Investing can appear confusing and intimidating to a novice. But if you plan to retire or meet other money goals, investing now can help you earn financial returns for your future. If the intimidation factor or other financial pressures are keeping you from investing, you should know that you don’t need to be a wealthy Wall Street guru to invest. For most people, understanding the basics and choosing the right investment strategy is enough to get started.
Here’s how beginners can start investing ASAP.
Understand the basic types of investments
Investing usually involves putting your money into securities that increase in value or pay you interest to grow your investment over time (though there is always the risk of your investments losing value). There are many different types of investments, but some of the most popular are:
Stocks represent a share of ownership in the company issuing them, and are bought and sold on the stock market. Stock prices fluctuate based on the perceived value and performance of the company. (What should you do about stock market dips?)
Investors constantly buy and sell shares based on what they believe a company’s value will look like in the future, said Robert R. Johnson, professor of finance at Creighton University. “Stocks are more high-risk, high-return types of investments … (they) typically deliver returns to investors in the form of dividends and stock price appreciation.”
Bonds are a type of loan to a corporation or government organization, with the understanding that the organization will pay you back with interest after a certain amount of time. These investments are lower-risk, but they only provide a predetermined return comprising the principal and the interest payments.
“In return for the bondholder’s money, the corporation is obligated to make periodic interest payments to the bondholder and to repay the loan when the term of the loan ends. The basic terms of the bond include the bond’s maturity (the original length of the loan), the coupon rate of interest (the rate of interest on the bond), and the denomination of the bond (the amount of the loan),” said Johnson.
Mutual funds are a mixed portfolio of stocks and bonds managed by a professional investment manager. When you invest in a mutual fund, you don’t choose individual investments; instead, the funds are diversified and spread between different holdings. This diversification reduces the investor’s risk because you aren’t putting all your money in one place.
Mutual funds can be focused on aggressive growth, low risk or some combination thereof.
Exchange-traded funds are bundles of securities that can be bought or sold through a brokerage firm on a stock exchange. They are traded daily, like a stock. Compared to mutual funds, ETFs have lower investment minimums and offer real-time prices when you purchase or sell.
Choose the right investment strategy
When deciding how to invest your money, you’ll need to determine your investment strategy, which depends on your goals and how many years you have to invest.
If your financial goal is far in the future, such as retiring 40 years from now, you can start with higher-risk investments like stocks, which are less predictable and fluctuate in value. If you have less time to invest or you are risk averse, you can invest in bonds, money market funds or other lower-risk securities.
“There is an old Wall Street adage: ‘You can eat well or sleep well,’” said Johnson. “If someone has a very conservative portfolio—government bonds and treasury bills, for example—they will be able to sleep well because they won’t experience much volatility; prices won’t vary much. But in the long run they won’t build much wealth and won’t be able to eat as well as the individual who crafted a more aggressive portfolio containing common stocks.”
Choose an investment type
Beginners who want a simple investment solution should avoid chasing the highs and lows of individual stocks. According to Johnson, buying individual stocks is risky, even with companies you’re jazzed about. For beginning investors, a mutual fund or ETF may be the best bet.
“A mutual fund or ETF diversifies and the volatility of that investment will be much less than that of the average single stock,” Johnson said. “These funds have low minimum investments and provide beginning investors with an easy way to start.”
Popular among both mutual funds and ETFs are index funds, which follow the performance of a stock market index. They feature low fees and generally rise in value over time, which makes them great options for beginning investors.
If you’re looking for a safer return on your investment, consider choosing a bond fund, a mutual fund that consists of only bonds, which offers lower returns but is more secure and delivers returns in the short term.
Choose where to invest
Once you’ve figured out a strategy and investment type, you need to actually choose where to invest your money. Many platforms allow people to invest in stocks, bonds, mutual funds and ETFs. For beginners, the easiest and most popular ways to invest usually involve the following:
Employer-sponsored retirement plans: Employer retirement plans, such as a 401(k), let you defer paying taxes on your contributions until you withdraw them in retirement. Others let you pay taxes now to avoid paying taxes on the returns later. Many employers match employee 401(k) contributions up to a certain amount. If your employer offers this option, make sure to take advantage because it’s free money. Plus, you can set your contributions to come right out of your paycheck (there is an annual contribution limit).
Individual retirement accounts: IRAs are savings vehicles that let you invest funds for retirement in a tax-advantaged plan outside of your employer. Traditional IRA contributions are tax-deductible now, while Roth IRA contributions are taxed but you won’t pay taxes on your returns or withdrawals when you receive funds in retirement. There is an annual contribution limit. (Learn how to open an IRA.)
Brokerage account: If you want to invest outside of your employer plan or an IRA, you can invest through an online broker. While your contributions aren’t tax-deferred, there are no contribution or income limits either.
Robo advisers: Robo advisers are cheaper versions of brokers that manage your investments using an algorithm. They have low fees and are suitable for beginning investors.
If you decide to open your own online broker or robo adviser account, there is no limit to how many accounts you can hold or how much you can contribute. Look for a company that offers low fees, diversified portfolio options and the investments you wish to make.
Make sure to check the minimum required amount to open an investment account. Plenty of options offer low minimums.
The dollar amount you invest on a regular basis depends on your income and expenses. You should look at your monthly budget to determine how much you can afford to invest. If your employer offers matching contributions to a 401(k) up to a certain limit, you should try to contribute at least that amount so you aren’t leaving free money on the table.
Advisers commonly recommend that investors sock away around 15% of their income in a 401(k), though that may not always be feasible. The earlier you start investing, the bigger nest egg you can build. According to Ally Financial, a good rule is to invest 1% of your income when you start working in your 20s, and increase by one percentage point annually. If you’re starting later in life, you’ll probably need to contribute more to catch up.
If you can automatically contribute to your investment account from your paycheck, making those contributions will be a no-brainer, though some accounts will allow you to make contributions on demand.
Not all investments are easily cashed in. Retirement accounts often penalize early withdrawals. You should make sure to have an emergency savings account separate from your investments in case you need quick access to cash.
Revisit your investment strategy over time
Your investment strategy needs to adjust as you age. For example, if you’re saving for retirement, it’s a good idea to move your investments into lower-risk options as you get older to minimize the risk of losing the funds when you need them.
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Image: M. B. M.