Investing is one of the most reliable ways to generate wealth over time. If you are new to investing, we are here to help you get started. It’s time to make your money work for you. Let’s get started with our guide to investing.
Here are some of the best ways to invest money:
Guide to Investing – For Beginners
Stocks are a type of security that gives stockholders a share of ownership in a company. Sometimes, they are also referred to as “equities”. Units of stocks are called shares. They offer a method to investment in the company’s current and expected profits from the company’s perspectives, stocks are a way to raise money to fund growth, develop products, and carry out various corporate initiatives. When you invest in a company’s stock, you profit alongside them.
Companies and municipalities borrow money using bonds. A bond is an instrument of indebtedness. Bonds are fixed-income debt instruments that basically amount to a loan from an investor to a company or government agency. A bond issuance includes details about interest rates, terms, and payment dates. The borrower agrees to pay back the loan on a particular date in the future and make coupon payments throughout the life of the loan, often twice a year. Coupon payments are periodic interest payments that reward the investor for lending capital and taking on risk.
An index fund tracks a market index. An index mutual fund or ETF (exchange-traded fund) tracks the performance of a specific market benchmark, such as the S&P 500 Index. Index investing is considered a “passive” investment strategy. Instead of selecting which stocks or bonds the fund will hold, a fund manager buys all (or a large representative sample) of the stocks or bonds in the index it tracks.
Three Things to Consider
The best way to invest your money comes down to YOU and these three things: 1) individual investment style; 2) personal finances; and 3) risk tolerance.
Your investment style refers to whether you are an active or passive investor. There are pros and cons to both active and passive investment strategies. The key is to remain focused on the long-term.
Individual Investment Style – Active Vs Passive Investing
Active investing places an emphasis on conducting your own research. You will be making the investments yourself, usually through an online brokerage account, and constructing and maintaining your own portfolio(s). To be successful as an active investor, you’ll need three things: 1) the ability to commit time to managing your portfolio; 2) the ability to identify and analyze investment opportunities; and 3) the desire to do the work. We believe the emphasis needs to reside on the last item – desire. If you are like us, you enjoy studying the markets; the idea of finding investments that produce superior returns excites you.
Active investing offers several advantages:
- Flexibility – active managers are not required to hold specific stocks or bond
- Hedging – the ability to use short sales, options, and other strategies to insure against losses
- Risk management – the ability to get out of specific holdings or market sectors when risks get too large
- Tax management – including strategies tailored to the individual investor, like selling money-losing investments to offset taxes on winners.
Passive investing works for many investors. Allowing professional portfolio managers to manage your investments – for example purchasing an index mutual fund – can still produce excellent returns over a long-time horizon. See our article on investing with Vanguard Index Funds.
Passive investing offers a variety of benefits, including:
- Very low fees – there is no need to analyze securities in the index
- Good transparency – investors know what stocks or bonds an indexed investment contains
- Tax efficiency – an index fund’s buy-and-hold style does not trigger large capital gains tax.
In the past couple of decades, index investing has become the strategy of choice for investors who are satisfied by equaling market returns instead of trying to beat them. Research by Wharton faculty, at the University of Pennsylvania, and others has shown that, in many cases, “active” investment managers are not able to pick enough winners to justify their high fees.
Actively managed investments charge larger fees to pay for the research and analysis needed to beat index returns. Although many managers succeed in this goal on an annual basis, few are able to beat the markets consistently over longer time horizons.
Additional work, More Risk for More Reward. This style focuses on researching and investing yourself.
Passive: Simple, Stable, and Predictable. This style requires a hands-off approach.
Personal Finances – How much money do you have to invest?
Many people avoid investing because they think it requires a high salary. Additionally, others may believe that investing requires having an initial large lump sum of cash that would otherwise exclude them. The truth is you can begin investing with less than $100. The key is to get started early and maintain a consistent contribution strategy, covering a diverse array of assets, that grows over time. This takes discipline and patience. But the rewards are great for those that are willing to commit. The amount of money you’re starting with isn’t the most important thing — it’s making sure you’re financially ready to invest and that you’re investing money frequently over time.
Before investing we always recommend setting up an emergency fund. Most experts believe you should have enough money in your emergency fund to cover at least 3 to 6 months’ worth of living expenses. Start by estimating your costs for critical expenses, such as housing, food, health care, utilities, transportation, personal expenses, and existing debt.
Here more savings is always a practical and prudent strategy. Here are some specific instances where it could benefit you:
- During a recession when unemployment rates are higher.
- If you’re in a high-risk industry where layoffs are common.
- You’re part of the gig economy or your income isn’t steady.
- If you’re retired and living on a fixed income (most of your money may be tied-up in the market).
Don’t panic if you can’t come up with that money right away. You can build up your savings by setting aside smaller amounts on a regular basis. Start with a nominal each week. Set aside a small amount every paycheck. If you keep it up, over time you’ll eventually meet your goal.
Starting Small Can Have Massive Effects
For Example – Look at the table below. Savings add up quickly. Saving $20 dollars a week will produce $1,043 in savings at the end of the year. And this is without investing those savings
The important thing is that you’ve started saving for unforeseen emergencies. While this is certainly a good target, you don’t need this much set aside before you can invest.
