How to Start Investing: A Beginner’s Guide

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Deciding to invest is one of the best things you can do for your future self. It is the single greatest wealth builder for the average person. But many people aren’t quite sure how to get started. Fear no more. This is the definitive guide to learn how to start investing. 

Why Invest

At its core, investing is sacrificing money today in exchange for more money in the future. If you are still unsure of whether you should be investing, think about this. 

Imagine you invest $1,000 today. 10 years from now, that $1,000 may turn into $2,000. And another 10 years later it’s $4,000. And 10 years after that it’s $8,000.  

This is not some “get rich quick” scheme, this is just math. If your investments earn 7% per year, a fairly conservative historical long-term average of investing in stocks, your money will double roughly every 10 years.

When you invest, your money is making you money. Every day. While you’re awake. And while you sleep.

Investing is the 8th wonder of the world and is the single greatest wealth creation tool available to you. But the key is to start today so that your money can grow for as long as possible, continuing to grow month after month and year after year. 

If you someday wish to retire or have financial security, investing is not optional. Many are fearful because they don’t know how to start investing, but instead, be fearful of the financial risks of not investing.

compounding investment returns
Compounding investment returns over a long period is the secret to wealth creation.

Asset Classes

Once you’re convinced that you need to invest and want to learn how to start investing, the next step is understanding the available asset classes. Let’s focus on the basics:

  1. Stocks
  2. Bonds

Stocks

A stock is a slice of ownership in a company. So if a company has 10 shares in total, and you own 1 share, you own 10% of that company. Pretty cool that you can own a piece of Netflix, or Tesla, or any other public company, huh?

Stocks can make you money in two ways:  

  1. Appreciation
  2. Dividends

Appreciation simply means that the price of a stock has gone up from when you bought it. If you buy a share of stock for $50 and you sell it for $60, you made a 20% return. 

Dividends are the earnings that companies payout to their investors. Not all companies pay dividends, but for those that do, think of these as your slice of the company’s profits.

The sum of Appreciation + Dividends = Your Total Profit.

How to Start Investing

Bonds

Now let’s look at bonds. Bonds are just another word for debt. Who issues bonds? Lots of people issue bonds, but the two biggest sources are governments (federal, state, etc.) and companies. 

Here’s how a bond works. You give money to someone today. They get to use your money, so in return they pay you interest for that privilege (the bond’s coupon). At the maturity of the bond (when the bond “expires”), you will get your initial investment back. There are many different types of bonds depending on your risk profile and investment goals.

Bonds tend to have lower returns than stocks because they are generally considered less risky. The reason for this is that if a company defaults, debt holders have a higher priority to be paid back than shareholders (those that own stock).

Now of course there are other alternative asset classes like real estate, but we’ll save discussion on those asset classes for another post. 

Asset Allocation

On the road to learning how to start investing, you’ll need to understand some basics about asset allocation – that is how much should be in stocks vs. bonds. If you’re just starting out, use this simple formula, and then adjust for your risk tolerance. 

Take 100 minus your age. If you’re 25, this means 100 – 25 = 75.

This rule of thumb means approximately 75% of your portfolio should be in stock investments with the remaining 25% in bonds. 

No one rule is right for everybody, but if you’re new to investing, this is a good place to start. Depending on your tolerance for risk, you can adjust this ratio up or down.

How to Start Investing

Now that you’ve got a handle on the basics, you need an investment account to get started investing. For many of you, the first place you’ll want to invest is in your 401(k) or IRA, as these accounts have distinct tax advantages. See our article about which account to invest in first.

If you already have one of these accounts, awesome! If not, see if a Roth or traditional 401(k) is available through your work or open an IRA account with a brokerage firm like M1 Finance. Already have a 401(k)? Check out our guide on making sure you’re making the most of it.

When opening a new brokerage account, be sure to choose wisely. Some brokerage firms offer many investment products with low fees (Vanguard, Schwab, etc.), but there are many others that don’t have good low-cost fund options. 

An alternative to opening a typical account with someone like Vanguard or Schwab is to open an account with a robo-advisor. While this sounds scary, think of it as a low-cost way to manage your wealth hands-free. Good options here include folks like Wealthfront or Betterment.

You may be wondering what the upsides and downsides are to using a robo-advisor.

