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If you’re looking to invest in the financial markets for the very first time, you must have a firm grasp of what this entails. Not only in terms of asset classes, potential returns, and investment strategies, but also which risks need to be taken on board.
In this guide, we cover the ins and outs of investing for beginners. This includes the process of choosing an investment path, the many different markets and assets that you might consider, how to define your financial goals, and more.
Things to Consider Before Investing
Before you even get to the stage of choosing an investment, there are many important factors that you first need to consider. At the forefront of this is to take a step back and assess your current financial situation.
- For example, if you are currently holding debt at an unfavorable rate of interest, now might not be the right time to invest.
- In other words, if you are paying 22% interest per year on a credit card balance and expect to make an average annual return of 10% on the S&P 500, it would be unwise to allocate any of your capital to investing at this moment.
- Instead, it would be far more beneficial for you to work towards paying off your high-interest debt.
- Then, once this has been achieved, you can reconsider your financial circumstances.
In addition to assessing your outstanding debts, you should also evaluate how much you have in cash. That is to say, it’s always a sensible idea to have an emergency fund that is large enough to see you through six to nine months. This sentiment has never been truer in the current global financial environment.
In summary, if your debt and cash flow levels are both where they should be, it’s then time to consider the first step of investing for beginners: choosing an investment approach.
Pro Tip: Your savings should always come first before you even think about investing. Your savings are the foundation that feeds your investments.
How to Invest Your Money
In this section of our guide on investing for beginners, we are going to explain the two core strategies in which you can invest. Then, we will take a closer look at the most common asset classes that you might want to consider as a first-time investor.
Step 1: Decide on an Investing Approach
Depending on your skillset, prior experience, and amount of time that you can dedicate to the financial markets, you will either look to invest on an active or passive basis.
As the name suggests, if you are an active investor, you will actively look to research the markets and ultimately choose which assets to buy and sell. You will also be responsible for timing the market.
For example, you might decide to buy Apple stocks and hold on to them for several months before cashing out. As an active investor, not only did you decide which asset to buy but also when to enter and exit the market.
On the other hand, passive investing is the polar opposite of its active counterpart. This is because you will take a hands-off approach to investing. You can achieve this by investing in a fund. This might be an index fund that tracks the Dow Jones or S&P 500, or an ETF that tracks a portfolio of dividend stocks.
Mutual funds and even robo advisors are also examples of passive investment vehicles. Crucially, the key point here is that once you have passively invested, there is little else for you to do. Your chosen fund will determine which assets to buy and sell and when.
Ultimately, although the thrill of picking and choosing your investments can be exciting — if you’re an inexperienced and/or time-strapped investor — you might want to opt for a passive strategy.
Note: Historically, passive investments like index funds have earned more money than active investments like actively managed mutual funds.
Step 2: Decide on an Asset Class
Once you have assessed whether you wish to invest actively or passively, you then need to think about the type of assets that you wish to gain exposure to.
Each asset will come with its risks and potential rewards so this part of the investment decision-making process is important.
To help clear the mist, below we discuss some of the main assets that you might consider adding to your portfolio.
Perhaps the most popular asset class for investors — both newbies and seasoned traders – is traditional stocks.
Most investors in the US will focus on the two primary domestic exchanges — the NYSE and the NASDAQ. With that said, many online brokers also give you access to international markets, such as those based in the UK, Europe, Asia, and others.
Additionally, you also need to consider the type of stock you are interested in. For example, blue-chip stocks are typically companies that have a long-standing reputation in their respective sectors and ultimately carry less risk.
Think along the lines of Microsoft, Johnson & Johnson, Mcdonald’s, Nike, and Goldman Sachs. You then have growth stocks, which are companies that are expected to outperform the wider market as they are still in the early stages of their corporate journey.
This stock type would include Tesla, Square, Uber, and Coinbase. Many investors will also focus on the specific sector that the stock is involved in. In the midst of the coronavirus pandemic in early 2020, it was tech stocks like Amazon, Apple, and Facebook that led the way. In times of economic uncertainties, investors might flock to staple sectors like tobacco, manufacturing, and healthcare.
