It feels like you can’t go a minute without hearing someone mention the stock market, saving and investing for retirement, or preparing for a financially secure future.
You’re constantly hearing about investment hype, doomsday forecasts, or the latest get-rich-quick-scheme.
So, what are you to make of all this?
You want to build wealth and think investing may be the way to do it. But — you also want to protect what you have and avoid becoming worse off.
Don’t worry; we’ve got you. While investing can be overwhelming and complex, it doesn’t have to be. Let’s go over some of the basics to help you begin investing sooner than later.
Why You Should Invest
First and foremost, if you have the financial means to do so, you should absolutely invest.
Parking your cash in a checking or savings account (even a high-yield version) means that it will hardly grow.
That’s because those accounts typically pay minimal amounts of interest, often not even keeping pace with inflation.
But, when you put some of those funds into an investment account, you have the opportunity to make some actual money due to the power of compound interest.
Food for thought: though there will be unavoidable short-term volatility in the stock market, investors should enjoy a 7% average return over the long haul. That’s much better than the 0.10% (or less) your standard savings account is likely giving you.
When your money grows faster, you can achieve your financial goals quicker.
Smart investing can fund a comfortable (maybe even early) retirement and other significant milestones.
It can also help you build the wealth you need before you end your career to buy your dream home or take that vacation of a lifetime.
Before You Begin Investing
Now that you’re (hopefully) sold on the rationale behind investing, let’s look at some pre-work you need to do before diving in. There are two main things you'll want to do:
- Make sure your financial house is in good order
- Familiarize yourself with basic investment language and concepts
Let’s look at each in turn.
Review Your Financial House
- You have a well-stocked emergency fund (think 3-6+ months of living expenses)
- You have no high-interest or unsecured debt (usually from credit cards)
The first rule reduces the likelihood that you’ll have to tap into your investments when your income or budget takes a hit. The second is just good math.
If you can make 7% in the stock market, but your credit card debt is costing you 20%, it makes good financial sense to pay off that credit card debt ASAP.
An exception to that would be to take advantage of your employer’s company match in your 401k or other retirement accounts.
If you can swing it, invest enough into that account to obtain the full match offered. If you can't, begin investing what you can and increase the amount as soon as possible.
Familiarize Yourself with Basic Investing Concepts
Since you’re reading this article, you’ll have this one pretty well covered. However, we encourage you to do as much research as you need to feel comfortable (unless you come down with a case of analysis paralysis!).
Without further ado, here are some of the beginner terms that you should know:
- Portfolio: The total collection of your investments.
- Trading: Buying or selling investments.
- Risk tolerance: How comfortable you are with uncertainty and volatility (drastic changes up and down). Something to consider: in general, riskier investments have higher payoffs. Only you can decide how much risk feels right to you, though. It’s not worth losing sleep!
- Investment timeline or horizon: How long you plan to keep your money invested before needing it. As a rule of thumb, the longer your investment timeline, the more risk you can take. Since you don’t need the money for an extended period, you can comfortably ride out short-term drops in value.
- Diversification: Ensuring your portfolio has a mix of investment types (stocks, bonds, real estate, etc.), so if one performs poorly, the others can soften the blow – better preserving your total net worth.
- Asset allocation: The mix of investments that you choose to hold. This will be based on your risk tolerance, investment timeline, and diversification strategy. For example, someone with a high-risk tolerance and long investment timeline may decide to have 80% stocks (more potential risk, but more potential reward) and 20% bonds (less inherent risk, but less potential reward).
- Rebalancing: Getting your portfolio back to your desired asset allocation. Market activity can cause you to hold more of one type of asset than you’d like. Rebalancing is the act of selling some of what you have too much of and buying more of what you’re short on to restore that preferred mix.
- Dollar-cost averaging: Investing consistently regardless of what the market is doing. Since timing the market is futile, it’s often prudent to save in your investment account(s) steadily. By keeping an even keel, you won’t always be buying when the investment is fetching top price. And you’ll be taking advantage of when it isn’t. If you have a lump sum to invest, however, you can certainly do that, too.
- Other Investing Terms to Knowand our full Glossary of Personal Finance Terms
Related reading about investment types: Though it’s beyond the scope of this beginning investor article to really dig into the investment types, listed below are articles and resources to further your learning:
- Alternative Investments
- A wide variety of investment products explained at Investor.gov
Tips for When You Invest
Now that you’ve got some of the basics down, you’re ready for some strategic pointers:
- Invest what you can afford. But — strive to hit at least 15% of your income. Always try to maximize any retirement account employer match for which you’re eligible.
- Invest in what you understand and support. For example, cryptocurrency might be all the rage right now, but if you don’t get it, skip it until you do.
- Always, always, always check the fees for each investment. Once your money starts to grow, what seems like an insignificant cost can eat into your returns. Shop for the lowest possible price to invest.
- Determine how much help you need — if any. If you DIY your investing strategy by investing in passive (i.e., not professionally managed) investments, you can save quite a bit of money over the long haul.
- Automate your investing. By setting up automatic transfers into your investment accounts, you’ll be more likely to maintain the investing habit — especially when the market hits an inevitable rough patch.
- Treat investing as a long game. You won’t get rich quick. But — if you’re patient and resilient, chances are, you will build wealth over time. Buy and hold.
- Understand the different investment accounts. Your employer’s 401k or retirement account is vastly different than your Roth IRA or brokerage account. Your retirement account is likely funded with pre-tax dollars, and there will be severe penalties imposed if you withdraw from it before age 59.5. On the other hand, your Roth IRA or brokerage account is funded with post-tax dollars, so you can dip into them pre-retirement without penalty.*
*For brevity’s sake, this is a simplified discussion. Please review the withdrawal rules and logistics for each type of account that you have or are interested in opening.
Opening Your New Investment Accounts
Typically, opening an investment account is all done online, and you’ll get walked through the process, making it easy for a new investor. Here are a few more pointers on the different account types:
- Employer’s retirement account: Ask your human resources department for any information they can provide about starting your 401k or another retirement account. If you never opted out, it’s possible that your employer automatically enrolled you. If that’s the case, you’ll merely need to update the default investment selections and per paycheck contribution amount on file.
- Brokerage account (to buy stocks, bunds, etc.): If you have a retirement account, consider opening your brokerage account with the same financial institution. You’re already familiar with them, and you’ll be able to see your different investments at a glance in one place. Of course, if you dislike your retirement account provider, you’ll want to shop around. Choose a brokerage firm that features low trading fees and the investments that you want.
- IRA account: Again, for simplicity and ease of management, check to see if your existing financial institution can help with setting up your IRA accounts. You can also visit a local bank to open the account.
Pro Tip: Use Personal Capital for tracking your investments and other financial accounts – it's free and has many helpful financial tools.
Final Thoughts on Investing
As you can see, there is a lot of information out there about investing.
While this article is intended to provide a good overview of the basics for the beginning investor, it’s by no means an exhaustive list of terms or a complete primer on the subject. You’re encouraged to do as much research as you need to feel informed.
If you’re feeling confused or need additional assistance, consider speaking with a qualified financial professional for guidance.
Article written by Laura