If you’re wondering how to invest your money, you’re probably trying to decide on which stocks, mutual funds or exchange-traded funds (ETFs) to buy. Of course, you can invest in more than equities and pooled equities. There’s also gold, real estate, baseball cards, your neighbor’s nephew’s college roommate’s startup, etc. But online brokerage accounts and commission-free transactions are making investing in securities more accessible than ever before. Read on for a general discussion of why stocks are a good way to put your money to work and how to get started. We’ll also cover common investing wisdom. But for professional help, use SmartAsset’s free matching tool to find a financial advisor near you.
About half the country doesn’t invest their money in the capital markets. Many don’t have the cash for it. But a lot are simply uninformed – and intimidated. If you’re in the latter camp, you’ve come to the right place.
Investing lets you take advantage of the powerful effects of compound growth. Say you make $50,000 a year and you manage to save 10% of your salary in a jar every year for 30 years. Assuming your salary remains unchanged and you don’t have to dip into the jar, you’ll have $150,000.
But it could be more. If you took your 10% savings and invested them in the markets, you would have your accrued savings plus the money it earned. Stocks often pay dividends. Additionally, they generally appreciate over the long term, so that when you sell, you’ll realize a gain. This all means that $5,000 worth of stocks every year grows in value over time. Investing is putting your money to work for you, also known as making money from money. Sounds good, right?
How to Start Investing
Many people assume that you have to be rich to start investing. That’s not necessarily true. If you want to get started trading stocks, you may need as little as $100 (say, 10 shares at $10 each). To buy into a mutual fund or ETF, you’ll generally need around $1,000. If you’re just starting out, $1,000 could be a lot. But once you start investing, you could see that amount grow.
To invest money, you’ll need to go through some sort of middleman. That could be a no-frills website like E-Trade that charges nothing to buy and sell stocks or ETFs. Or it could be a big mutual fund company like Vanguard that embeds its management fees in the cost of its funds (and also offers brokerage services). Or, it could be a financial advisor who sits down with you for lengthy discussions about your financial goals and then makes investing decisions on your behalf, charging you for their services. You’ll have to choose one of these arrangements, because plunking down your cash on the floor of the New York Stock Exchange is not an option.
If you were paying attention during the last financial crisis, you’ll remember that markets can crash. Investment portfolios can go from soaring to underwater in a flash. The risk that stocks you own will decrease in value is known as “equity risk,” and the amount of equity risk you take on an as an investor is known as your “equity exposure.”
Another risk associated with investing is that the company whose stock or bond you buy could go out of business altogether, defaulting on its obligations. Both of these risks are relatively dramatic scenarios, but they happen.
There’s another form of investing risk that’s not so dramatic. It’s more insidious and less commonly understood. That’s the risk that your investments will underperform through lack of attention or lack of knowledge on your part. You might put all your 401(k) contributions in a money market account where they won’t grow enough to beat inflation. You might try to beat the market, throwing good money after bad in a series of risky trades. You might panic and sell off your stock when its value has plummeted in a downturn, only to have to re-invest when stock prices have risen. These mistakes are easy to make.
To help you on your road to investing success, we’ve compiled some of the investing wisdom that experts generally agree on. Some investing advice is evergreen for a reason.
Take the advice to “buy low and sell high.” It makes sense, doesn’t it? You want to pay a reasonable price for a stock and have its value increase over time. Then, you can sell it for more than you paid. Of course, if you follow the much-recommended buy-and-hold strategy, you won’t be involved in individual decisions about “selling high,” but the principle still stands. You don’t want to sell all your shares in a downturn or buy stocks that are already very expensive.
Another piece of advice you’ll hear a lot is to avoid high fees. Research shows that the actively managed funds that charge the highest fees tend to underperform passively managed index funds that merely aim to track the market. Some investment advisors steer their clients into higher-fee investments that offer lower returns – or risks that might make their clients uncomfortable. You don’t want this to happen to you. Every dollar you pay in fees is a dollar you can’t spend in retirement.
Speaking of retirement, conventional wisdom states that you should reduce your equity exposure as you get closer to your golden years. Say you’re 65, with 90% of your portfolio in stocks and 10% in bonds. If the bottom drops out of the stock market, the portfolio you were counting on to help you retire at age 67 will be seriously depleted. You’ll probably have to retire later and you may never recover the money you had. To prevent this kind of scenario, experts generally advise investors to adjust their asset allocation more toward fixed income securities as they approach retirement. That way, you’ll still have the growth potential of stocks to help your money grow throughout your retirement, but you won’t have extreme volatility.
Investing doesn’t have to be complicated. You don’t have to read obsessively about company fundamentals, check stock tickers or read 50 books about how to “beat the market.” Most people will be well served going with a risk-adjusted asset allocation of stocks and bonds that comes with low fees.
Photo credit: © iStock/RapidEye
Tips for Rookie Investors
- Test the waters with ETFs. There’s a very good reason for the huge popularity of ETFs, which are baskets of stocks that trade like stocks. They are less risky than individual stocks, plus they offer tax benefits.
- Don’t go at it alone. Hire a professional who’ll have the research and know-how to maximize the return of your investments while minimizing the risk. To find the right advisor for you, use SmartAsset’s pro matching tool. It will recommend up to three advisors in your area, based on your information.