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Do you want to learn how to invest but don’t know where to begin? We’ve put together this handy guide to investing for beginners to set you on the right path to protecting and growing your hard-earned money.
Who Can Invest?
Right off the bat, let’s answer this question: Who can invest?
The answer is really simple: Anyone!
We have this image in our heads of investors as looking either like the dude from the Monopoly game or like Gordon Gekko from Wall Street.
Once upon a time, that may have been true. After all, already-affluent men were the ones with the spare cash and time to devote to the stock market.
However, it’s no longer the case. Largely thanks to the internet, investing has been democratized. In fact, you can get started with only a few dollars.
Anyone — regardless of age, gender, income, etc. — can start investing today.
Why Should You Invest Your Money?
I’ve heard the same story from many people I know: “What’s the point of investing? I have so little money to invest left over after paying my bills. Either I won’t make enough to make a difference, or I’ll lose it all!”
First things first. We here at Investor Junkie certainly do not want you to lose it all. That’s why we warn folks against risky behavior such as day trading. Our goal is to provide you with safe, sustainable ways to grow your money for important events such as retirement or your kids’ college education. We certainly don’t want you to gamble that precious nest egg away!
As for the other point — not having a lot of money to start investing — you’d be surprised how a little goes a long way. That’s thanks to the power of compound interest.
With compound interest, time is on your side.
Let’s say you’re 25 years old and you can pull together $5,000 per year to invest. That’s money you may have accumulated from holiday bonuses from your boss and birthday checks from good ol’ Aunt Mabel.
Anyway, if you were to invest $5,000 every year for 40 years, when you’re 65 and ready to retire, you’ll have spent just $200,000. But if you were to put that money into a safe investment with, say a 7% annual return, you’ll have made $1,068,048. More than $1 million!
And if you were to increase your monthly contributions, you’d see even more money when it’s time to retire. Of course, although Millennials are perfectly poised to take full advantage of compounding, anyone can benefit.
However, the sooner you get started investing, the better — even if you’re a teenager.
Here are some essential steps you should take when you’re beginning your wealth-building journey.
When Is the Right Time to Start Investing?
The answer to this question should be a no-brainer. The obvious answer is right now! Remember, as I stated above, time is on your side. So make the most of that advantage.
Now, of course, how you invest and what you should be investing for may vary with age. For instance, if you’re 30 years old, you’ve got a few decades before you retire. You can play with long-term investments such as stocks that would be too risky for someone on the cusp of retirement. After all, stocks can lose their value quickly, but if you have 30 more years before you need that cash, you can afford to make that gamble.
If you’re closer to retirement age, you want to focus on maintaining what you’ve already got. Safer, steadier investments — especially where there are dividends involved — are a better choice for you.
What Should You Invest In?
Before you start investing your money, you should have an understanding of the different types of asset classes available to investors today. We can define “asset class” simply as a group of similar types of investments. You can invest in one asset class or many. A mix of asset classes can give you a well-rounded portfolio that can weather ups and downs. For example, real estate might be going up while stocks are going down! The mix of asset classes in your portfolio is often called your asset allocation.
Here are the basic asset classes for investors:
- Equities: Basically, stocks. You own shares in something.
- Fixed Income: Also known as debt. You lend money to a government or institution and will be paid interest in return. Examples include bonds and certificates of deposit.
- Cash: Also including cash equivalents. You invest your money in an interest-paying savings account, for example.
- Real Estate: Here, you own physical property.
- Commodities and Precious Metals: As with real estate, you own a physical thing — be it gold, oil or pork bellies. You can trade them, but thankfully, you rarely have to take possession of them.
- Futures and Other Derivatives: You own trades (futures, options, etc.), the value of which depends on an underlying asset. It’s complicated.
What Is Your Investing Style?
If you’re like most of us, you’ve gotten suckered into taking one of those goofy Facebook quizzes: Which Star Trek Alien Are You? Which Stinky French Cheese Matches Your Personality? You know the drill.
Well, here’s one that is actually useful: What’s Your Investing Style?
The only way to really answer this question is by being honest with yourself. Check out the two major investor profiles and determine which one fits your investing style best.
Which statement do you agree with?
- “I would prefer to have a professional manage my investments for me.” If you’d rather “set it and forget it,” you’re going to be happiest using a Robo advisor. They do all the heavy lifting for you! However, you might find the lack of control over what you invest in limiting.
- “I like to do the research and pick investments myself.” Do you prefer a hands-on approach? If you get a thrill out of research and having control over what’s in your portfolio, you’re a DIY kind of an investor. You’ll do best by finding the best stock broker, rolling up your sleeves and getting to work.
Choose Your Investment Strategy
Before you start investing, you should think about what type of strategy you’d like to use. This step involves determining what your financial goals are — including what you’re saving and investing for, when that event will occur, and how much you’ll need.
There are many different financial strategies to choose from, from stocks and funds to real estate and peer-to-peer lending. Some strategies will require you to be actively engaged in investing, while others are “set it and forget it.”
Not all investment strategies will work for all people. That’s why you need to consider your financial situation — both present and future — first.
Here’s a quick rundown of some of the most popular investment strategies:
Buy-and-Hold Investing: You’re in it for the long run. This long-term strategy involves buying stocks now and holding them for years, when they will hopefully be worth more.
Growth Investing: Many of these plays are shorter term than what you’ll get with buy and hold. With growth investing, you buy stocks whose earnings are expected to outpace the market as a whole.
