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How To Start Investing, A Step-By-Step Guide For Beginners

Are you tired earn small amounts of interest on your savings? Are you ready to break out of your rut and start investing?

Now is a great time to learn. As stock prices have fallen with the changes in the economy, more people can jump into investing, buying investments they otherwise may not have been able to afford. Riding the market’s waves, you can be a part of the upswing when things get better.

TL;DR If you’re just here to find out who we recommend as the best investment platform, we recommend M1 Finance for beginning US-based investors and Wealthsimple for UK-based beginners.

What is investing?

Let’s start with understanding what investing really means. Investing means putting money into something you expect to increase in value over time, and therefore giving you a good return on the money you initially invested. It’s making money while you sleep. 

Investing is not necessarily about putting money in. Getting a university degree could also be considered an investment, as you would expect to get a good job and salary after graduating. But in this article we’ll focus on financial investments, that can be money, a financial asset or security like a stock or bond. 

How investments earn money

An investor earns money when his or her investments increase in value, through dividends or through interest payments. When you buy an item or a stock for $20 and a few years later it’s worth $60, then the item or stock has appreciated in value. 

You can also earn money through interest payments when you’re a lender. When someone has taken out a loan or mortgage, they will have to pay back that loan, and most likely interest, through monthly or annual payments. You can also buy a bond. That’s is a loan to the government or corporate company, who pay back the loan and interest on the amount you lent them.

A third way to make money through investments is dividends. If you own stocks in a company, that company can issue dividends to you and other shareholders to share the profits that the company makes.  This would be an extra bonus if the stock is also increasing in value.

Why invest?

Investing is for the longer term. The good news is that over a long period of time, you make much more money with investing than leaving your money in a savings or checking account.

Here’s a simple example

Checking account: 0.5% annual interest
Savings account: 1% annual interest
Investment account: 6% annual index average

If you would stick $10,000 in each account, then after 20 years you would earn:

Checking account: $1,051
Savings account: $2,213
Investment account: $23,102

As you can see, the difference is more than $20,000! No matter how much money you have available, it’s always better to invest that amount than leaving it in a savings or checking account. Even if it’s just 10% of your monthly earnings, just start investing. And start as soon as you can.

TIP! Use the free, powerful financial planning tools from Personal Capital to take control of your financial life and get objective advice from their fiduciary financial advisors.

Why you should start investing early

If you’re thinking about retiring early, you should start investing early. The main reason for that is time and compound interest. Compound interest means returns earned on money that was previously earned as interest. It’s like a snowball effect, also known as exponential growth.

Here’s an example of why you should invest early:

Let’s look at the investments of two people. Both of them put in $100 and earn an interest of 10% a year.  Earning a 10% interest a year might be a bit ambitious but let’s use it to make the example easy to understand. 

This means after one year they would have made $110 ($100 deposit + $10 in interest). After the second year their investment would be worth $121 ($110 + $11 in interest), and so on for the following years. 

If person 1 started investing at the age of 20 and the other person at the age of 30, then by the age of 65 person 1 would make double the amount of money compared to person 2, thanks to the extra 10 years of compound interest.

Understanding investment risks

No investment is without risk. If you want to build wealth you will need to accept a significant amount of risk. You can build strategies to mitigate and minimize those risks, but it’s important to understand what the risks are.

Here’s an outline of the types of risks that investing brings.

Economic or market risks
Economic risks, sometimes also called market risks, are the influence of overall economic conditions of a country or the world, that can influence the value of your investment. This also applies to investments in stocks, companies, bonds, and some other investments. A market crash or pandemic like the coronavirus can have a big influence on the value of your investments. Don’t get caught with all your investments in one sector of the economy.

Inflation risk
Typically, people in the financial world calculate that inflation is 3 percent per year. If your annual return on investment is lower than the inflation rate, for example, 1 percent, than your loss would be 2 percent. Please note that inflation is different per country and can change from time to time.

Default risk
A default risk relates to the quality of the underlying investment. If you invested in stocks of a company and that company has to file for bankruptcy, then you face the risk of default as you won’t get the return you were promised. The same applies to bonds in pension funds.

TIP! M1 Finance is an excellent robo-advising service, a great way to start investing. They offer commission-free trades on 6,000 stocks & funds, free checking accounts and charge no investment management fees. You can invest, borrow and spend your money in one account. For UK readers, we recommend Wealthsimple as the leading robo advisor.

A step-by-step guide

Even if you’ve never invested a dime before, it’s easy to get started with these simple steps.

1. Invest what you can afford

Just like you must create a budget – you must create an investment plan.

First, ask yourself, do you know how much you have to invest? Have you stocked up your emergency fund? Any money you invest should be money you ‘don’t need.’ It should be money that if you lose, you can still pay your bills and your standard daily living costs.

Your emergency fund should have 3 – 6 months of expenses in it. If your emergency fund is stocked, then you can navigate some of your money to investments, potentially growing your savings even more.

2. Choosing the right plan

Next, figure out why you’re investing.

Is it to save for retirement or just to invest?

If you’re saving for retirement, you’ll want to open a retirement account. The most common are the IRA or Roth IRA. Both have tax advantages but in different ways.

A standard IRA provides you with a tax deduction during the year that you contribute up to a specific amount. In 2020, you may contribute up to $6,000, which means you can deduct $6,000 from your taxes. But you pay taxes on your earnings when you withdraw during retirement. Since most people are in a lower tax bracket when they retire, they save money.

A Roth IRA doesn’t offer a tax deduction now, but your earnings grow tax-free. When you withdraw the funds during retirement, you don’t owe taxes since you already paid taxes when you contributed the funds.