Pros:

  • Matches your portfolio to your investing goals and risk profile
  • Hands-off (no effort required)
  • Low minimum investment required

Cons:

  • Robo-advisors charge a fee for this service
  • Not 100% personalized to your needs
  • Limited control over portfolio

If you’re willing to put in just a little bit of work, consider managing your investment portfolio yourself.

Lastly, we know some of you are saying to yourselves that this sounds great, but you don’t have any money to invest. If that’s the case, check out some ideas on how to invest when you’re broke.

Build Wealth by Starting Early
Starting early gives your wealth more time to grow.

Picking Investments

Let me start with a favorite movie quote of mine from the movie The Wolf of Wall Street. 

“Nobody… and I don’t care if you’re Warren Buffet or if you’re Jimmy Buffet. Nobody knows if a stock is gonna go up, down, sideways or in circles. Least of all, stockbrokers, right?”

When it comes to investments, picking stocks is hard. Stocks go up, and stocks go down, and even the brightest minds in finance consistently fail to outperform the broader market.

Index Investing

Here’s my approach:  instead of trying to pick individual stocks and bonds, I just buy a basket of stocks and bonds and know I will perform the same as the broader underlying markets.

This isn’t to say you can’t buy individual stocks, just know that chances are you won’t be able to outperform the broader market over the long-term.

To buy a basket of stocks or bonds, the best vehicle to do so is through a mutual fund (or ETF). Think of mutual funds as a portfolio that you can buy to gain instant diversification. Instead of buying 1 stock, you can buy 10 stocks, or 100 stocks, or 1,000 stocks in one simple portfolio. 

By buying a basket of stocks, you are reducing your risk.

There are both good and bad mutual funds and ETFs. While these two structures work a bit differently, for now, don’t worry about the differences.

To identify good options, look for broad indexes of stocks (that track an underlying index, or basket, of securities). As an example, an S&P 500 index fund usually contains the 500 stocks in the S&P, so buying this fund gives you instant diversification across a pool of 500 stocks. We have put together a detailed guide on investing in mutual funds to get you started.

While you can diversify in different ways (geography, market cap, etc.), the key is spreading your risk across different stocks and bonds.

Fund Expenses

When selecting a fund, you must determine the fund’s expenses. If a fund charges say 1% in expenses, this means every year 1% of your portfolio is getting eaten by fees. This doesn’t sound like much, but if your total return is 7% per year, this means over 14% of your returns are being lost to expenses.

Passively managed index funds (e.g. an S&P 500 index) often have much lower expenses (in the ballpark of 0.05% or less). These represent significant savings, allowing you to track the market’s performance without paying big money to a fund manager. 

Find a few indices to put your money to spread your risk across asset classes and minimize fees. As an example, right now my portfolio looks something like the below (I’m in my 20s and am comfortable investing more heavily towards stocks):

  • 54% domestic stock indices (with a mix of large-cap, medium cap, and small-cap)
  • 27% international stock indices (with a mix of developed and emerging markets)
  • 10% bond index
  • 9% alternatives (primarily real estate)

One last consideration is that buying overlapping index funds doesn’t increase diversification. For example, if you buy an S&P 500 index with Vanguard and an S&P 500 index with Schwab, you’re not diversifying, as you’re effectively buying the same underlying basket of stocks. 

Track Investment Performance

Whether you are setting goals for retirement or just want to know which of your investments is performing the best, using a dedicated tool can be massively helpful.

We recommend Personal Capital for this purpose. It has some awesome financial planning tools and allows you to track all of your accounts in one place. You can check out our full review of Personal Capital to learn more!

Getting Started

As you get started in investing, think carefully about what you can afford to invest. I aim for 20% of my income to go into investments (across my 401(k), IRAs, etc.). However, any money you need in the next few years should not be in the market. 

While the market can be volatile, investing in low-cost, diversified funds and leaving your money invested over a long period brings you a step closer to your financial goals.

Lastly, I leave you with this quote from Warren Buffett. “Be greedy when others are fearful and fearful when others are greedy.” It is easy to get spooked when the market falls, but instead of being fearful, use market declines as an opportunity to buy stocks on sale. In the long run, it’s like buying something on Black Friday, except it only gets more valuable over time. 

Do you have questions about how to get started? Let me know in the comments below!

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