Investing for Beginners: What First-Time Investors Need To Know

Choosing stocks, mutual funds and other types of investments can be intimidating for first-time investors. To help you get started, GOBankingRates has put together these tips on how to understand investing for beginners.

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You’re already on the first step: understanding why investing is important. Strategic investments can grow your money over the long term, and the sooner you start, the more time you have to ride out the ebbs and flows of the stock market as well as capitalize on the power of compound interest.

What Is Investing?

Put broadly, investing is the creation of more money through the use of capital. There are different types of investments — including stocks, bonds and real estate — and each comes with its own level of risk.

One of the core principles of investing is that you must take on a certain level of risk in anticipation of a future return. Generally speaking, the higher the amount of risk you take, the higher your potential future return — or loss.

The very term “investing” implies a long-term time frame. This makes it different from trading, which is the active buying and selling of investments, and from spending, which is an exchange of capital for goods and services without the potential for future returns.

Types of Investments

When you open an investment account, you can put your money into any number of vehicles: Investing in mutual funds, exchange-traded funds and bonds are all options.

A typical investment portfolio includes a mix of volatile and more predictable options among different asset classes, which enables your portfolio to weather the lows of the market while capitalizing on its highs. Review these types of investments and see if any fit your needs.

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Stocks

When you start investing in stocks, you are buying a small portion of a company. The value of your stock market investment rises and falls as the company succeeds or fails.

You can also make and lose money based on market trends, among other factors. Researching how to invest in stocks would be your first step to success.

401(k)

A 401(k) allows you to make contributions from your paycheck before or after taxes. Your contributions get invested — and you control how.

Many employers that offer 401(k) plans will match your contributions up to a limit. If your employer offers a match, make sure you contribute enough to your 401(k) to get the full match.

Traditional or Roth IRA

Contributions you make to a traditional IRA are tax deductible and subject to taxes only when you make withdrawals. A traditional IRA is best for investors who won’t need their savings before they’re 59 1/2 because there are penalties for early withdrawal.

A Roth IRA is an individual savings account that’s not tax deductible. Your savings will grow tax-free, and you can make qualified withdrawals tax-free. Because a Roth IRA is not tax deductible, you won’t need to pay taxes on your earnings when you make a withdrawal, as long as you’re at least 59 1/2.

Mutual Funds With Target Date

Mutual funds are comprised of stocks, bonds and other investment vehicles. A mutual fund investment allows you and other investors to buy into a collection of securities via the mutual fund share market.

For small investors, mutual funds are an easy way to diversify investments, as you can usually buy mutual fund shares for $1,000 or less. In fact, some mutual funds now have no minimum investment requirement at all.

Some mutual funds have target dates, with set portfolios that automatically reduce their risk profiles as they approach their maturity dates.

Index Funds

An index fund is a passive way to gain exposure to a particular stock market index. One of the most popular types of index funds is an S&P 500 index fund, which holds the 500 stocks that comprise that index.

One of the main appeals of an index fund is costs are typically quite low, such as the 0.02% annual expense for the Schwab S&P 500 Index Fund.

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Exchange-Traded Funds

Like a mutual fund, an ETF pools money from numerous investors. You can, however, trade and sell ETF shares on the stock exchange, but you can only buy them from a broker.

Real Estate

Purchasing a commercial property or home as an investment is one way to invest in real estate, but it might require more capital than you have readily available.

Another form of real estate investing is through a real estate investment trust, or REIT. An REIT is a company that owns a property such as an office building, mall, apartment building or hotel. Individuals can invest in an REIT, and earn a share of the income produced through the real estate ownership — without actually having to go out and buy commercial real estate.

Treasury Securities and Bonds

There is a wide range of Treasury securities, including bills, notes, bonds, Treasury inflation-protected securities, floating-rate notes and savings bonds. Bills have maturities of 52 weeks or less, while notes have maturities extending up to 10 years. Bonds have maturities of 20 or 30 years.

All Treasury securities are backed by the full faith and credit of the U.S. government, making them among the safest investments in the world.