As you can imagine, knowing which stocks to add to your investment portfolio can be a daunting task. This is again why you might be better off sticking with a passive form of investing.
For example, you might consider an index fund like the S&P 500. This will see you indirectly invest in 500 large-scale companies that are listed in the US. This index fund is regularly reweighted to reflect the performance of each constituent.
You can make money from a stock investment in two ways:
- Capital gains: Put simply, if you sell your stocks for a higher price than you originally paid, the proceeds are known as capital gains. For example, if you bought a stock at $100 per share and sold it at a price of $150 per share — your capital gains are $50 per share.
- Dividends: Many companies in the US stock market pay dividends. This means that the company distributes some of its income to stockholders. Dividends are usually paid every three months and will typically offer a yield in the 2% to 5% region.
Ultimately, the key takeaway here is that the stock market is super diverse. With tens of thousands of companies to choose from — you need to think wisely about which stocks you add to your portfolio.
A great way to reduce the risks of a stock investment (or any investment for that matter) is to diversify. We talk about this in more detail further in this guide.
|There are various options to choose from||Returns are not guaranteed|
|Your investment is highly liquid||Stocks may be volatile compared to other asset classes|
|You can diversify across different industries & sectors||–|
|Some companies pay dividends||–|
Unlike stocks, your financial returns on bonds are predictable. This is because bonds come with a fixed rate of interest so you always know how much money you will make. For those unaware, bonds are issued by governments and corporations as a means to raise capital.
If you buy a bond from the issuer, you will be paid interest. This is usually paid annually or bi-annually and the rate of interest will depend on the risk associated with the bonds. You will only get your initial investment back — known as the principal – when the bonds mature.
The length of the bond will also vary and can range from a few months up to several decades.
Here’s a quick example of how a bond investment works:
- You buy $10,000 worth of corporate bonds that pay an annual interest rate of 3%;
- The bonds have a maturity of seven years;
- The interest — known as a coupon payment – is paid annually;
- This means that at the end of each year, you will receive an interest payment of $300;
- This will happen every year until the bonds mature; and
- Seven years later, you get your original $10,000 investment back.
Like any investment you make, bonds do come with their risk. This centers on the ability of the issuer to repay the money it borrows. This shouldn’t be a concern of yours if you are buying bonds issued by the US government (US Treasuries).
However, if you were to buy bonds from a corporation with a shaky balance sheet, then, of course, the risks of default are higher. The level of risk associated with the bonds will have a direct impact on the yield. In other words, the higher the risk, the higher the yield.
|Bonds pay fixed returns to investors||Bond prices decline when interest rates rise|
|Less volatile than other asset classes like stocks||Low liquidity|
|Less risky than stocks||Bond performance impacted by a high inflation rate|
|Bonds are universally rated by credit rating agencies||–|
Cash & Cash Equivalents
Many investment portfolios will contain a percentage of cash and cash equivalents. This ensures that there are funds available to cover short-term debt obligations or to enter into a new investment opportunity.
With that said, it is also possible to earn interest by putting your cash into an interest-bearing account. This includes the likes of traditional savings or Certificate of Deposit (CD) accounts.
The interest that you can make by holding cash will be minute in comparison to the opportunities available in the wider investment scene. The risks of loss are, of course, much lower. If the account is FDIC-insured, the risk of default or bankruptcy will be covered up to the first $250,000.
|Highly liquid||Low returns|
|Can reduce volatility in your portfolio||You may have to pay a penalty if you redeem the certificate prior to maturoty|
|Safe and stable income||–|
Futures & Derivatives
If you’re new to the world of investing, then financial derivatives like futures and options will not be for you. This is because they are complex financial products that are typically accessed with leverage.
Futures and options are also short-term products, so you’ll need to be actively entering and exiting positions to ensure you are trading in a risk-averse manner.
|High liquidity||Most brokers require a minimum deposit|
|Futures contracts are regulated||Some commodities require physical delivery|
|Futures exchanges provide clearing & reporting||–|
|Investors can leverage margin account when trading futures||–|
Commodities & Precious Metals
Well-diversified investment portfolios will often allocate funds to commodities and precious metals like gold and silver. This ensures that you are not over-exposed to the wider stock markets. During times of economic uncertainty, precious metals like gold will often thrive. This is because gold is often viewed as a safe haven’ and subsequently, a hedge against falling stock markets.
