Investing can be a valuable tool for building a better future. It can increase your wealth over time, helping you work toward the life you envision for yourself and your family. That’s what makes the idea of earning money while you sleep so enticing. Understanding how investing works is definitely worth your time.
However, beginners who are new to the world of investing often find it overwhelming. There are many options to explore, new terms to learn, and a lot of conflicting information to sift through. Plus, since it involves risking your money, it can be stressful.
Investing is complex, but it doesn’t have to be difficult. There are some key decisions you’ll need to make to get started. Let’s break these down into manageable steps.
1. Start investing as early as possible
Investing at a young age is certainly a wise strategy for building a solid financial foundation. By doing that you increase how much you can gain from compound earnings. The money you earn from your investments will earn even more money, creating a snowball effect that helps your account balance grow over time.
The stock market, or any other market that you’ll invest in, will inevitably have its ups and downs, but investing early gives you the advantage of time. With years ahead of you, you can weather the market fluctuations and allow your investments to grow. Starting now, even if it means beginning with a small amount, can set you on a promising path. The sooner you begin, the more time your money has to work for you.
2. Decide how much to invest
Many financial experts recommend that you invest a specific percentage of your after-tax income — about 10% to 25% of your post-tax earnings. If setting aside that much of your monthly income for investing seems challenging, don’t let that discourage you. Sometimes, even putting aside a small amount can make a difference with the right tools.
As founder and CEO of Alloy Wealth Management Mark Henry puts it:
If you need to start small and gradually work your way up to that goal, that’s completely fine. The important thing is to begin.
Here are a few important factors to consider when deciding how much to invest:
Take a close look at your monthly earnings to see how much you have left after covering essential expenses. If you’re struggling to make ends meet, it may be more beneficial to focus on building an emergency savings fund or paying down debt first.
Managing debt, especially high-interest debt, can be challenging without a solid plan. Assess how much you owe and the interest rates attached to those debts. Figure out how much you can safely invest while still covering at least your minimum payments. As you reduce your debt, revisit your investment contributions and consider increasing them.
An emergency fund is vital for handling unexpected expenses without relying on debt. If you’re still working to save three to six months’ worth of essential expenses, it may be wise to start with a smaller investment amount while you build that financial safety net.
To help you manage your finances going forward, you might consider the 50/30/20 budgeting rule. This approach divides your monthly budget into three categories: 50% for essential needs, 30% for discretionary wants, and the remaining 20% for debt repayment, savings, and investments.
3. Open an investment account
When people talk about trading stocks, currencies, or commodities, they’re often referring to using a brokerage account. For most people, a brokerage account is their main account for investing. Here’s a quick rundown of what you need to know:
If you’re 18 or older, you can easily open one of these accounts. You have the freedom to deposit as much money as you want, whenever you want, and you can choose from a wide array of investment options. Plus, you generally have the ability to withdraw cash whenever you need it.
While brokerage accounts are straightforward to set up, they do come with tax implications. You’ll typically need to pay taxes on any realized investment gains each year, including profits from selling investments or receiving dividends.
Why consider one? Brokerage accounts are popular for their versatility, allowing you to invest and trade a broad range of options as you work toward your financial goals or simply build wealth over time. They’re a practical choice for anyone looking to dive into the world of investing. If you find an account that has low fees and minimum balances, opening a brokerage account can be a smart move.
4. Pick an investment strategy
Your investment strategy should reflect your savings goals, the amount of money you need to achieve those goals, and your timeline for reaching them.
If your savings goal is years away, you can afford to invest most of your funds in stocks. With such a far-off horizon, you have the opportunity to ride out market fluctuations. However, selecting individual stocks can be complex and demanding. For some, investing in indices makes more sense because it offers a way to achieve broad market exposure with lower costs and less complexity.
Conversely, if you’re putting money aside for something in the near future, like a home down payment or a vacation within the next five years, it’s wise to be more cautious. We’ll explore specific strategies designed for different groups later in this article.
5. Understand your investment options
Once you’ve determined your investment strategy, the next step is to decide what to invest in. Each investment comes with its own risks, so you should understand the details, how much risk you’re comfortable with, and whether that matches your financial objectives. Here are some popular investment choices:
Stocks
Stocks are a piece of ownership in a company, also referred to as equities. You buy stocks at a share price, which ranges from just a few dollars to several thousand, depending on the company’s market value. This allows investors to enter the stock market at various levels and makes it accessible for both new and experienced investors alike.
Stocks are seen as some of the best investments based on past returns, often outperforming other options like bonds.
Bonds
A bond is a loan you provide to a company or government, which agrees to pay you back after a specific period, along with interest. Generally, bonds are viewed as less risky than stocks because you know exactly when you’ll receive your money back and the interest you’ll earn. However, they can limit your overall growth potential if you’re looking to build wealth over time.