Where Can You Start Investing?

To invest, you’ll need to open some type of brokerage account. Common options include:

• Online brokerage firms

• Robo-advisors

• Employer-sponsored plans

Online Brokerage Firms

An online brokerage firm offers an easy way to start investing. You can apply for an account online and be up and running within minutes. Top online brokers include such well-known names as Fidelity, Schwab, TD Ameritrade and E-Trade.

Once you open an account at an online brokerage firm, you can enter your own trades in a wide variety of securities, ranging from stocks and bonds to mutual funds, options and sometimes cryptocurrency.

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Robo-Advisors

A robo-advisor is a special type of online broker that manages your portfolio for a low fee. Robo-advisors like Betterment and Wealthfront allocate your funds to portfolios consisting of exchange-traded funds that cover various market segments, such as large-cap stocks, government bonds and foreign stocks.

Portfolios are built based on client answers to various questions about investment objectives and risk tolerance.

Employer-Sponsored Plans

Employer-sponsored plans, such as 401(k) plans, allow for pretax payroll contributions to various investments, usually mutual funds.

In addition to the ability to make pretax contributions, funds in a 401(k) plan grow tax-deferred until withdrawal. Many employers also make matching contributions to 401(k) plans on behalf of employees.

Costs To Start Investing

Although costs continue to trend lower in the investing world, there are a number of types of fees and minimums you may face when you begin to invest. Some of the most common are account minimums, commissions and fees.

Account Minimums

Some brokerage firms require larger minimums than others to open a new account. However, if you’re looking to invest $10 or less, you’ll be happy to learn that many online firms now have no minimum balance requirement at all, including Charles Schwab, Fidelity and E-Trade.

Commissions

Just like many firms now have no minimum balance requirement, many online brokerages also charge no commissions for stock and ETF trades. However, some firms, especially full-service firms, may still charge relatively hefty commissions per trade.

Check with your broker — or the website of your online broker — to determine how much your trades will cost before you place them.

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Fees

Some firms may charge miscellaneous fees in addition to transaction fees. For example, full-service brokerage UBS charges a $100 annual service fee to maintain an IRA account. Unless you have at least $1 million in assets, low-cost leader Vanguard charges $25 if you execute a stock trade over the phone instead of online. Robo-advisors like Betterment and Wealthfront charge between 0.25% and 0.40% annually to manage your portfolio.

How To Start Investing

Deciding how to invest money involves making several choices. Use this overview to get a handle on the basics.

Step 1: Set Goals To Achieve Your Long-Term Plans

The first step in investing for beginners is to establish why it’s important to you. List your long-term goals so you can figure out how much they’ll cost and how you can use investing to achieve them. Here are some examples of financial life goals:

• Retiring

• Paying for a child’s college education

• Buying a house or other real estate

• Building a business

Once you know what you want, you can start planning. You’ll need to find answers to these questions to create a road map that will help you reach your ultimate goals:

You can turn to financial advisors and use online calculators to help you break down your goals. If you need more capital to invest to increase your potential annual earnings, set shorter-term savings goals — like saving a certain amount of money to open a high-yield certificate of deposit or money market account. Your plan will likely involve using several financial tools and account types to achieve your goal.

Step 2: Review Your Budget

By creating a budget, you can determine how much money you have to invest. You can assign portions of your income to various savings goals, ranging from shorter-term ones, like buying a house, to longer-term ones, like retirement. Before you allocate money to your investment goals, however, many financial experts recommend putting aside money for an emergency fund.

Budgeting is an important step because you’ll want to know how liquid you are before you lock money into an investment. For example, if you need assets to pay for your student loans, you must plan ahead to make sure those funds are available in time. If you’re already 50 and don’t have any retirement savings, however, you won’t want to contribute as much to your child’s college fund as your retirement account.

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Step 3: Determine Your Risk Tolerance Level and Choose Your Investment Type(s)

The level of risk appropriate for your portfolio generally depends on your preferences and when you need to access your funds. One of the best investment tips for beginners is to take a risk-tolerance quiz to help you determine how much risk you can reasonably take on when you invest. A quiz will ask you questions regarding how you spend and save money — and what you would do with a windfall.