You can invest in commodities through an ETF with ease. This allows you to get direct exposure to the value of the asset without worrying about storage or logistics. Plus, when you invest in a commodity ETF, your capital is super-liquid.
This is because ETFs are traded on public exchanges like stocks, so you can cash out your position at any time. We should note that commodities can be a lot more volatile than solid blue-chip stocks; do bear this in mind.
|High liquidity||Can be volatile|
|Can provide higher returns than other asset classes||Can be difficult to store|
|Can provide portfolio diversification||–|
|Can offer protection against inflation||–|
Real estate is a strong and solid investment sector — especially in the US. The key problem is that this industry is typically reserved for those with the capital to purchase a property outright or through a long-term mortgage.
The good news is that you do not need to purchase a property to gain exposure to the real estate scene. On the contrary, there are hundreds of publicly-listed REITs (Real Estate Investment Trusts) active in the market.
REITs are similar to mutual funds, insofar as the provider will purchase assets on behalf of its investors. In this case, that’s real estate. This might include commercial properties, residential units, healthcare facilities, or even shopping malls.
Best of all, many REITs are shaped in the form of an ETF, meaning that you can invest small amounts and cash out whenever you see fit.
When it comes to financial returns, you can grow your capital in the same way that you would when buying a property in the traditional sense.
- Rental payments: The REIT will collect rental payments from commercial and residential tenants. As an investor, you will be entitled to your share, which equals less fees. This is usually distributed every three months, although some REITs do this on a monthly basis.
- Appreciation: You can also make money from a REIT when the value of its property portfolio appreciates. This will be represented in the NAV of the REIT — much like an ETF.
|High returns||Less liquid and more paperwork|
|A regular stream of income from tenants||Can take time to grow|
|You have control over your property||A vacancy can interrupt your cash flow|
|A large number of options to choose from||–|
|Real estate can provide tax benefits||–|
Many investors will also allocate funds to alternative asset classes. This typically refers to an asset that sits outside of the traditional stocks and bonds sector. Examples include cryptocurrencies like Bitcoin, fine art, rare whiskey, and peer-to-peer lending.
The alternative investment space does come with its benefits and drawbacks. In terms of the positives, you stand the chance to earn a much higher rate of return. As a prime example, Bitcoin increased by over 1,000% in 12 months preceding April 2020.
However, what comes with higher-than-average returns is enhanced risk. That is to say, alternative investments are a lot more speculative and volatile than traditional assets, so it’s important to keep your stakes modest should you wish to access this marketplace.
|Portfolio diversification||Highly volatile|
|Potential for higher returns||They may be more illiquid and harder to price|
|Hedging against risk with non-correlated asset classes||They tend to be less regulated|
|Access to more sophisticated asset classes||–|
Step 3: Define Goals & Time Horizon
Once you have considered which asset classes are suitable for your risk/reward profile, it’s time to think about your specific goals. This can vary wildly depending on your projective investment time horizon.
The broad definition of short-term investing is an investment that is held for less than 12 months. With that said, short-term investing can refer to active trading strategies — such as day trading or swing trading.
This means that you might keep hold of an investment for a few weeks, days, or even hours. This type of investing is best reserved for those that have the time and resources to actively monitor and research the wider financial markets.
Crucially, not only do you need to choose the right investment, but you’ll need to enter and exit the market at the right time. Unless you have experience in the investment arena, this is a difficult feat to achieve.
Naturally, long-term investing refers to an investment that is held for at least one year. However, this will often see an investor hold onto an asset for many years or even decades.
For a newbie investor who doesn’t have the time to actively master the art of trading, long-term investing is ideal. This is because you don’t need to concern yourself with short-term volatility.
Instead, you will look to ride out the ups and downs of the financial markets over time. Long-term investing is particularly suited for those of you that are working towards a retirement nest egg.