Mutual funds
Mutual funds are a curated collection of investments. They allow you to bypass the need to pick individual stocks and bonds and give you a diversified portfolio in one convenient purchase. Some mutual funds have professional managers who make investment decisions. There are also index funds that match the performance of stock market indices, such as the S&P 500, without active management. The downside is that you have less control over the specific investments within the fund.
Exchange-traded funds (ETFs)
ETFs are similar to mutual funds in that they bundle together multiple investments. The key difference is that ETFs can be bought and sold throughout the day, just like individual stocks. This often means that ETFs have a lower price point than mutual funds. On the flip side, they’re subject to market volatility throughout the day.
Investment strategies
An investment strategy is your financial roadmap. It outlines what you plan to invest in, how much you’ll invest, and when you anticipate selling those investments.
It’s important to note that there isn’t a one-size-fits-all strategy. Each investor has different goals and interests, so determining the right approach for you involves considering several key factors:
- Age — Are you leaning toward caution as retirement approaches, or are you more willing to take risks for potential growth as a younger investor?
- Dependencies — Do you have family members or children who rely on you financially?
- Goals — What are your specific investment goals? Saving for retirement, a home, education, or something else?
- Lifestyle — How much disposable income do you want to have while you invest?
- Financial situation — How much can you realistically set aside for investments without straining your daily budget?
- Expected returns — How long are you willing to wait to see returns on your investments?
With these considerations in mind, let’s explore common investment strategies to guide you toward your financial goals:
Active vs. passive investing
Active investing involves regularly buying and selling assets, like stocks or bonds, in an attempt to outperform the market. This strategy demands a keen eye on market trends and a willingness to make quick decisions. If you enjoy diving into market analysis and want to seize opportunities as they arise, active investing might suit you.
In contrast, passive investing takes a more relaxed approach. Here, you invest in indices or other diversified portfolios that track the overall market. This strategy requires less daily attention and is designed to grow your investments over time with minimal management.
Growth vs. value investing
Growth investing focuses on companies expected to grow faster than the overall market. These are often found in innovative sectors like technology and renewable energy. Investors in this category typically don’t receive dividends because these companies often reinvest profits to fuel their growth. The potential for high returns is appealing, but this strategy involves greater risk, as it’s based on future expectations rather than current financial performance. So, it suits long-term investors who can withstand market ups and downs.
Value investing, on the other hand, involves buying stocks that you believe are undervalued by the market. Think of it as finding a quality product at a reduced price. Value investors look for companies that have strong fundamentals but may have experienced setbacks affecting their stock prices. This strategy tends to be less risky than growth investing, so it’s suitable for conservative investors seeking stability.
Dollar-cost averaging
Dollar-cost averaging is a simple and effective investment strategy where you invest a fixed amount of money at regular intervals — like $500 every month — regardless of market conditions. This method helps minimize the stress of trying to time your investments perfectly. By spreading out your purchases, you can reduce the impact of market volatility on your overall investment. Just bear in mind that it can lead to higher transaction costs.
How to create a diversified portfolio
Building an investment portfolio isn’t just about putting money into a few assets and hoping for the best. Here are four key tips to create a well-rounded portfolio:
Embrace diverse investments
Begin with a strong foundation of diverse asset classes. Avoid closely related investments and instead aim for assets that don’t move in tandem.
For example, you could invest in tech stocks like Microsoft and Apple, along with commodities like oil and gold. While these markets have some connection, a drop in oil or gold prices typically won’t significantly affect tech stocks. If two investments appear too similar, consider other options.
Keep an eye on costs and fees
Consider not just broker fees but also the total investment and other expenses. A good rule is to avoid investing money you can’t afford to lose.
Once you know how much you can invest, decide how to spread that across different markets. For instance, you could allocate 50% to stocks, 30% to commodities, and 20% to forex. These percentages can evolve as your investment journey progresses.
Stay engaged, don’t go on autopilot
While long-term investments are important, don’t just set it and forget it. Ignoring your portfolio means missed opportunities and losses. If one asset is doing well, consider increasing your investment. If something is underperforming, don’t hesitate to sell it.
Common mistakes to avoid as a beginner
Beginners tend to make the same mistakes. So, if any of these seem familiar, it might be time to rethink your investment approach:
Unrealistic expectations — Build a diversified portfolio based on your risk tolerance and goals. Don’t let others’ experiences shape your expectations, as market returns are unpredictable.
Overinvesting — Patience is key in investing. Frequent changes to your portfolio can incur costs and increase risks. Focus on learning about your current holdings instead of overreacting.
Getting swept up by media hype — Don’t let sensational headlines dictate your decisions. Conduct thorough research from reliable sources to inform your investments.
