Investing for Beginners: A Crash Course on Making Your Money Grow
You’ve probably heard that investing is one of the best ways to put your money to work.
The power of compounding can turn even modest savings into an appreciable nest egg over time.
If you saved $100 a month and tucked it away under your mattress, you’d have $36,000 at the end of 30 years.
But if you invested that same $100 a month and averaged returns of 8% per year, the $36,000 you’d set aside would have grown to more than $140,000 after 30 years.
But if you’ve never put money into the stock market before, the prospect can be overwhelming. What investments should you choose? And what kind of account do you need to get started?
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 ways to invest, including purchasing tangible items, like real estate or fine art, with the intent of selling them later. But in this post, we’re going to focus primarily on stocks and bonds.
The stock market is the abstract space where investors buy and sell stocks. When you invest in stocks, you buy shares, or small pieces of ownership, of a company.
When you invest in stocks, you profit when the company performs well. You earn money 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. That means it distributes part of its profit back to shareholders. Smaller companies issue dividends less frequently than larger ones. They often need to reinvest that money in the firm to keep growing.
Shareholders are also vulnerable to losses if things don’t go as well as hoped. If the company loses money, your shares may lose value. Thus, when you invest in stocks, you’re making a relatively high-risk investment.
Because the stock market can be volatile, it’s best to invest in stocks for the long term. One of the most common beginning investor mistakes is trading based on what’s in the news. Short-term stock investors often sell at low prices in a panic and miss out on the long-term growth that happens over time.
Bonds are actually debts issued by corporations or, more commonly, governments.
When you invest in bonds, you’re lending your money to the bond issuer.
Investing in bonds provides a reliable return because bonds pay a fixed amount of interest at fixed intervals, often twice a year. That’s why they’re known as fixed-income assets.
Because bond issuers are legally obligated to repay their debts, bonds are considered a safer investment than stocks. However, bonds don’t have the exponential growth potential that stocks do.
The lowest-risk bonds are those 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 has the extra advantage of 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.
Investing in corporate bonds is riskier than investing in government bonds. The safest corporate bonds are known as investment-grade bonds. The riskiest corporate bonds are called junk bonds.
Because investors assume a high level of risk when they buy junk bonds, they earn higher interest rates.
Mutual funds are prebuilt collections of stocks, bonds and other types of investment assets. Typically, mutual funds are 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.
Investing in a mutual fund allows individual investors to buy a diverse segment of the market without doing all the footwork to research and buy individual stocks.
Unlike stocks, mutual funds aren’t traded on the stock market. To buy and sell shares of a mutual fund, you have to go through the investment company that manages the fund. You can only do so at the end of the trading day.
Many mutual funds require an upfront investment of anywhere from $1,000 to $2,500, which may be steep for beginners.
Exchange-Traded Funds (ETFs)
Exchange-traded funds are similar to mutual funds in that each is a basket of different investment assets. One key difference: ETFs generally aren’t actively managed by a live human being. Instead, ETFs are usually passively managed index funds.
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.
For example, some ETFs are collections of companies in the same industry or geographical locations. Or they may focus on companies with a similar market capitalization — that is, the total dollar value of the company’s shares available on the market.
Because an index fund is passively managed, the fees are usually lower than what you’d pay for a mutual fund.
Unlike mutual funds, ETFs are traded exactly like stocks throughout the day on stock exchanges. There’s no minimum investment amount, beyond the price of a single share.
Certificates of Deposit (CDs)
CDs, or certificates of deposits, are among the lowest-risk investments out there. You agree to let a bank or financial institution hold onto your money in exchange for a guaranteed interest rate.
Because the risk is low, so is the reward. 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.
Where Do I Start Investing?
The best way 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 whole lot of extra cash lying around, don’t worry. There are plenty of investment vehicles to choose from. You can even invest with $100 or less.
Your Employer’s Retirement Plan
If your employer offers a 401(k), contributing part of your wages is a great move for beginner investors. And if your benefits package includes an employer match, you’ll definitely want to take advantage of that free money.
Your plan will probably offer you several curated investment options to choose from, consisting primarily of mutual funds and ETFs. (You typically can’t use your 401(k) to invest in stocks and bonds for individual companies.)
Roth or Traditional IRA
Even if you don’t have access to a 401(k), you can open an individual retirement account. Most people can choose between a Roth or traditional IRA.
Contributions to a traditional IRA are taken pretax today, which means you can deduct them for tax purposes. They’re later taxed when you withdraw them. With a Roth IRA, your contributions are taxed now but grow tax-free and are 100% yours in retirement.
You can create your own portfolio from scratch by purchasing individual stocks, bonds and ETFs. But if you’re not up to DIYing your investments, robo-advisors are a good option. A computer algorithm will automatically select investments for you, based on your age, goals and risk tolerance.
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.
Taxable Brokerage Account
With a few exceptions, money in your retirement accounts is usually off limits to you until you’re 59 1/2. You’ll frequently incur taxes and penalties if you withdraw it early.
If you’re investing money that you may want to withdraw before retirement or you’re trading stocks, opening a taxable brokerage account is a good option. You don’t get the tax benefits of a retirement account, but you have a lot more flexibility.
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 started investing with as little as $5, and they offer curated ETFs to help you diversify your holdings.
You can also set up regular, automatic contributions, which will fuel your portfolio’s growth over time.
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 on how to best mitigate those risks ahead of time.
1. Invest in a Diversified Portfolio
Perhaps the most important investment strategy is diversification. A diversified portfolio means you have a wide range of assets, including different types of holdings and different issuers.
Why is diversification so important? Well, it’s just like that old saying about not putting all your eggs in one basket. If you drop that over-laden basket and don’t have any other eggs in reserve, you’re in a messy situation.
If one of the companies you own stock in goes under, for instance, you won’t be entirely sunk if you own shares of other firms — and some government bonds, for good measure. Some investors like to diversify even further by investing not only in stocks and bonds, but also in real estate and other tangible assets, like gold or silver.
Mutual funds and exchange-traded funds are popular among new investors because they offer immediate diversification.
2. Set Goals for Investing
What are your goals for investing? If you need the money for a short-term goal, like a down payment, you shouldn’t invest it in stocks. You’re better off putting it in a CD, money market account or high-yield savings account. But if you’re looking at a long-term goal, like retirement, investing in stocks makes more sense.
You might even consider hiring a financial advisor to make sure your investing decisions are appropriate for your long-term goals. An advisor can help you assess your risk tolerance and make more informed decisions.
3. Learn More About the Stock Market
Research the assets you’re considering, keeping both their historical performance and current events in mind. The easiest way to learn about the stock market is simply to spend a few minutes each day reading the news.
You can also enhance your personal finance knowledge by reading some of our favorite books about investing for beginners.
4. Commit to Investing for the Long Term
And finally, keep in mind that you’re investing for the long term. Market fluctuations are an everyday reality.
Although it can be tempting to rip your money out of the market when you see a scary headline, don’t look at investing from a short-term perspective. Diversify your holdings, and sit tight through the lean times. The market usually corrects itself over time.
Jamie Cattanach’s work has been featured at Fodor’s, Yahoo, SELF, The Huffington Post, The Motley Fool, Roads & Kingdoms and other outlets. Learn more at www.jamiecattanach.com. Senior editor Robin Hartill contributed reporting.