Best Beginner Investing Tips
There are no guarantees that you will make money when investing in the financial markets. To ensure you give yourself the best chance possible of growing your wealth in a risk-averse manner, there are several key strategies that you should consider.
This includes the following:
Maximize Your Employer-Sponsored Retirement Plan
It goes without saying that if you are looking to build a long-term portfolio of investments, you should maximize the employer-sponsored retirement plan that you have access to. Known as a 401(k), this allows you to allocate some of your salary into a retirement plan in a tax-efficient manner.
The basics of a 401(k) plan are as follows:
- You can defer up to $19,500 of your annual salary in 2021 to your 401(k) plan;
- The annual limit in 2021 for joint contributions (you and your employer) is $58,000; and
- In most cases, you’ll need to wait until you are 59 years old before you can withdraw your capital without incurring a tax penalty.
Crucially, the overarching benefit of setting up a 401k is that you will avoid paying any capital gains or dividend tax on your investments for as long as they remain in your plan.
Maximize Tax Efficient Accounts
In addition to 401(k) plans, you might also consider an individual retirement account (IRA). This is similar to a 401(k), insofar that you will benefit from a tax-efficient account that is aimed towards your retirement nest egg.
However, IRAs are different, as, unlike 401(k), they are not offered by an employer. Instead, you will set up an IRA.
There are two variations to an IRA, which we explain below:
- Traditionally IRA: A Traditional IRA allows you to make ‘pre-tax’ contributions. This means that you will get immediate tax benefits. This option is best suited for those that expect to remain on the same tax band (or lower) when the age of retirement is met.
- Roth IRA: A Roth IRA is best suited for those that expect to retire on a higher tax bracket. This is because the account allows you to make ‘after-tax’ contributions. As such, your Roth IRA contributions will grow tax-free.
Irrespective of whether you opt for a Traditional or Roth IRA, both accounts are super tax-efficient.
Invest for the Long Term
The golden rule in the world of investments — especially when it comes to the stock markets – is to invest in the long term. This is because the financial markets will rise and fall throughout the year, meaning that the value of your investment will follow suit.
But, by staying firm and holding onto your investment in the long run, you will avoid the need to worry about short-term volatility. Of course, there is no guarantee that your investment will recover from a market downfall.
But, over time, the stock market has historically moved in a long-term upward trajectory. A good example of this is the S&P 500 index — which has generated average annual returns of over 10% since its inception in 1926. That’s almost 100 years of solid data.
Pro Tip: Long-term investments almost always outperform the market when investors try and time their investments. This is the reason you should be a long-term investor. Emotional trading tends to impact returns.
One of the best tips to consider when investing is to employ a dollar-cost averaging strategy. The main concept of this is that you will look to make regular investments as opposed to injecting a one-off lump sum.
In doing so, you will purchase your chosen asset at a different cost price on each investment. In turn, you will be ‘averaging’ out your base cost price. Once again, this has the desired result of removing the need to worry about short-term volatility.
- Let’s suppose that you have a lump sum of $24,000 to invest;
- You decide to put all your eggs into one basket by purchasing $24,000 worth of Tesla stocks at $900;
- 12 months later, Tesla stocks have declined to a price of $790;
- This means that you will only break even when the value of Tesla stocks returns to $900; and
- When or even if this happens remains to be seen:
Now let’s see what a risk-averse investor would do when dollar-cost averaging.
- You decide to split your $24,000 investment over 12 months;
- In month one, you purchase $2,000 worth of Tesla stocks at $900;
- In month two, you purchase $2,000 worth of Tesla stocks at $800; and
- In month three and four, you repeat your $2,000 investment but at a cost price of $700 and $600.
At this stage, you have made 4 x $2,000 investments into Tesla at four different stock prices. As per the example above, your cost price so far is $790. This is crucial, as had you invested the full lump sum into Tesla — you would have been stuck at a cost price of $900 per share.
But, by dollar-cost averaging, you are turning a market slump into a positive. This is because as the stocks decline, you are entering the market at a cheaper price. As such, over time, you are riding out short-term volatility.
Diversification & Rebalancing
Perhaps the most important tip to consider when investing is to ensure you are well-diversified. This means that you spread your investment capital out into different assets, markets, and economies.