It’s also a smart idea to get rid of any high-interest debt, such as credit cards, before starting to invest. The stock market has historically produced returns of 9%-10% annually over long periods of time. If you invest your money at these types of returns and simultaneously pay an APR of 20%+ or higher to your creditors, you’re putting yourself in a position to lose money over the long run.
Many sources recommend investing between 10% to 15% of your income each month. According to the popular 50/30/20 rule, you should reserve 50% of your budget for essentials like rent and food, 30% for discretionary spending, and up to 20% for savings and investing.
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Who Wants to be a Millionaire?
Not so fast. For the average person, becoming a millionaire is easier said than done. Many investors find that the closer they get to that number, the more feasible it will become for them to afford new opportunities and reach their lifestyle goals. And when you consider the fact that future retirees who plan to live on a fixed income of roughly $50,000 a year will need between $1 million and $1.5 million to carry them the rest of their lives, suddenly the idea of saving a million dollars feels like a sobering goal.
If you’re 25 years old and want to reach $1 million by the time you’re 65, you can invest as little as $240 per month, assuming a 9% yearly return. But once you hit age 30, these numbers start looking a little different.
Let’s look at the monthly dollar investment amounts that are required for a 30-year-old, given an investment time horizon of 35 years, to reach $1 million.
A 30-year-old making investments that yield a 3% yearly return would have to invest $1,400 per month for 35 years to reach $1 million.
If they instead contribute to investments that give a 6% yearly return, they will have to invest $740 per month for 35 years to end up with $1 million.
But if they choose investments that yield a 9% yearly return, which is comparably more aggressive, they will need to invest $370 per month for 35 years to reach $1 million.
A 3% return may be achieved through a conservative portfolio of government and triple A rated corporate bonds, whereas a 6% return is a bit more moderate and usually consists of a combination of stocks and bonds. A 9% return denotes a more aggressive portfolio that’s stock-heavy.
What is Your Risk Tolerance
Risk tolerance is the degree of variability in investment returns that an investor is willing to withstand. It is an important component in investing and each investor should have a realistic understanding of their ability to handle swings in the value of their investments.
Risk tolerance is often associated with age. People who are younger and have a longer time horizon are often able to and are encouraged to take on greater risk than people older with a shorter-term horizon.
Greater risk tolerance is often synonymous with equities, equity funds and ETFs, while lower risk tolerance is often associated with bonds, bond funds, and ETFs. Age itself shouldn’t solely determine a switch in asset classes. Those with a higher net worth and more disposable income can also typically afford to take greater risks with their investments.
Are all investment successful? No. Each investment has a specific risk-reward profile. Each type of investment has its own level of risk, but this risk is often positively correlated with returns. It’s important to find a balance between maximizing the returns on your money and finding a risk level you are comfortable with.
For example, government or AAA-rated corporate bonds offer predictable returns with very low risk, but they also yield relatively low returns of around 2-3%. By contrast, stock returns can vary widely depending on the company and the time frame. When viewed over long time periods, of a decade or more, the whole stock market on average returns almost 10% per year. Keep in mind that the market’s long-term average of 10% is only the “headline” rate: That rate is reduced by inflation. Currently, investors can expect to lose purchasing power of 2% to 3% every year due to inflation.
Understanding Different Levels of Risk
Even within the broad categories of stocks and bonds, there can be huge differences in risk. For example, a Treasury bond or AAA-rated corporate bond is a very low -risk investment, but these will likely have relatively low interest rates. Savings accounts represent an even lower risk, but offer a lower reward.
On the other hand, a high-yield bond can produce greater income but will come with a greater risk of default. In the world of stocks, the difference in risk between blue-chip stocks and penny stocks is enormous. *Some examples of the blue-chip stocks are Microsoft Corporation (NASDAQ: MSFT), Apple Inc. (NASDAQ: AAPL), Amazon.com, Inc. (NASDAQ: AMZN), The Coca-Cola Company (NYSE: KO), and The Walt Disney Company (NYSE: DIS). Because of their size and stability, many blue-chip stocks pay stable and consistent dividends.
Resources Available for New Investors
Today, new investors have a wealth of resources available to them. One good solution for beginners, choosing a passive approach to investing, is using a robo-advisor to formulate an investment plan that meets their risk tolerance and financial goals. A robo-advisor is a service offered by a brokerage that will construct and maintain a portfolio of stock- and bond-based index funds designed to maximize your return potential while keeping your risk level appropriate for your needs.
The robo-advisor industry was built on passive investing: using low-cost funds linked to a preset mix of investments; for example, the S&P 500 index of large companies. Rather than beat the market, which is extremely hard to do, these funds simply aim to match whole market gains over time. There are three robo-advisors we recommend:
- Personal Capital
For another article aimed for our beginner investors, take a look at Investing in Dividends.
For more in-depth articles to help you navigate your financial journey, check our Personal Finance page out!
Disclaimer: Nothing on this site nor any published commentary by The Investor Weekly is intended to be investment, tax, or legal advice or an offer to buy or sell securities. Information presented is believed to be factual and up-to-date, but we do not guarantee its accuracy and should not be considered a complete discussion of all factors and risks. Data quoted represents past performance, which is no guarantee of future results. Investing involves risk. Loss of principal is possible. Please consult with your investment, tax, or legal adviser regarding your individual circumstances before investing.