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Friday 15 October 2021

Investing for Beginners: Start Here if You Don't Know Anything

You've probably heard that investing is one of the best ways to put your money to work.

But if you've never put money in the stock market, the prospect can be overwhelming.

What investments should you choose? How much money does it take to get started? And what kind of account is right for you?

Investing may seem intimidating, so it's important to learn the basics.

We'll explore different types of investments, including stocks, bonds, mutual funds, certificates of deposit and retirement savings plans like 401(k)s.

We'll also discuss where to actually invest your money, such as tax-advantaged investment accounts, robo-advisors and online brokers.

Finally, we'll detail some key concepts and strategies to guide you on your investing journey.

Investing for beginners doesn't have to be complicated. Here's how to get started.

What Should I Invest in? 5 Types of Investments for Beginners

Investing is a way to build wealth by purchasing assets that you anticipate will grow in value over time.

There are many different investment vehicles. Each carries its own potential risk and reward.

Types of Investments:

  • Stocks
  • Bonds
  • Mutual funds, index funds and exchange traded funds (ETFs)
  • Certificates of deposit (CDs)
  • Annuities
  • Options and futures
  • Cryptocurrencies

For beginning investors, it's wise to start with simple investments such as mutual funds, index funds and ETFs, before moving on to more complex investments like real estate.

Stocks

When you invest in stocks, you're essentially buying a small ownership share of a company â€" and its profits.

The earning power of a company drives its long-term stock price â€" for better or worse. Stock prices can be impacted by factors inside the company, like strong quarterly profits or poor revenue, and by events outside the company's control, like political turmoil or a broad economic recovery.

You can make money from stocks in two ways:

  • Your shares increase in value. If the company's outlook is good, other investors will be willing to pay more money for your shares than you originally paid.
  • The company pays you a dividend. This means the company distributes part of its profit back to shareholders. (That's you.) Smaller companies issue dividends less frequently than larger ones.

Shareholders are vulnerable to loss if things don't go as well as hoped. If the company loses money, your shares may lose value. Thus, when you buy stocks, you're making a relatively high-risk investment.

Despite that risk, one of the most common beginning investor mistakes is selling shares in reaction to the daily news cycle. Constantly checking stock prices or tweaking your investments can lead to impulsive â€" and costly â€" decisions to sell.

For the average investor, you're better off investing in stocks long-term. Historically, the average annual stock market return is 10%, or an average of 7% to 8% after inflation. Keeping your money invested allows you to weather the stock market's unpredictable ups and downs. As long as you don't sell when stocks are low, you won't actually lose money.

Pro Tip

Diversification is a strategy used to manage risk. It works by spreading your money across different types of investments so that if one loses money, the others will hopefully make up for the loss.

You can also offset the risk of owning individual stocks by purchasing multiple shares of different publicly traded companies, and of companies across different sectors. For example, don't invest in only tech companies. Diversify with investments in energy, pharmaceutical and transportation companies.

Investing in other assets like bonds is another way to help mitigate the risky nature of stocks while still profiting from their high returns.

Bonds

Bonds are debts issued by corporations or, more commonly, governments.

When you invest in bonds, you're lending money to the bond issuer.

Investing in the bond market provides a reliable return because bonds pay fixed interest payments at fixed intervals, often twice a year. That's why they're known as fixed income investments.

Because bond issuers are legally obligated to repay their debts, bonds are considered safer than stocks. However, bonds don't have the exponential growth potential that stocks do. In fact, bond yields have been declining since the 1980s.

The lowest-risk bonds are issued by the U.S. Treasury. Municipal bonds, which are issued by state and local governments, are slightly riskier.

Investing in Treasurys and municipal bonds also comes with tax breaks: You don't pay federal income tax on the interest you earn from municipal bonds, and the interest you earn on Treasurys isn't taxed by states.

Lower risk and tax advantages are two reasons people often shift their asset allocation toward bonds as they near retirement. Bonds are a safe choice if you don't have much time to bounce back from market losses.

Investing in corporate bonds is riskier than investing in government bonds. The safest corporate bonds are called investment-grade bonds and the riskiest bonds are called junk bonds.

Because investors assume a high level of risk when they buy junk bonds, they earn higher interest rates.

Still unsure about the difference between stocks and bonds? We'll explain.
In this illustration, a woman waters a tree that is growing money.

