Saving is the first step to building wealth, and putting your savings to work through investing is a good way to continuously grow that wealth. While stocks are usually the first thing people think about investing, you can also invest in real estate, baseball cards or just about anything else. This guide focuses on the basic financial instruments, including stocks, bonds, mutual funds, ETFs and CDs. Each of these come with different levels of risk and return, so which ones are right for you largely depends on your goals, time horizon and risk tolerance. A financial advisor can make recommendations for you, while also helping you build a financial plan for the future.
Investing for Beginners: Why Even Invest?
For most of us, simply placing our money in a savings account won’t make us rich. You’d have to earn a lot, and save most of it. Instead, we need our money to make money, which is one way of describing what investing is. When you invest, you tap into the power of compound interest. Here’s how it works:
- You invest $8,000 and your investments grow 6% annually
- Left where it is, it will grow $480 by next year for a total $8,480 in the account
- After another year passes with a 6% gain, your balance will jump $508.80 for a total $8,980.80
- The following year, the gain would be $538.85 for a total $9519.65
- And the year after that, the account would earn $571.18 for a total 10,090.83
As you can see, compounding can transform modest savings into a serious nest egg over time. The earlier you start investing, the more you stand to gain from the magic of compound interest.
For a simpler way of figuring out how your money could grow through investing, try the Rule of 72. This simple math equation can make it easy to figure out what your potential returns could look like. Rather than trying to understand the nuances of such a calculation, this time-tested shortcut could prove to be invaluable.
Types of Investments
Stocks or equities are shares of a company that you ideally buy low and sell higher. For example, when Facebook first went public in May 2012, you could buy shares for about $38 each. The company’s stock has skyrocketed since then, making it one of the most successful investments of this millennium.
Dividends are another way stocks can earn you money. Depending on the company, it will pay out a part of its earnings per share, often four times a year, according to a set schedule. But while Facebook does not pay dividends, other established companies like AT&T, Exxon Mobil and Coca-Cola do. These typically range up to $1 per share, which could lead to some quick and significant gains.
As much upside as stocks have, however, they also have considerable risk. For example, while Facebook opened around $38 per share, it fell to $18.05 three months after its initial public offering (IPO). This is fairly common in the stock market, as company’s can gain or lose value quite fast. On the other hand, the trade-off is potentially high returns.
Mutual Funds & ETFs
Mutual funds and exchange-traded funds (ETFs) are similar in that both are baskets of different stocks and/or bonds. Some focus on a certain sector (like large-cap companies), while others track certain indexes. Designed to offer diversification, they are less risky than individual stocks, since your money is spread across many different investments.
That said, mutual funds and ETFs have some differences. The biggest of these is how they trade. When you buy a mutual fund, you don’t actually know what price you are paying. This is because the price resets every night, based on the closing prices of the fund’s holdings. So if you sent $3,000 to open an account, you would be told how many shares it bought on your statement. If shares closed at, say, $76.23 per share, you would have 39.354 shares (assuming it’s a no-load fund.)
ETFs, on the other hand, trade like stocks, meaning you can see the price as they fluctuate throughout the day. In turn, you can set the price you’re willing to pay beforehand. There are no minimums for these securities, though your brokerage may charge a commission per trade. Many ETFs follow well-known indexes like the S&P 500 and the Dow Jones Industrial Average. Others track collections of stocks that concentrate on industries like healthcare, technology or agriculture.
Fixed-income securities include several different types of securities, such as U.S. Treasury bonds, corporate bonds, municipal bonds and CDs. It’s easiest to think of them as loans to the government, corporations, state agencies and banks, respectively. You agree to let them “borrow” your money for a set period of time, and they will pay you interest and your money back at the end of the period. Generally, the longer the period, the higher the interest rate. Though this isn’t always the case.
While the potential for growth is low, these investments are relatively safe. Of course, some corporate bonds are bigger risks than others. And actually, the riskier the corporation (because its finances are shaky), the higher the interest rate they’ll pay. Also, because bonds can be sold on a secondary market, their price can fall. This happens if rates suddenly jump up. (People want to unload their bonds so they can get the higher interest rate.) You won’t lose money on your bonds if you can hold them to maturity. But if you need or want to sell them, you may lose money.
