How To Start Investing for Beginners: 7 Easy Steps

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The best way to start investing is with the basics on how investing works. Beginners don’t need an elaborate plan before investing but it’s smart to cover key points, such as how much money is needed to get started investing, discovering what type of investor you are, gauging risk tolerance, and choosing the best investment account types.

How Does Investing Work?

Investing in capital markets means buying and holding investment securities, such as stocks, bonds, or mutual funds, that can outpace inflation over time. Put simply, investing is a way to make your money work so that it’s worth more tomorrow than it is today.

For example, when an investor buys and holds stocks, their money can grow through stock dividends, which are payments to shareholders that can come in the form of additional shares of stock, and through price appreciation, which is the stock price going up over time. Over time, these returns have a compounding effect, which Albert Einstein has called the eighth wonder of the world.

Saving vs. Investing Money

Saving and investing are both ways to set aside money for the future; however, saving money is different from investing money. Saving involves setting aside money in safe, low interest-bearing accounts for short-term use. Investing involves building wealth for long-term goals, such as retirement, with assets that are more volatile and have higher risk of loss but potential for higher returns.

Saving Investing
Goals Best for short-term goals and emergencies Best for long-term goals, such as retirement
Growth Lower interest, lower growth potential Higher returns, higher growth potential
Risk Extremely low risk, possibly guaranteed Moderate to high risk, no guarantee, may lose money
Accessibility Highly liquid, easily accessed Not highly liquid, may take a few days or more to access funds

Trading vs. Investing

When comparing trading vs investing, both styles may utilize some of the same investment securities, such as stocks or exchange-traded funds (ETFs), but there are key differences, such as holding period, risk parameters, frequency of transactions, and security analysis.

Trading Investing
Security Types Stocks, ETFs, Commodities, Currencies, Derivatives Stocks, Bonds, Mutual Funds, ETFs
Holding Period Short-term, from less than a day to weeks or months Long-term, from years to decades
Risk Parameters High to extreme potential risk of loss Moderate to high potential risk of loss
Frequency of Transactions High frequency of transactions, sometimes daily trades Low frequency of trades, monthly to annual trades
Security Analysis Technical analysis: statistical trends, price patterns Fundamental analysis: measuring intrinsic value

When to Start Investing

In the U.S. you have to be 18 years old to buy stocks through your own investment account but adults can open minor accounts for younger children. But age isn’t the only determining factor for deciding when to start investing. The best time to start investing is when you are financially ready.

You may be ready to start investing if:

  • Your monthly debt payments are less than 20% of your monthly income, or less than 30% if you have a mortgage.
  • The interest rate on your debt is less than the expected return on your investments. For example, a reasonable return to expect for stocks is 7-8%. So, if you have a credit card balance at 9% or higher, you may want to pay that off before investing.
  • You have money set aside for emergencies.
  • You have a basic understanding of how investing works.

How Much Do You Need to Start Investing?

The amount of money you need to start investing generally depends upon the type of investment account you are using and the type of investments you want to buy. Therefore, the minimum amount to get started investing may be a range from as little as $10 or as much as $3,000 or more.

For example, to start investing in your employer’s 401k plan, you can typically start with as little as 1% of your pay. However, if you start investing with a mutual fund in a brokerage account, you may need a minimum initial investment that typically ranges from $100 to $3,000 or higher.

How to Begin Investing in 7 Easy Steps

To get started investing, there are general steps that beginners will follow. Within each step, investors may customize for style and objectives. Steps to begin investing include setting goals, determining what type of investor you are and choosing the best brokerage, the account type and investments to reach your goals.

Step 1: Set Your Goals and Timelines

Before you buy your first investment, you’ll need to establish a goal, such as college savings or retirement, and a timeline that will serve as an estimated number of years to reach the goal. The goal and timeline can then help to choose an account type and suitable investments.

Investment Goal and Timeline Example

Following the SMART acronym for setting investment goals can work as a good outline. SMART stands for:

  • Specific
  • Measurable
  • Achievable
  • Realistic
  • Timebound

For example, reaching $1 million for retirement by investing $300 per month, averaging an 8% return for 40 years is a SMART goal.