Mutual Funds

A mutual fund is a prebuilt collection of stocks and sometimes bonds. You are essentially buying small pieces of many different assets with a single share purchase â€" without all the footwork to research and buy individual stocks and bonds yourself.

Typically, a mutual fund is designed and managed by financial professionals. However, some mutual funds are index funds, which means their makeup and performance is tied to a market index, like the S&P 500 or the Dow Jones Industrial Average. We'll talk more about index funds when we discuss ETFs.

A minimum investment can range from $500 to $3,000, though some offer a minimum investment of $100 or less.

Mutual funds can be a good option for new investors because they offer convenience, instant diversification and access to professional money managers.

It's important to keep in mind that actively managed mutual funds carry fees. After all, you're paying someone else to do the work for you.

Pro Tip

The Financial Industry Regulatory Authority offers a Fund Analyzer tool with analysis of over 18,000 mutual funds and ETFs, including how fees and expenses may impact your bottom line.

While some mutual fund managers achieve impressive short-term gains, research shows that mutual funds struggle to consistently outperform the broader market over time.

Exchange-Traded Funds (ETFs) and Index Funds

Exchange-traded funds and index funds are similar to mutual funds in that each is a basket of different investment assets.

One key difference: ETFs and index funds aren't actively managed by a live human being. Instead, these investments are passively managed.

Index funds and ETFs are often used interchangeably. That's because many ETFs track a market index.

The only big difference between the two is how they're traded. You can buy and sell an ETF throughout the day, while you can only trade an index fund at the price point set at the end of the trading day.

Because they are passively managed, ETFs carry low fees. The average expense ratio for a managed mutual fund in 2019 was 0.66%, according to Morningstar, compared with an average blended fee of 0.09% for ETFs.

Many ETFs seek to replicate the performance of the overall stock market or a major stock index. Others aim to represent a smaller segment of the market.

Some ETFs are collections of companies in the same industry or geographic area. For example, Vanguard's International Equity Index ETF (VSS) tracks major non-U.S. companies while the Health Care Select Sector SPDR Fund ETF (XLV) tracks U.S. health care companies like Johnson & Johnson and Pfizer.

ETFs can also focus on companies of a similar size and market share. Vanguard's Small Cap Value ETF (VBR), for example, includes companies with a market capitalization between $300 million and $2 billion.

Certificates of Deposit (CDs)

CDs, or certificates of deposit, are among the lowest-risk investments. You agree to let a bank or financial institution hold onto your money in exchange for a guaranteed interest rate.

CDs have a fixed term length and a maturity date. You lock funds in a CD for a certain time, usually three months to five years. You'll face a penalty for withdrawing funds early. After the term ends, you'll get your initial investment back, plus a little interest.

Because the risk is low, so is the reward. CD rates may earn only slightly more interest than high-yield savings accounts.

CDs aren't a good option for growth, but they are a good way to earn interest safely if you can't afford to take a risk on the stock market.

How Much Money Should a Beginner Investor Start With?

One of the biggest misconceptions about investing is that you need thousands of dollars to get started.

That simply isn't true. Some investing apps let you begin investing in the market with as little as $1.

For new investors, it's more important to start as early as possible. Starting small is always better than not starting at all.

If you're right out of college or working a low-paying job, you may not have much money left over to invest. Over time, you can invest more money, diversify your holdings and build a strong portfolio. For example, you can step up your 401(k) contributions at work after every raise.

It's also important to build an emergency cash savings fund before you start investing. You don't want to use money you're saving for your future in order to cover unexpected costs like a sudden job loss or car repairs.

Where Do I Start Investing?

The best place to start investing depends on your financial goals, as well as how much money you can afford to invest.

But if you don't have a few thousand dollars lying around, don't worry. There are plenty of avenues to get into the market, including online brokers, robo-advisors and retirement savings plans.

Two cubicle workers push each other on a chair down the hallway at their office.

Your Employer's Retirement Plan

If your employer offers a 401(k), contributing part of your wages should be step one. If it includes an employer match, be sure to contribute the level needed to qualify. It's essentially free money for your future.

It's smart to start contributing to a retirement investment account as soon as possible. The longer you wait, the more you'll have to play catch-up later.

Traditional 401(k) plans offer favorable tax treatment from the federal government. Your money is invested pre-tax, and grows tax-deferred until you withdraw funds.