Of all the fixed-income securities mentioned here, CDs are the safest. They are money deposited in banks that you agree not to touch for six months to six years. Since they are bank products, Federal Deposit Insurance Company (FDIC) insures them for up to $250,000. So no matter what happens to the bank, you will get your money back up to $250,000. If interest rates spike higher than what you’re earning, you can withdraw your money early for a penalty, which is typically three to six months of interest.
Exploring Investment Risks, Returns, Time Horizons & Strategies
Every investment strategy falls somewhere on the spectrum of low return/low risk to high return/high risk. The reason everyone doesn’t jump into the stock market is because, unfortunately, there aren’t many or any investments that are high return/low risk. So those who chase the highest returns invest most heavily in stocks.
On the other hand, if you are averse to risk or are unwilling to invest in equities, you might stick to ETFs, mutual funds or bonds. This conscious decision leaves you open to the possibility of lower returns than if you invest in mostly stocks.
One important principle to follow, no matter your financial goals, is diversification. When you diversify, you invest in multiple sectors of the market to protect yourself from sharp declines. This could involve buying both domestic and foreign securities and combining risky and safe investments in percentages that best align with your risk tolerance.
The decision between a high-risk, high-return investment strategy and its counterpart should depend, in part, on your investing time frame. Conventional wisdom states that the farther you are from retirement, the more risk you can afford to take.
That means you can have a stock-heavy portfolio in your 20s, when you can afford to chase returns. Then, even if your portfolio takes a hit during a recession when you’re in your 30s, you’ll have time to make up your losses before you retire. By the same logic, the closer you are to retirement, the more you want to focus on preserving your gains and avoiding too much risk.
If you hit 67 with lots of money in your portfolio, enough to last you 30 years even if there are ups and downs in the market, you can afford to make the shift to bonds. But some people make that shift too soon, missing out on the gains that they need to keep their investments growing and make it through retirement. With people living longer in retirement and therefore requiring more retirement income, experts are shying away from advising that anyone eliminate their equity exposure too soon.
Where to Start Investing
Most of us don’t have the time to research dozens of individual securities. There are a number of different routes you can take for access and help with investing.
The premier choice is typically brokerage firms. These services come with fees, which you should research to find the lowest. There are plenty of brokerages you can join forces with, such as:
|Brokerage Firm||Trading Fees||Minimum||Best For|
|TD Ameritrade |
|– Stocks: $0 (online) |
– ETFs: $0 (online)
– Bonds: $1
– Mutual funds: $0 load/$49.99 no-load
|$0||– Online traders |
– Investment veterans and newbies alike
|Merrill Edge |
|– Stocks: $0 (online) |
– ETFs: $0 (online)
– Bonds: $0 (online new issues)
– Mutual funds: $0 load/$19.95 no-load
|$0||– Bank of America account holders |
– Customer support users
|– Stocks: $0 |
– ETFs: $0
– Bonds: $1
– Mutual funds: $19.99
|$0||– Active and experienced traders|
If you’re uneasy about going into investing on your own, consulting a financial advisor may be a good idea. These individuals often have experience integrating your long-term financial plans into a portfolio. On top of this, they can help with plenty of other financial planning services, such as:
- Retirement planning
- Education fund planning
- Tax planning
- Estate planning
- Insurance planning
- Philanthropic gift planning
If you want to turn a modest salary into a comfortable retirement income, you’ll likely have to invest in some way. Many employees get investing opportunities through their employers via a 401(k). If this is you, it’s important to take advantage of the educational resources your company offers.
In general, do your homework before investing your hard-earned money. In addition, avoid plans and accounts that charge high fees. Contribute to your 401(k) early and often so you can start saving for retirement.
How to Start Investing
- If you want to learn about investing, the services of a financial advisor could be helpful. SmartAsset’s free financial advisor matching tool can match you with up to three advisors in your area in just five minutes. Get started now.
- A robo-advisor is a unique alternative to a financial advisor, as they can automatically manage your investments based on your investor profile. Robo-advisors typically have lower fees and account minimums, making them a good option for newbie investors with less to invest.
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