Step 2: Discover What Kind of Investor You Are

Before you know what kind of investments to choose, you’ll need to discover what kind of investor you are. To do this, you’ll need to gauge your tolerance for risk, determine your risk capacity, decide if you want to take an active or passive approach, and consider whether or not you’ll help.

What’s Your Risk Tolerance?

Risk tolerance is a measure of how much risk you’re comfortable taking with investments. For example, if you have a high risk tolerance, you’re generally comfortable accepting a high degree of risk in exchange for the possibility of receiving high returns on your investments. But if you’re risk averse, you would be more comfortable with lower risk investments that may produce lower returns.

How Much Can or Should You Invest?

After gauging risk tolerance, investors need to gauge their risk capacity, which is how much of their money they can afford to invest. In different words, risk capacity, which is sometimes called objective risk tolerance, is an amount you can invest that won’t break your budget. Generally, 10% of income is a healthy beginning target for long-term investing.

Risk capacity can also refer to the amount of risk that an investor can objectively bear, independent of their risk tolerance. A young investor with a stable salary and low expenses may have the capacity to take more risk, even though their tolerance for risk is low.

Are You an Active or Passive Investor?

The active vs passive investing decision is a matter of style and preference. Active investing involves actively choosing stocks or other assets to invest in, as well as active management of investments, while passive investing involves more of a buy-and-hold strategy with passive investment selection, such as index funds.

How Much Support Will You Need?

Are you a do-it-yourself kind of investor or might you prefer to enlist the help of an investment advisor or financial planner? It’s important to explore this part of your investing personality and preference before choosing the type of account and the type of broker you’ll end up using.

Step 3: Select an Investment Account

Choosing the right kind of investment account is nearly as important as choosing the best investment types (stocks vs. bonds) for your goals. The decision about investment account types will depend upon a few key factors, such as taxation, income, and whether or not you have access to an employer-sponsored retirement account.

A. 401k or 403b Employer-Sponsored Retirement Account

For beginning investors, a 401k plan or a 403b plan offered by their employer can be the best way to start investing. Most of these plans have similar features and benefits, such as automatic payroll deduction, choice of pre-tax or Roth after-tax contributions, a selection of about 10-15 mutual funds, and the ability to contribute up to $20,500 per year in 2022, plus another $6,500 for investors age 50 or over.

B. Traditional IRA or Roth IRA Retirement Accounts

For investors wanting a supplemental or alternative retirement account to a 401k an individual retirement account, or IRA, can be a smart choice. A pre-tax traditional IRA can be a good choice for investors who expect to be in a lower tax bracket when making withdrawals in retirement. A Roth IRA is generally a better choice for younger people who are expecting to be in a higher tax bracket in retirement. A SEP IRA is an option for self-employed individuals needing higher contribution limits than other IRAs.

C. Taxable Brokerage Account

While a brokerage account is generally taxable to the account owner, there are no contribution limits, no penalties for withdrawals, and greater flexibility than other investment and savings vehicles, such as retirement accounts. Brokerage accounts can be held by an individual, jointly with other individuals, and can be opened for minors (UGMA or UTMA).

Step 4: Pick a Broker Service or Advisor

A broker, also called a brokerage, is a firm that offers investment accounts, investment securities, and if needed, assistance in trading (the buying and selling) of securities for their accounts. Investors may choose a discount online broker, a full service broker or advisor, a robo advisor service.

A. Discount Online Brokerage

A discount brokerage is ideal for investors who want to manage their own investment portfolio for a reduced cost. Typical discount brokers offer online access and the account owners place their own trades, many of which are at no cost.

B. Full-Service Broker

Investors who prefer advice for a fee can open a trading account with a full-service broker. A typical full service broker will be paid by commissions on trades or sales charges, called “loads,” on mutual funds.

C. Independent Investment Advisor or Financial Planner

A typical independent advisor, such as a Registered Investment Advisor, or RIA, may charge a fixed fee for a specific service or they may charge an ongoing fee based on a percentage of assets under management. The client may choose their own brokerage and open their own accounts or the advisor may choose the brokerage and open accounts on behalf of the client.