Your 401(k) plan will likely offer a handful of investment choices based on your target retirement date, mostly mutual funds and ETFs. You typically can't use your 401(k) to invest in individual stocks and bonds.

Pro Tip

In 2021, you can contribute up to $19,500 a year to a 401(k), or $26,000 a year if you're age 50 or older.

Roth or Traditional IRA

If you don't have access to a 401(k) at work â€" and even if you do â€" you can open an individual retirement account (IRA) with a financial institution or online broker to work toward building an even bigger nest .

IRAs come with more investment choices than 401(k)s, including individual stocks and even alternative investments.

Most people can choose between a Roth or traditional IRA.

With a traditional IRA, all your dollars go into the account tax-free but you pay taxes on the backend when you withdraw funds.

Meanwhile, a Roth IRA withholds taxes when you deposit money at the beginning but offers you tax-free withdrawals on the backend.

Contributions to a traditional IRA qualify as a deduction on your yearly tax bill. Contributions to a Roth retirement account do not.

While you can open an IRA through either a bank or a brokerage firm, we suggest going with a brokerage. Bank IRAs are usually limited to super-conservative investment options, like CDs, which have low potential growth. Opening an IRA with a brokerage firm will give you access to a full array of investments.

Pro Tip

In 2021, you can contribute up to $6,000 a year to an IRA, or $7,000 a year if you're age 50 or older.

Taxable Brokerage Account

With a few exceptions, money in your retirement accounts is off limits until you turn 59 1/2. You'll face a 10% tax penalty from the Internal Revenue Service if you withdraw funds earlier.

If you plan to tap your investments prior to retirement, opening a taxable brokerage account may be a good option. You don't get the tax benefits of a retirement plan, but you get a lot more flexibility with this type of investment account. Capital gains tax is assessed differently, depending on how long you own a stock.

If you sell a stock you've owned for less than a year, the profit will be subject to the short-term capital gains tax rate. Stocks owned for a year or more are taxed at a typically lower long-term capital gains rate.

It's also important to keep in mind that some brokerage services aren't free. If you want a professional to manage your account, for example, you'll pay for this service.

Here are some brokerage fees to be aware of.

Trade Commission 

Also known as trading costs, this fee is applied when you buy or sell stocks. Trading costs are becoming rare, and many discount brokers offer commission-free trading, including TD Ameritrade, Charles Schwab and Robinhood.

Mutual Fund Transaction Fee 

This fee applies when you buy and/or sell a mutual fund.

Expense Ratio Â 

This annual fee is charged by mutual funds, index funds and ETFs as a percentage of your investment in the fund.

Management or Advisory Fee 

This fee is usually a percentage of assets under management and is paid to financial advisors or robo-advisors.

If you're a new investor, look for discount brokers with low minimum investment requirements and access to tailored investment advice.

Robo-Advisors

A robo-advisor is a type of online investment account that automates stock investing for you. It can be a great option for new investors because robo-advisors charge low fees and take the guesswork out of building a diverse portfolio.

Robo-advisors  â€"  such as Betterment and Wealthfront â€" are online brokers that use computer algorithms and advanced software to build and manage your investments. There are typically five to 10 pre-made portfolio choices, ranging from conservative to aggressive.

After you create an account, you'll be prompted to complete a questionnaire designed to evaluate your income, age, goals and risk tolerance.

From there, the robo-advisor picks the right portfolio for you. You can choose a different one if you disagree with the algorithm but you typically can't select the individual investments inside your portfolio.

Robo-advisor portfolios are mostly made of low-cost index fund ETFs and sometimes other investments, like mutual funds.

Robo-advisors let you choose between a taxable brokerage account or an IRA â€" and they'll help you choose the right account type for you.

Most robo-advising companies charge annual management fees that range between 0.25% and 0.50%. Some require an initial investment of $5,000 or more, but most robos accept account minimums of $500 or less.

Investment Apps

Only have a few bucks to spare? A micro-investing app may be a good option.

Apps like Stash and Acorns make investing for beginners easier than ever.

Investment apps are robo-advisors that let you start investing with as little as $5. Both Acorns and Stash invest your money into a custom ETF portfolio based on your age and personal risk tolerance.

You can also set up regular, automatic contributions, which will fuel your portfolio's growth over time.

In general, Stash is a good option for beginner investors who want a more DIY, hands-on approach because the app allows you to select your own stocks and ETFs.