Real Estate: Whether it’s buying shares in a crowdfunding project or fixing and flipping a house by yourself, real estate investing can be among the most lucrative and short-term investments out there. There’s also plenty of risk, however.
Peer-to-Peer Lending: For our purposes, this involves using a platform such as Lending Club or Prosper. You invest in interest-bearing debt notes that aren’t without risk but do have enormous potential for investors.
We’ve created a guide with some good starting places for beginners. Take a look and ask yourself some questions before deciding what path you’ll follow on your investment journey.
How to Define Your Investment Budget
OK, so budgeting may get a bad rap (and maybe not everyone should have one). But in reality, having a budget can be extremely helpful when it comes to saving money to use for investing. When making your budget, be sure to include plenty of funds for investing.
Now, there are plenty of methods for setting up and maintaining a budget. It doesn’t have to be rocket science. You can use a spreadsheet and just paper and a pen. Or you can use one of the helpful online services that do the heavy lifting for you. (Betterment and Personal Capital have free budgeting and personal finance software that we particularly like.) It’s also a Robo advisor, so you can get started investing right away at the same time!
Reduce Fees and Fund Expenses
Investment expenses — i.e., fees — can take a hefty chunk out of your returns. So make sure you’re not getting ripped off.
There are many different kinds of fees — everything from account maintenance costs to mutual fund loads. And there are many ways to cut back on them or even avoid them altogether!
Every type of investment carries its own set of fees. However, here are the most common fees you’ll see:
- Account Maintenance Fees: Typically an annual fee below $100. This fee is often waived once you hit a minimum balance in your investment account.
- Commissions: A flat amount per trade or a flat amount plus percentage per trade. This amount will vary depending on your broker and the funds you invest in.
- Mutual Fund Loads: Either front-end, back-end, or a combination of both. These can sometimes be waived if the funds are held in brokerage accounts with the same broker.
- 12b-1 Fees: an Internally charged fee on mutual funds. This will reduce the value of your fund by up to 1% and will be deducted automatically every year.
- Management or Advisor Fees: A fee paid to an advisor who manages your accounts. This could add up to thousands of dollars per year, all avoidable if you manage your own account instead.
We’ve reviewed several products that are fee-free. In fact, one of our favorite robo advisors, Wealthfront, is free for accounts under $5,000. That makes it a great place to get started.
And if you’re looking for a fee-free stockbroker, you’re in luck. The competition in this space is heating up, which means some brokerages are slashing their fees to zero. Robinhood has been a trailblazer, but even old favorite Firstrade has gone fee-free.
OK, so this step is critical. Asset allocation is the strategy by which you divide your investment portfolio among several different asset categories. These can include stocks and bonds, but also real estate, alternative investments and even cash.
The point of asset allocation is to minimize your risk by keeping your portfolio diverse. It’s simply not putting all of your eggs in one basket.
Asset allocation is definitely not one size fits all. And there are several methods and models for determining which allocation is right for you.
Here at Investor Junkie, we tend to favor allocation models that use Modern Portfolio Theory. Known also by the acronym “MPT,” this strategy helps you decrease your return risk by diversifying your portfolio into many assets. MPT holds that asset classes are not correlated with each other. As one asset goes down in value, another can go up. When one zigs, another zags.
In general, Robo advisors use Modern Portfolio Theory in their algorithms to help tailor-make a portfolio allocation for you.
What to Do Next
OK, so now that we’ve covered the basics of how to invest, it’s time to get started! But don’t worry — we’re not going to cut you loose. Here at Investor Junkie, we’ve made it our mission to help you every step of the way.
Even if you are a DIY investor and decide to step up a level, you’ll find articles about everything from derivatives to real estate.
But for the time being, here’s your homework assignment:
If you’re a DIY investor, select a stockbroker. We’ve reviewed the most popular online discount brokerages out there. Here’s a guide to choosing the right stockbroker.
If you’re a “set it and forget it” investor, select a
Remember, investing may seem daunting at first, but it doesn’t have to be a terrifying ordeal. If you do your research and due diligence — and play it safe with your hard-earned money — you should be well on your way to a healthy and robust financial future.
A Few Terms to Know
Whether you choose to hire a Robo advisor or go it alone, there are a few terms you should know when you start investing.
- Stock: A stock is a share of ownership in a company. It represents a claim on that company’s earnings and assets. Generally, when a company performs well, the value of the stock grows. And when the company doesn’t meet expectations… well, it goes down.
- Bond: Buying a bond is lending money to a company or government (federal, state or municipal). Bonds have maturity dates at which time you can cash them in and collect interest money.
- Mutual Fund: A mutual fund gathers money from a lot of investors and invests it in assets such as stocks and bonds.
- Cash: Yeah, it’s the green notes in your wallet. But in portfolio terms, cash usually refers to CDs (certificates of deposit), money market accounts or Treasury bills.
- Expense Ratio: You’ll see this term when it comes to mutual funds. “Expense ratio” refers to the expenses of owning a fund, including annual maintenance and administration fees, as well as the costs the mutual fund takes on for advertising.
- Price-to-Earnings Ratio: When looking at a stock’s fundamentals, the price-to-earnings ratio (or P/E ratio) is important. It examines a company’s stock price as it relates to its earnings. A low P/E of 10 or less means the company isn’t doing so well. But higher is not necessarily better — a ratio of over 25 may be a sign that the industry is about to have its bubble burst.
So You Want to Learn About Investing?
If you have any questions feel free to contact us at any time.