If you’re investing to reach a shorter-term goal, choose a standard investment account. These accounts don’t have tax benefits, but also don’t charge penalties if you withdraw funds before retirement. You are free to withdraw your earnings at any time.

3. Think long-term

As we’ve explained above, investing at a personal level is for the longer term. Sudden price movements, up or down, can happen but will even out in the longer term. Be patient and think longer term. It’s better to think about it as an investment so you can potentially retire early.

4. Diversify, diversify, diversify…

Limit your risks by investing in different things. This is also known as diversifying your investment portfolio. If one investment has failed for whatever reason, you won’t be shut down if you have a portfolio with different types of investments.

Your retirement accounts, your home and your investment accounts, stocks, or bonds you might own… are all different types of investments. A savings or checking account or debt you might have, all those are not investments. They’re short-term assets. They won’t build long-term wealth and aren’t part of a diversified portfolio.

TIP! DiversyFund makes it easy to buy shares in a portfolio of fully vetted, multifamily real estate — a low-risk type of real estate. You can own a piece of the SEC-qualified Real Estate Investment Trust (REIT) they manage. Historic returns vary from 11% to 18%.

5. Choose your platform

There are many different ways to invest. Do you want help or are you a DIY investor? Also, think about what you want to or can afford to pay as that will play a role.

  • Online discount broker – Sites like E*TRADE and TD Ameritrade offer low commissions and simple platforms many can manage on their own. They do offer quality customer service options if you need help too.
  • Standard broker – If you’re not the DIY type and need some hand-holding, a standard broker can help you through the process. You’ll pay higher commissions, but get assistance and advice when making trades.
  • Robo-advisors – If you prefer a completely hands-off approach to investing, robo-advisors offer the best of both worlds. You’ll pay low commissions and have automated investing. Once you determine your risk tolerance, the robo-advisor does the rest, handling your investments for you and even rebalancing your portfolio as necessary. M1 Finance is the leading robo-advisor in the US and Wealthsimple is an excellent option for UK readers.

6. Choose your investments

Once you choose a plan, it’s time to choose your investments. This is the fun (and scary) step. The key is to diversify your investments. In other words, don’t put all of your eggs in one basket. If you invest in stocks, for example, invest in a variety of stocks in different industries, but also include investments in other more stable investments, such as bonds, CDS, or mutual funds.

  • Stocks – You buy shares of a company or ownership in the company. You exchange the shares on the stock market, such as the New York Stock Exchange, through a broker or online broker. The goal is to buy low and sell high, but of course, it doesn’t always work out that way.
  • Mutual funds – This mixture of funds is like a professionally compiled mixture of stocks and bonds. Mutual funds carry less risk than individual stocks since they are diversified and most follow a specific index, such as the S&P 500.
  • ETFs – Exchange-traded funds are like mutual funds, but they trade on the stock market. ETFs are great investments for first-timers since they have low minimum investment requirements and yet provide ample diversification.
  • Bonds – With the lowest risk out of any other investment, bonds also have the lowest yield. They are a great investment to include in your portfolio to diversify your risk, but don’t rely on them solely for a return or you may be disappointed.

7. Choose the right broker

Each investment account has different requirements. As you shop for the right platform or broker, think about how much you have to invest.

Ask yourself how much you can open an account with as many have opening balance requirements. Narrow your choices down to the brokers that you can afford. Next, determine what investments they offer, as not each broker trades every investment.

For example, if you have your heart set on trading ETFs for their diversification and low price points, you’ll need a broker that offers a wide selection. This allows you to choose the ETFs that you want to invest in and that aligns with your beliefs.

Also, know the account balance minimums. Some brokers charge service fees if your balance falls below their threshold. Other brokers have minimum balances you must meet before you can invest.

If you’re ready to start investing, do your research. Know what you can handle and what you want out of your investments. Then compare your options. Today there are hundreds of discount brokers available online, but that doesn’t mean they are all created equal.

Know your risk tolerance, how much help you want, and what you’re willing to pay in commissions. Beginners often do well with robo-advisors and online discount brokers, but even within these options, you have a myriad of choices. As mentioned above, we recommend M1 Finance for beginning US-based investors and Wealthsimple for UK-based beginners.

8. Only buy what you can understand

Warren Buffett, one of the world’s most famous and successful investors, once said: “Never invest in a business you cannot understand.” Never invest in very complex things that you can’t understand. Also, only invest in things you believe in. Don’t listen to anyone else, just invest in what you personally believe in.

9. Keep learning

If you don’t fully understand an industry or market, start doing some research about it. What makes an industry profitable, who are the big players in that industry, what economic/political influence is there on that industry, etc. The internet is full of useful background articles about every industry. Always keep learning, but only invest in things you understand and believe in.

10. Automate your investments

Let’s face it, you have a day job, a family, etc. You’re busy and you’re not a full-time trader on the stok exchange. Automate your investments and leave it so you can focus on your daily routine. Robo-advisors can help with automation.

11. Grow your monthly investments if you can

Contribute to your monthly investments if you can. As explained above, the more you invest, the higher the returns over a longer period of time. Invest the money you don’t need and see if you can increase that even a little bit every month or quarter.

TIP! Join 7 million other people and invest your spare change automatically with Acorns. You can sign up for just $1 or $3 per month. You can also earn bonus investments when you shop with 350+ top brands.

We explain how you can make money, save money and grow money.

Make money: learn how to build wealth and how to earn money from the internet.

Save money: learn how to save money and how to make budget plans.

Grow money: learn how to invest and trade.

Please note that under no circumstances should any information from this blog be used as replacement for professional financial advice.

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