If you find that you are highly averse to risk, you might want to take on more conservative investments, like bonds. If you’re open to tackling more risk, you’ll want more volatile stocks in your portfolio, which might enable you to grow your savings faster but at the risk of losing more money.

Step 4: Choose a Platform

When you’re ready to buy, decide first whether you’ll be managing investments with a robo-advisor, a financial advisor or on your own. Here are the three platforms from which you can choose:

• Traditional Advisors
  Having a professional oversee your investments can help you keep your sights set on long-term goals, so you might want to consider hiring a financial planner. If you plan to hire one, make sure he is a fee-only financial advisor. A fee-only advisor doesn’t earn commissions based on product sales, meaning he has fewer conflicts of interest and can provide more comprehensive advice.

• Robo-Advisors
  A robo-advisor is an online wealth management service that offers investment advice based on algorithms. A robo-advisor takes human financial planners out of the equation. Although you’re liable to spend less on fees with a robo-advisor, don’t expect to receive advice on personal wealth management issues, like dealing with your taxes.

• Yourself
  You can also manage investments on your own. With the wealth of information online, there are numerous resources to help you navigate the intricacies of investing. Without professional help, however, you’re liable to make costly mistakes — and you’ll need to spend time managing your portfolio as you figure out how to start investing.

Step 5: Invest

If you put time and attention into learning how to start investing, you’ll likely be successful. Choosing the best technology, expert advice and strategy for your financial situation and personal preferences is the first step toward making smart investing decisions.

Tips for Beginner Investors

If you follow the above outline, you’ll be setting yourself up for success, but there are things to keep in mind as you begin investing.

Start Small To Build a Habit

It’s easier to invest if you start small. By consistently contributing even small amounts to a savings account, you can start getting in the habit of setting money aside.

Over time, try to increase your contributions by living off a smaller amount of your income. Soon you won’t even miss that money from your daily spending, and in the meantime, your savings will grow.

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Think Long Term

The stock market rises and falls every day. Even if you’re worried you’ll lose all of your money, it’s typically better to ride out the storm. Often, your investments will bounce back.

Invest Only What You Can Afford

The whole premise of investing is that you must accept some risk in order to generate a return. Where there is risk, there is the potential for loss.

If you risk money you can’t afford to lose, such as your emergency savings or the down payment for your home, you may suffer a tremendous financial setback if your investment goes sour.

Investing In What You Believe

You might be more likely to stick to a long-term investment plan if you only buy things you believe in.

For example, if you think that Elon Musk is a modern genius who will transform the world, you might be interested in investing in Tesla stock and following the news surrounding the company. If you’re passionate about the environment, diversification in the workplace, fairness in employment or other similar issues, consider an environmental, social and governance fund, commonly referred to as an ESG investment.

Do Your Research

Whether you plan to manage your investments on your own or want help from an advisor, stock market news can be mind-boggling.

If you’re working with a financial advisor, don’t be afraid to ask questions about how the financial markets and your portfolio are working.

If you’re reading up on stock market news, look up terms you come across and commit them to memory.

Don’t Be an Active Day Trader Just Yet

Even professional investors have a hard time beating the stock market. If you’re just starting out as an investor, leave the day trading to the experts.

Start saving consistently and build up a nest egg before you start dabbling in more speculative investments.

Understand the Fees

Fees and expenses can dramatically impact your investment results. Before you begin investing, understand all the costs involved, from commissions to fees to taxes.

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Diversify Your Portfolio

Diversification is often touted as a way to reduce risk within a portfolio. Some investors, however, confuse risk reduction with risk elimination. All investments come with a certain degree of risk.

However, by properly diversifying your portfolio, you can maximize your returns for a given level of risk.

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Stephanie Faris and Gabrielle Olya contributed to the reporting for this article.

Last updated: May 6, 2021

This article originally appeared on GOBankingRates.com: Investing for Beginners: What First-Time Investors Need To Know