How To Start Investing

Learning how to start investing is intimidating. At least, it was for me. And I’m not alone! A large number of Americans say that the fear of losing money keeps them from investing. Learning how to invest doesn’t have to be complicated, but it’s usually portrayed as something only professionals should do.

The fact is that investing is something that anyone can and should be doing. You don’t need to be a math whiz to put your money to work. Does that mean that investing is safe, and you’re guaranteed not to lose any money? Not at all. But there are a few things you can do to start investing that are simple, easy to understand, and effective.

If you aren’t sure if you have enough money to even start investing, you probably don’t realize that you can start with very little money. I used to worry about that too. I got my first job at a car dealership when I was 15 to help my mom pay bills.

And even though I started getting regular paychecks so early, I didn’t start investing until several years later. I just kept my money in a savings account. I worked so hard for that money that I didn’t want to risk losing it. The thought of buying stocks also sounded extremely complicated. Honestly, I didn’t even know where to start.

I thought investing was only for rich people. I didn’t realize I was wasting precious time.

This guide would have been all I needed, which is why I created it for you and anyone else looking to learn how to start investing for the first time!

Investing Your Money Is Important

A lot of people talk about wanting to start investing their money, but they can’t really articulate why it’s better than just keeping their money in a checking account.

Well, the reason is actually pretty simple. To begin, let’s define what the word ‘invest’ even means. At a basic level, to invest is simply to spend money with the expectation of getting more money in return. That’s it. To invest, you simply buy something in the hope that you’ll earn more money later in investment returns.

This is important because it explains why it’s so important to invest. Let’s say you are worried about having enough money for retirement. You might be stocking away every dollar you can into your bank account so that it’s there when you turn 65.

Investing Helps Protect Your Money From Inflation

But the problem with that is that your typical checking account or savings account pays virtually (or literally) nothing in interest. So your money is actually losing value due to inflation (the gradual increase in the prices of things at stores). A hundred years ago, a can or bottle of Coke or Pepsi cost 5 cents. Today, a bottle of Diet Coke could cost you $1.99. This increase in price is inflation.

So, if your money isn’t invested and growing, it’s actually losing value, since the prices of things will increase over time.

Another concern we’ve heard a few people say is that they don’t want to invest because they are afraid of paying more taxes. This is nonsense because you will usually only pay taxes on profits, so in the end, you will still have more money (after taxes) than if you hadn’t invested at all!

Investing is an awesome way to grow your money over time (hopefully it will grow much faster than inflation does) so that when you are ready to retire, you won’t have anything to worry about besides which new hobby you want to try out.

Learning How To Start Investing Is Less Complicated Than It Seems

Movies make the stock market look like a crazy flurry of activity, and we just didn’t want to lose the little money that we had.

I guess growing up with little money made us wary of the ‘financial system.’

Now that we understand how simple it is to invest your money, we wish we would have started right away.

If you are looking to learn how to start investing, then this article is for you.

One of the simplest and easiest approaches is to invest long-term in your retirement. By choosing to invest in retirement, you’re able to ignore many of the challenges that make investing riskier or more difficult.

Trying to time the market, investing in individual stocks or another asset class (bonds, real estate, etc.), value investing, and navigating capital gains tax can all add to the complexity and risk of investing. We find it’s often best just to keep things simple.

Setting Your Financial Goal

Before you finish this article, use our easy retirement calculator to determine how much you should be saving for retirement. If you’re anything like us, seeing that number might be all the motivation you need to start investing in the future.

Such a large financial goal might feel overwhelming, but don’t worry. You still have a lot of time on your side. If anything, it should highlight why you should focus on saving and investing as much money as possible!

The other tool you can take advantage of now is the power of compound interest, which is basically the interest earned on an increasingly large amount of money. To see the incredible multiplying power of compound interest in action, check out this compound interest calculator.

The younger you are, the better an investment opportunity you have in front of you, as you’ll have more time to let compound interest grow your savings. This is true whether your investment goal is to speed up your retirement plan, build your emergency fund, or pay off student loans.

The truth is that learning how to invest in stocks is simple, but most people assume it’s complex and confusing.

