuate, but generally trends upwards over time. When you’re investing in the market, assuming you’re not looking to be a day trader, you’re usually looking for returns over a longer investment period.
It’s imperative to create an investing strategy and to refer back to it in times of market volatility. If the market is crashing, it might seem like a good time to scrap your strategy and sell, sell, sell. But doing so may mean you cash out at a lower price per share, and you might miss the rebound.
Automation is Your Friend
Once you decide which investments you’d like to get into, automate your contributions. If you choose to use an employer-sponsored retirement plan, this becomes quite simple as most contributions are taken directly out of your paycheck. But if you’ve decided to open an IRA or taxable brokerage account, you may want to set a recurring monthly contribution to keep your investments on schedule. A “set it and forget it” investment strategy enables you to continuously invest and get the best of both the highs and the lows over time.
It’s Okay to Ask for Help
If you’re hesitant to get into the market with limited knowledge, you may find that seeking professional assistance is the best path forward. If you’re planning to work with a financial advisor, make sure they are a fiduciary, which means they legally have to put your interests first when making any investment decisions or recommendations.
A financial advisor can help you determine what type of investment strategy will benefit you over the long-term. They can also offer assistance with retirement planning, tax planning, and basic personal finance questions.
Investing is no longer an activity reserved for the wealthy or elite. Anyone with a smartphone and a few dollars can become an investor. And given that investing is one of the best ways to increase wealth, there’s no reason why you can’t get started today. Do your research and seek out help if you need it, but remember that the longer you wait, the less time your money has to compound and grow!