Chasing high yields — High-yield investments can be tempting, but remember that past performance is not indicative of future results. Focus on the overall picture and manage risk.
Timing the market — Market timing is challenging and often ineffective. Consistent contributions to your portfolio are typically more beneficial than trying to predict market movements.
Forgetting about inflation — Evaluate returns in real terms, considering inflation’s impact. What you can actually buy with your investment gains matters more than nominal returns.
Failing to start or stay invested — Don’t let fear or lack of knowledge stop you from investing. The greatest minds agree that success requires ongoing effort and a willingness to learn.
Long-term investing tips
As we wrap up, let’s go over some of the most helpful tips that long-term investors can follow. These general guidelines can help anyone, no matter where you are in your investing journey:
Invest in what you understand — Choose investments in industries and companies you are familiar with. This helps you make informed choices, as well as gives you more confidence during market fluctuations.
Cut your losses, hold your gains — Understand that there’s no guarantee a stock will recover after a downturn. Letting go of underperforming investments may feel uncomfortable, but it’s a smart move to prevent further losses.
Don’t chase stock tips — Be skeptical of stock tips, no matter where they come from. Always do your own research before investing your money. Some tips might be valid, but true long-term success relies on thorough analysis.
Be cautious with penny stocks — Low-priced stocks may seem safer, but losing money on a $5 stock feels the same as losing it on a $75 stock. Both represent a total loss. In fact, penny stocks are often riskier due to less regulation and higher volatility.
Stay informed, but don’t overwhelm yourself — Keeping up with market news and trends is essential, but avoid drowning in information. Focus on reliable sources and filter out noise that doesn’t contribute to your understanding. Quality over quantity.
Keep an open mind — Well-known companies tend to be great investments but don’t overlook smaller firms that may have significant potential.
Hopefully, this guide helped you understand how to start investing. The most exciting part, though, is putting that knowledge into action!
FAQ
What is investing, and why should I do it?
Investing means putting your money to work so it grows over time and helps you build real wealth. While holding cash or saving in the bank is secure, investing allows your money to grow more significantly through compounding and long-term gains.
How much money do I need to start investing?
The amount you start with depends on your goals, the type of investment, and how comfortable you feel. But generally, you don’t need a huge sum to start investing. At FBS, beginners can start investing with an initial deposit as low as $5. Plus, with leverage options, you can stretch that deposit significantly.
What is the best age to start investing?
As early as possible — the sooner you begin, the more time your money has to grow. Ideally, you want to start young to take on more risk and develop good financial habits. Ultimately, the best time to start investing is now.
How do I determine my risk tolerance?
Assess your financial situation, define your investment goals, and evaluate your understanding of investments. Consider how comfortable you are with market fluctuations and potential losses. For a specific percentage and valuable insights, consider using online risk assessment tools.
Should I invest in stocks, bonds, or mutual funds as a beginner?
Beginners might want to focus on stocks because they have the potential for higher returns over time, plus it’s exciting and lets you own a share of companies you believe in. Bear in mind that they’re more volatile and carry more risk, so start with a few well-researched stocks.
How do I create a diversified investment portfolio?
Choose a mix of asset classes, including stocks, indices, forex, and commodities, to spread risk effectively. Within each asset class, select a variety of individual investments, like different sectors for stocks. Regularly check and adjust your portfolio to keep your ideal asset mix as markets shift.
What are robo-advisors, and how do they work?
Robo-advisors are automated investment platforms that create and manage your investment portfolio using algorithms. You answer a few questions about your financial goals and risk tolerance, and they create a personalized portfolio for you.
However, unlike expert advisors, robo-advisors don’t teach or explain investment concepts. That means you miss out on educational insights and trading tips that help you understand the market and make informed decisions on your own.
How much of my income should I invest?
It depends on your financial goals, expenses, and personal circumstances. A common guideline is to aim for 10% of your income, but if you can invest more without impacting your essential needs, that’s even better. Consider starting with a small amount that feels manageable to you, and as your financial situation improves, gradually increase it.
What is dollar-cost averaging, and how can it help me?
Dollar-cost averaging is investing a set amount of money on a regular schedule, no matter how the market is doing. It’s designed to reduce the impact of market volatility, as you buy more when prices are low and less when they’re high. Despite some downsides like the potential for missed opportunities, you avoid the stress of trying to time the market and encourage disciplined investing.
How do I choose the right investment strategy?
Consider your time horizon — how long you plan to invest before needing access to your funds — since longer horizons allow for more aggressive strategies. Evaluate your knowledge and experience with different investment types, and research various strategies, such as growth investing, value investing, or passive/active investing, to find one that goes with your objectives and comfort level.