Before we start learning how to start investing, here’s some good news: You don’t need a degree in finance or to have worked on Wall Street to invest wisely! We learned that lesson the hard way, so you don’t have to!

The first step is to decide which type of account you want to use to invest your money.

Note: The remainder of this article does use some investment vocabulary, but don’t panic. The words themselves may be new, but that shouldn’t intimidate you. We’ll go through step-by-step and break down what terms like “taxable investing accounts” and “index fund” mean, so bear with us.

Step 1: Choose An Account Type: Tax-Favored vs. Taxable Investing Accounts

To invest your money, you’ll need to open an investment account. The process is almost identical to opening a new bank account. Within this account, you’ll be able to transfer in money from your bank and decide what you want to invest in.

Let’s break down the two major types of accounts you’ll use.

There are multiple types of accounts you can use to get your money invested in the stock market. We like to first group them into two main categories: Tax-Favored and Taxable Investing Accounts.

Tax-Favored Accounts

Tax-favored (aka tax-advantaged) accounts are given tax advantages by the government to encourage people to put money into their own retirement account. The big ones are the 401(k) and the IRA (including Roth IRA). Here’s our guide on how to open an IRA.

Taxable Investing or Brokerage Accounts

On the other hand, Taxable Investing Accounts can be invested in the same way as 401(k)s and IRAs, but do not get the same tax advantages. The profits you earn in a taxable brokerage account get taxed as capital gains. This is in addition to the income tax you already paid on the money you put in! They do, however, have the advantage of being able to be withdrawn penalty-free at any time.

Regardless of which type of account you use, you will choose how your money is invested. You can buy stocks (small parts of a company), bonds (a loan to a company or the US government that pays interest over time), index funds (basically a group of many stocks), or any other type of security (fancy word for a tradable investment).

Which Type of Investment Account to Use To Start Investing

We suggest opening investment accounts and investing in the following order in order to minimize your tax bill:

1. 401(k) up to the employer match (if your employer has one)
2. Roth IRA until you max it out ($6,000 limit in 2020)
3. 401(k) beyond employer match until you max it out ($19,500 limit in 2020)
4. Taxable accounts (no annual dollar limits)

We recommend investing in this order because it will help you minimize the amount of taxes you’ll pay over your lifetime. This isn’t the right order for everyone, but it will be more than enough for most people.

Remember that the tax-advantaged accounts like a 401K and Traditional IRA have annual limits and cannot be withdrawn before retirement without paying a penalty. 

If you hope to save money for ten years and then use that money before you retire, then a Roth IRA might be the perfect account for you. Roth IRAs let you take the money that you invested out of the account (this doesn’t include your profits) without a penalty, even if it’s before retirement.

If all of this is confusing and you can’t get a 401K through your job, it’s probably a safe bet to start with a Roth IRA.

Step 2: Open An Investment Account

Whether you want to open a tax-advantaged or taxable brokerage account, you have to select a brokerage firm where you will deposit your money and choose your investments. There are a ton of different firms that you can use. Here’s our guide to opening an IRA.

The only exception here is that if your company offers a 401K retirement savings program, you must use the 401K service company that they select.

Some of the standard names in the industry are Vanguard, Fidelity, Charles Schwab, and the list could go on. There are also robo-advisors out there like Wealthfront and Betterment, which are basically automated brokerage firms that decide what to invest in for you.

And there are also start-up brokerage firms like Robinhood, Webull, and M1 Finance, though they offer more limited options and include several very cheap stocks (sometimes called “penny stocks”).

Ultimately, which one you pick is a personal decision.

We like Vanguard and Fidelity because they offer a range of low fee investment fund options as well as the ability to put your portfolio in tax-advantaged accounts and standard taxable accounts.

If you don’t ever want to even think about your investments, a ‘Robo Advisor’ could make a lot of sense, since they take your money and invest it for you (for a fee, of course).

Step 3: Choose Your Investments

This step is where the fun begins. Everyone assumes that learning how to invest is complicated. But it doesn’t have to be. Actually, the data shows that it shouldn’t be.