The above example of investing in Tesla stocks is the complete opposite of a well-diversified strategy as you are putting all of your eggs into one asset. Instead, you would be far better off investing in lots of different stocks from varying sectors and industries.
The overarching benefit of diversifying is that you are covering several potential outcomes. For example, if the stock markets are down, then it is hoped that your investment into gold and bonds would help counter some of these losses.
Additionally, rebalancing your portfolio regularly is also important. This means reassessing your chosen investments and evaluating whether they still align with your long-term financial goals. If not, you might decide to add, remove, or replace some of the assets in your portfolio.
Keep Fees Low
Regardless of the asset(s) you wish to invest in, certain fees will be applicable. This is because you need to use an online broker to access your desired market.
With this in mind, it’s best to choose a platform that offers low or even 0% commission. Also, keep an eye out for ongoing fees. This will certainly be the case when you invest in an ETF, index fund, or mutual fund. After all, the provider in question will need to charge you a fee for managing your money.
Start with Index Funds
If you have virtually no experience or understanding of selecting investments — it might be best to stick with an index fund. For example, through a single investment into the S&P 500, you’ll be diversifying across 500 large-cap US-listed stocks. You can do this through an ETF provider at super-low fees.
Alternatively, it might be worth considering a mutual fund. In a similar nature to an ETF, the mutual fund will manage your capital. But, mutual funds are actively managed, meaning they will look to outperform the market — as opposed to simply tracking it.
Ultimately, by opting for an index fund — you invest in passively. You can still employ some of the strategies mentioned above too, such as dollar-cost averaging and diversification (for example, investing in several different index funds).
Investing Golden Rules
Check our investing golden rules infographic to find out how you can start investing the right way.
FAQ About Investing for Beginners
We’ve found some of the most frequently asked questions about investing as a beginner. Here are our answers:
What Is Investing?
Investing is defined as the act of committing capital or money to an endeavor with the intention to make more money. In most cases, the amount you can make from an investment is directly correlated to the amount of risk being undertaken.
For example, both the risks and rewards of investing in Bitcoin will be significantly higher than that of US government-issued bonds.
Why Is Investing Important?
Investing has never been so important when you consider the rate of interest being paid by traditional banks. The average annual interest rate is still below 0.1%. In comparison, the wider stock markets have historically grown at a much faster rate.
Even more importantly, if you don’t invest, your money will lose its purchasing power over time. This is because of inflation. Put simply, if inflation stands at 2% for the year and you earn just 0.1% in bank account interest, your money is essentially worth 1.9% less.
Investing ensures present and future financial security. When you invest your money, your dollars are put to work to earn more dollars. Then, those dollars get reinvested to generate even more dollars. The money generated through your investments and reinvestments allows your dollars to grow over time. This is known as compound growth.
The idea is for your money to grow faster than the rate of inflation in order for you to build wealth over time.
When Should I Begin Investing?
You might be tempted to try and time your entrance into the financial markets. However, there is no time like the present, especially if you are looking to invest in the long-term via a dollar-cost averaging strategy. The younger you start, the more time you will have to build wealth and take advantage of the power of compound interest.
If you are looking to invest with the view of growing your wealth over time — never before has the process been so easy. All you need to do is open an account with an online broker, deposit some funds, and decide which investments to make.
However, there is a lot to think about before you make the financial plunge. This includes putting an investment plan in place based on your goals, determining which asset classes align with your tolerance for risk, and deploying a sensible strategy.
- How to Invest $20k | 14 Different Ways
- 19 Best Ways to Invest $10,000
- How to Invest in Gold: A Beginner’s Guide
- 12 Best Ways to Invest $5,000
- How to Invest in Index Funds: A Step-by-Step Guide
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Kane is a highly-skilled researcher and writer with expertise in finance, trading, and cryptocurrencies. Academically, Kane holds a Bachelor’s Degree in Finance, a Master’s Degree in Financial Crime, and he is currently engaged in a Doctorate. He is passionate about researching the money laundering threats of the virtual economy — notably, cryptocurrencies and blockchain technology.