D. Robo Advisor Service

As the name suggests, a robo advisor service works without the need for direct human contact. A typical robo advisor service begins with the client completing an online survey with information that gauges risk tolerance and identifies investment goals. The robo advisor then automatically buys investments that are suitable for the client, based upon the information collected.

Step 5: Select Your Investment Options

Once your risk tolerance is identified and investment accounts are open, you’re ready to select your investment options. It’s generally a good idea to diversify risk, which means to own a combination of different asset types, which are primarily stocks, bonds, and cash.

  • Stocks: Also called equities, stocks represent ownership in a company and enables the investor, or shareholder, to participate in profits and receive dividends paid by the company. Stocks are generally suitable for investors who have a moderate to high tolerance for risk associated with short-term fluctuations in price.
  • Bonds: Broadly considered as “fixed income,” bonds represent debt to a company. This makes the investor, or bondholder, the lender that receives interest payments from the company, or debtor. Bonds are suitable for investors with low tolerance for risk, preferring more stable returns compared to stocks.
  • Cash: Investors primarily use cash in their brokerage account to buy shares of their investment securities. A typical investment portfolio won’t hold more than 5% of assets in cash. Some active investors may hold more cash in certain market conditions.

Diversified Investment Portfolio Examples

Once an investor has identified what type of investor they are, their range of risk aversion or risk tolerance may define them in one of three broad categories, including aggressive, moderate, and conservative. These investor type categories help to determine a suitable mix of assets, which are primarily stocks, bonds and cash.

Investor Type Asset Mix Example
Aggressive 80-90% stocks, 10-20% bonds
Moderate 60-70% stocks, 30-40% bonds
Conservative 25-55% stocks, 35-55% bonds, 10-20% cash

Note: The above asset allocations are simplified examples, based upon investor types, according to standard risk tolerance guidelines. Each investor is unique and thus may require unique allocations. Proper diversification will also include a range of industry and sector representations within the stock mix, as well as a range of bond types, depending upon the individual’s risk profile and investing goals.

Mutual Funds, Index Funds and ETFs

Mutual funds, index funds, and exchange-traded funds ETFs, collectively known as “funds,” can be smart investment types for a first time investor or an experienced investor. Since funds can include dozens or hundreds of securities, such as stocks or bonds, in a single packaged security, they offer convenience and diversification.

  • Mutual funds are baskets of securities that can be active or passive management. Thus, an investor can gain access to professional management, while diversifying across multiple investment assets. Mutual funds are the most common investment found in 401k plans.
  • Index funds are mutual funds or ETFs that passively track an underlying index, such as the S&P 500. When an investor buys an index fund, they are buying a set of securities that can represent broad market segments or niche areas of the market.
  • ETFs are funds that trade like stocks (intra-day) but invest passively like index-based mutual funds. ETFs provide the same broad diversification attributes of index funds but many ETFs specialize more in stock market sectors or different asset types, such as commodity ETFs.

Step 6: Fund Your Account

Before placing trades in your investment account, you’ll need to fund it with cash. This is typically done with a simple form completed online that will connect your bank account with your brokerage for electronic funds transfer. Once connected, you can transfer single fixed amounts or you can set up recurring amounts to transfer periodically, such as monthly.

Step 7: Build & Automate Your Portfolio Management Strategy

Whether your investing style is active or passive, building a portfolio and managing it can be a simple process. You may start with automation, which is not only convenient but can help you reach your goals and can be part of a dollar-cost averaging strategy.

By necessity, a 401k or 401b plan is automated through payroll deduction. But accounts that you manage, such as a brokerage account or IRA, will require you to automate manually.

As for building a portfolio, your risk tolerance and financial goals can direct the asset allocation (mix of stocks, bonds, cash, or other assets), and the specific investment selection. Once the portfolio is established and you’re set up with automation, the minimal requirement for management is to rebalance the portfolio periodically, such as once per year. If you want a completely automated portfolio construction and portfolio rebalancing, a robo advisor service may be a consideration.