The dirty little secret that some of the big financial institutions don’t want you to know is that you shouldn’t pick individual stocks, unless you are comfortable taking that risk.

Picking Investments Doesn’t Have To Be Hard

If you aren’t trying to pick an individual stock, investing becomes extremely simple, and you may even find it boring. And that’s a good thing.

One simple strategy is to stick with low-cost index funds.

These are essentially single investments that contain slivers of many different stocks. In effect, you’ll own nearly the entire stock market. You can use them to build a simple 3 fund portfolio!

Owning such a wide variety of stocks is valuable because it means your portfolio (the collection of all of your investments) will be well-diversified (spread out across several different places).

Diversification is so important because it protects you from some of the risks the stock market brings. Because an individual company is a lot more likely to lose value than the entire stock market, choosing a broad stock fund (a fund that invests in many different companies’ stocks) can help keep your money safe.

The beautiful thing is that if you stick with diversified, low fee index funds, you can outperform the majority of professional investors.

Remember, oftentimes, the best investments are the most simple.

If you are wondering how to invest when the stock market is going up, here’s a solid guide: How To Invest In A Bull Market.

On the other hand, here’s what to do when stocks go down and how to invest during a stock market crash.

Some of you may be wondering about what other investing possibilities exist. While low-cost index funds are great for the hands-off, long-term investor, we recognize that not everyone wants to invest in this way.

Don’t worry. There are several other options available for different types of investments (also called “investment products” or “investment vehicles”) through online brokers.

And if you’d like to invest in stocks without having to pay fees or commissions, you’ll want to check out startup brokerages like Robinhood.

Robo Advisors Vs. Traditional Financial Advisors

First, let’s cover the extreme end of passive investing—robo advisors. These are even more low maintenance than index funds, as they use a series of algorithms to automate the process of investing.

Robo advisors are the most “set it and forget it” of popular investing styles because they allow you to just fill out a brief questionnaire, and then you’re good to go! One popular robo advisor is M1 Finance, which you can learn more about here.

A useful way to think about how robo advisors work is as a financial advisor app. They cut out the need for an online broker, which means you don’t have to go through a middleman to buy and sell investments. Robo advisors are generally best for the investor who wants a minimal amount of involvement with his portfolio.

Robo advisors operate similar to traditional financial advisors. That means you pay a small fee in exchange for not having to manage your investments. The key difference, however, is in the size of the fee and the allowed flexibility.

Robo advisors usually charge lower fees (also sometimes called the “expense ratio”) than in-person financial advisors, while still providing many of the same services of a traditional financial planner.

However, if you’re an investor who prefers the additional flexibility offered by a financial advisor, or if you’d rather work with someone face-to-face or via phone, you may want to look into traditional financial planners over robo advisors.

There’s also a growing crop of online-only financial planning companies like Facet Wealth. They give you on-demand access to a financial planner for a monthly fee. If you need more guidance, it could just be the best way forward for you.

Investing In Index Funds Vs. Actively Managed Mutual Funds

As we mentioned earlier, index funds are basically a large group of different stocks. The stocks themselves are held in what’s known as a “mutual fund,” which you can think of as the collection of assets (stocks, bonds, etc.) itself.

There are two types of mutual funds you can invest in: a passive index fund or an active mutual fund. The difference between the two names comes from how each is managed.

Passive funds generally aim to track the performance of a broad stock market index (hence the name “index fund”), like the S&P 500. By following such a large fund’s performance, you can have your investment grow over the long term at the same rate that the overall stock market grows (~7% annually based on historical data).

On the other hand, actively managed funds try to outperform the previously mentioned stock indexes using a number of strategies. This means there is more risk in the performance of your investment. However, this could be good or bad, depending on whether the person managing your money can beat the index.

Historically, most actively managed funds perform worse than the index, especially over the long-run. Also, actively managed funds almost always have higher fees, so if you’re a long term investor, think carefully before choosing between a passive or active fund.

We personally use passively managed index funds, but you should do your own research on services like Personal Capital to decide which type of mutual fund you prefer.