Acorns tends to be a better fit for people looking for a more passive, automated experience because the app doesn't allow you to invest in specific securities.

A woman with tattoos sits at a skate park.

Investing for Beginners: 4 Basic Strategies to Know

Now that you've got the lowdown on your investment options, here are a few more things you need to know before you start investing.

Since all investments involve some risk, it's imperative to be prepared and informed about how to mitigate those risks.

1. Maximize the Magic of Compounding Interest

The power of compounding can turn even modest savings into a sizable nest egg over time.

If you saved $100 a month and tucked it under your mattress, you'd have $36,000 in 30 years.

But if you invested that same $100 a month and averaged an 8% return per year, you would end up with more than $140,000 after 30 years.

Compounding occurs when the interest you earn on your money builds on itself like a snowball effect.

To maximize this compounding magic, you need to invest early and consistently. Making smaller contributions at an earlier age gives you a leg-up over someone who gets a late start â€" even if that person invests a lot of money at once.

Pro Tip

Use this interactive calculator from the U.S. Securities and Exchange Commission to see just how much your money can grow with compounding interest. Â 

If you start investing in your 30s or 40s, you can still benefit from compounding interest by simply letting your money grow. Avoid cashing out early so that your snowball of interest can gain momentum.

2. Diversification

Perhaps the most important investment strategy is diversification. A diversified portfolio means you have a wide range of assets, including different asset classes, companies, locations and industries.

Why is diversification so important? Well, it's just like that old saying about not putting all your eggs in one basket.

If one of the companies you own stock in goes under, for instance, you won't be as adversely affected if your money is spread across other companies and industries.

It's also wise to diversify across asset classes by owning a mix of stocks, bonds and even alternative investments like real estate.

Mutual funds and index funds are popular among new investors because they offer immediate diversification.

3. Understand Your Time Horizon

Your time horizon is how long you plan to hold an asset. Time horizons can range from a few months to several decades, depending on your goals.

Understanding your own time horizon â€" and investing goals â€" can help you pick the right investments.

If you're young and investing for retirement, your time horizon is long. You can be more aggressive with your portfolio by investing in riskier securities, like stocks, because you have more time to recover from volatility and loss.

While stocks can be volatile in the short term, over time, they historically outperform other investments. If you don't need access to your money anytime soon, consider stocks, ETFs and index funds for long-term growth.

However, if you need to tap your money within the next three years, you shouldn't invest it in stocks. You're better off putting your money in a CD, money market account or high-yield savings account.

That's because shorter time horizons give you less wiggle room to bounce back from market losses. If you need money for a down payment in two years, you don't want a sudden crash to derail your plans.

Likewise, many financial experts recommend shifting your portfolio to less risky investments as you near retirement because your time horizon is shorter.

Pro Tip

You might consider hiring an investment advisor to ensure your investing decisions are appropriate for your goals and time horizon.

4. Risk Tolerance

Risk tolerance is the amount of volatility an investor is willing to stomach. It's sometimes referred to as your 'sleep at night factor.'

In other words, how much risk are you willing to take within your portfolio before the thought of losing money keeps you up at night?

The answer is different for everyone. There's no right or wrong risk tolerance level.

Generally, younger investors are encouraged to take more risk and create aggressive portfolios. Investors nearing retirement, on the other hand, are encouraged to switch to safer securities like bonds to preserve their money.

However, it's important to consider how market changes impact you on an emotional level. You can be in your 20s and still stress out when the market drops. Or you might be near retirement but still comfortable day trading.

You can score your personal investment risk tolerance using this empirically tested risk tolerance assessment tool developed by two university financial planning professors.

Speaking with a financial advisor is one way to offset some of the anxiety many new investors face. Trained professionals can provide valuable insight on how to make investment decisions that match your personal comfort level.

Rachel Christian is a senior writer for The Penny Hoarder. Jamie Cattanach contributed reporting.

This was originally published on The Penny Hoarder, which helps millions of readers worldwide earn and save money by sharing unique job opportunities, personal stories, freebies and more. The Inc. 5000 ranked The Penny Hoarder as the fastest-growing private media company in the U.S. in 2017.



Source : https://www.thepennyhoarder.com/investing/beginners-guide-to-investing/?aff_id=178&aff_sub3=MainFeed__investing/beginners-guide-to-investing/

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