A Beginners Guide to Investing
May 29, 2020
If you’re like me, a twenty-something young professional who is attempting to decipher the mystery that is a 401(k), navigate the process of buying your first car or home, all while trying to build a semblance of a savings, you probably haven’t given the stock market much thought. You may have even said things like “It’s too complicated” or “I don’t have the time”.
Well folks, if this sounds like you, then keep reading. It doesn’t have to be that complicated and doesn’t have to take a lot of time. But what it can do is help you meet long term financial goals like retirement. So, forget your misconceptions that stocks only belong to grown-ups with fancy suits and read below for a beginner’s guide to investing.
The first thing to understand is that investing in the stock market and trading in the stock market can be two very different things. Investing in the stock market is characterized by:
- seeking larger returns over an extended period (5 years to 3 decades or longer).
- Can be done passively (buy it and forget it)
- Using a diversified portfolio of stocks, mutual funds, and bonds making it less risky
If you have a 401(k) this is most likely what that retirement investment account is made up of.
Trading on the other hand does require much more time in the way of research and can take a considerable amount of money to diversify. Trading is characterized by:
- Taking advantage of the rising and falling market to “buy low, sell high”
- Seeking more frequent, but smaller profits by holding stocks for a short period of time
- Requires hands-on management
- Buying individual stocks that can lead to a riskier investment
Basically, if you’re a stock market rookie like me, stick to the safer, long term investment route. You can always try your hand at trading in the future.
Now that we know we are looking to make a long term investment in the stock market, we’ve come to the first step.
Step 1.) What kind of investor do you want to be?
- I am interested in choosing stocks and stock funds for myself.
- I know I want to invest in stocks, but I would like someone to manage the process for me.
Once you have identified what kind of investor you would like to be, move to Step 2.
Step 2.) Open the right account.
Based on the answer you gave to step 1, you will select one of two accounts. Those who prefer to practice more autonomy in their investments should select an online brokerage account. With this account you choose which assets (stocks, bonds, ETFs) to invest in. Those who would like someone (or something) else to manage the account should use a robo-advisor account. Robo-advisors act like investment managers. They pick investments for your portfolio using algorithms based on your risk profile and goals. With a robo-advisor account there is generally a fee of .25% per year of your account balance.
Quick note here: If you do prefer the robo-advisor account then the information below isn’t really needed because you won’t be selecting which stocks, funds, or bonds to invest in. However, if you are up for going at it yourself, keep reading.
Step 3.) Determine what to buy
If you plan on managing your account, it is important to understand the difference between individual stocks and stock mutual funds or exchange-traded funds.
- Stock mutual funds and exchange-traded funds (ETF) allow you to purchase small pieces of many different stocks in one transaction creating instant diversification. These funds often track an index, like the famous S&P 500 Index*.
- Individual stocks can be purchased when you are wanting to invest in specific companies. Individual stocks can range in price from twenty dollars to thousands of dollars, so while diversifying a portfolio built out of individual stocks is possible, it can be quite costly.
The amount of money you have will also help answer this question. The smaller amount of money you have to invest, the more I would urge you to purchase ETF’s. You can buy these for a small amount of money and still maintain a diversified portfolio. Mutual funds are sold for a flat rate and often have a minimum of at least $1,000.
*This is a stock market index that measures the stock performance of 500 large companies listed on the stock exchanges in the U.S.
Step 4.) How much should I spend?
Remember this tip when investing in the stock market. The safer and longer term the investment, the more money you should contribute. If you are like me, a 20 to 30 something year old who is still a long way from retirement, you should be investing around 80% of your portfolio in stock funds like mutual funds and ETF’s. Bond usually earn less return, but they are also less volatile, making your investment in them less risky. Experts recommend investing 15-20% of your portfolio in bonds. The smallest investment of your portfolio should be individual stocks. These are the riskiest investments, especially when you are trying to save for something long-term, like retirement.
Step 5.) Be patient and watch your investment grow
If you’re looking for a second source (as you always should), I give you the wisdom of one of the greatest investors of all time, Warrren Buffet, who said, “ the most sensible equity investment for most people is a low-cost S&P 500 index fund” and “Only choose individual stocks if you believe in the company’s potential for long term growth." In essence, shoot for conservative reasonable growth and only buy riskier individual stocks if you’ve done your research. So get out there and start investing, in 30 years you’ll be glad you did!