Investing In Real Estate

Investing in real estate can be a useful way to diversify your portfolio further, as the value of real estate often follows different trends than the stock market. There are several different ways to invest in real estate, from buying a rental property to investing in real estate investment trusts (REITs).

Buying property is a good way to create a regular cash flow (rent from tenants), and if you can successfully flip the home, it’s possible to make a lot of money. 

That said, it can be difficult to buy a rental property if you don’t have much money. Also, owning property is subject to its own risks: property value can be a fickle thing, and paying for repairs and acting as a landlord is often stressful and time-consuming. 

If you’d rather avoid the hassle of finding tenants, dealing with landlord duties, and don’t have too much money to spend on rental properties, REITs might be a good option for you. 

By investing in a REIT, you’re basically investing in a company that buys properties, which means the company’s value is tied to the underlying rental properties.

Think of this strategy similarly to investing in stocks. In both cases, you’re becoming a shareholder (person who owns shares or stocks in a company) and thus get to enjoy part of that company’s profits.

However, REITs have their downsides. An absence of tenants still hurts the company’s bottom line (and therefore, your earnings), and the company keeps part of the cash flow rather than giving it to you. 

With all that in mind, understand that REITs can be valuable options for diversifying your investment portfolio, so long as you recognize the different risks they carry.

There’s also a lot of real estate crowdfunding platforms that you can use to invest in larger real estate projects!

How To Invest With ETFs

An ETF, or Exchange Traded Fund, is a type of investment that functions similarly to an index fund. Both can contain a collection of several different companies’ stocks, making them strong choices for the long-term investor looking to diversify.

However, this is where the first difference between ETFs and index funds arises—ETFs can be specialized to include other types of assets, including bonds, oil, and gold. This becomes important when you consider asset allocation in your investing strategy. 

Asset allocation is basically the balance between stocks and bonds. Because ETFs let you invest in more than just stocks, they help you balance your asset allocation by ensuring you have a healthy mix of stocks, bonds, and other assets in your portfolio.

Our guide on how to master asset allocation breaks it down in greater depth if you want to know more.

Outside of asset allocation, ETFs mainly differ from index funds in terms of account minimums and what you can do with them. ETFs often have lower account minimums than index funds, meaning you could still invest in an ETF if you don’t have enough cash for other alternatives.

The other key difference is that ETFs have shares that you can buy and sell, similar to shares of a company stock. 

Without getting too into the nitty-gritty of what this means for you as a casual investor, the endpoint is ETFs can help you pay fewer taxes than an index fund but can take longer and cost more to buy and sell. But, these differences are likely negligible if you plan to invest long term in either an ETF or an index fund, so don’t stress. 

In short, ETFs can be a useful way to adjust your asset allocation and cheaply diversify your portfolio without dealing with high account minimums.

Step 4: Deciding How Much Risk To Take When Learning How To Start Investing

Once you’ve decided what to invest in, you’ll want to decide how risky to make your investment portfolio.

Again, this is less complicated than it sounds. To figure out your risk tolerance, Vanguard has a useful risk tolerance questionnaire that can provide you with a general overview of how your portfolio should look.

In a passive index-fund based investment strategy, you’ll only need to pick as few as 2 or 3 different investments.

To lower the risk of your investment portfolio, one of those investments will be bonds. In general, the more bonds you invest in, the less risky your portfolio will be.

But that doesn’t mean you should only invest in bonds to lower the risk. Bonds also have lower expected returns, which means you are less likely to make more money.

There’s a trade-off between risk and reward, which means it’s often best to have a diversified portfolio to strike a good balance between profits and potential dangers. 

If navigating all these different factors is too much, you can always create a simple three-fund portfolio. Or, you can invest in a target-date fund (a fund that automatically adjusts your portfolio’s assets and risk to fit your needs as you get older).

Whether you choose to use a target-date fund, robo advisor, or become an aspiring real estate tycoon, know that investing can be a lot less complicated than it seems.

And if you follow one rule throughout your investing career, let it be this: the sooner you start investing, the better off you’ll be. But you don’t have to take our word for it. This is the same advice you’d get from Warren Buffet.