For anyone looking to take their net worth to new heights, investing is the way to go. When a person purchases shares of a company or fund, they become a partial owner of that business venture and are entitled to a portion of the earnings. Eventually, those earnings could become so great that they may even replace the investor’s employment income and help them to achieve financial independence.
However, investing can also be intimidating, especially for someone new to the game. Because the stock market is free to fluctuate in value, it's impossible for anyone to accurately predict what it will do next. There’s a great quote from the legendary founder of the investment company Vanguard Jack Bogle where he once said, “In 65 years in the business, I not only have never met anybody that knew how to do it, I’ve never met anybody who had met anybody that knew how to do it.”
So if the pros don’t know which investments are going to be the “winners”, then how is anyone else supposed to do it and make money? Fortunately, after investing for over two decades, I can say that anyone who follows a few simple principles is going to do alright over the long term.
The best way to start investing for beginners is to define what they want to accomplish and then layout a path for how they will get there. There are many ways to do this, and knowing in advance what risks, costs, and opportunities will be involved can help make the process as painless as possible.
In this post, we’ll explore everything a beginner needs to know about the world of investing. We’ll also go through the steps needed to open an account and start building a portfolio.
Investing for Beginners – The Principles for Success
If you’re new to investing or unsure about how to get started, there are a few key principles that you’ll first want to understand.
1. Investing is How You Grow Your Money
Despite what some people may think, investing is not the same as gambling. When someone invests in something, they are committing money or capital to a venture in hopes of earning a profit. The goal of every legitimate business in the world is to earn money and grow, and so investors can confidently assume that everyone involved has a vested interest in being successful.
Given enough time, investing can lead to the exponential growth of a portfolio through what is known as the compound interest effect. The compound interest effect is when money grows on top of the previous year’s earnings (through dividends, interest, and increasing share price). The result is like a snowball that grows larger the longer the cycle continues.To put this into perspective, consider that the stock market S&P 500 has returned an average annualized rate of 10.67 percent from 1957 through 2021. At that rate, someone who had invested $500 per month for 30 years ($180,000 in total) would have seen their nest egg grow to a value of $1,121,059. That’s almost $1 million more than what they personally contributed!
2. Investing is How You Beat Inflation
Everyone knows that as time goes on, the price of just about everything increases. But what some people aren’t aware of is the negative impact this can have on their money.
Essentially, inflation is the loss of consumer purchasing power. To say this another way, $100 today won’t buy you the same amount of goods that it could ten or even twenty years ago.
Over the past 50 years, the average annual rate of inflation is 3.81 percent. Comparing this to the S&P 500 which has returned 10.67 percent, the stock market is effectively growing investor money at a “real rate” of 6.86 percent. Since bank accounts barely pay any interest, the only real way for the average person to make sure that their life savings don’t become eroded by inflation is to invest in assets that grow above the rate of inflation.
3. Slow and Steady Wins the Race
Despite how the media portrays the latest millionaire who got rich by day trading or rolling the dice on the latest meme stock, that’s not investing. When someone puts their money into something without any reason or logic behind why they think it will grow, that’s called “speculation”. Shark Tank host and O’Shares ETFs Chairman Kevin O’Leary has even commented on this topic saying, “Day trading is not investing. Day trading is gambling.”
By a long shot, more millionaires are successfully created every day by the actions they took decades earlier. As we demonstrated with the compound interest effect, it doesn’t take much for a person’s capital to grow and multiply several times over. But one thing it does need is time and a whole lot of patience.
4. Investments are Never Guaranteed to Make Money
It’s incredibly easy for a person to convince themselves that just because the stock market has a positive return over the long term this will always happen year after year. However, the ride isn’t always so smooth.
Frequently when investing, the markets will go through what’s known as a “correction” which is when the price drops 10 percent or more from its peak. Between 1980 and 2018, the U.S. stock market has experienced 37 corrections. While only a handful of these corrections resulted in major recessions, the decrease in value could be problematic if the investor is living off of their investment portfolio (such as someone who is retired).
Even though the goal of investing is to make money, it must always be remembered that earnings are never guaranteed. There is no FDIC insurance like a bank account. Every investor needs to be prepared for the possibility that some of their investments may lose money or, on rare occasions, become completely worthless (like Enron back in 2001).
5. The Earlier You Start Investing, the Better
Anyone who wants to put the compound interest effect to work has to do just one simple thing: Start investing as soon as possible! The more time an investor gives their portfolio to multiply, the higher the chances for success.
Additionally, getting involved as soon as possible helps investors to gain experience. Like anything, they will make mistakes and wish they had done things differently now and again. But with each stumble, they’ll gain more confidence and become better at making their money grow!
Choosing the Right Investment
With so many different types of assets and financial products out there, how does someone know what to invest in?
Factors to Consider as You Begin Investing
The first thing any investor (experienced or novice )should do is to consider the following:
- Your Goals – Are you looking to build stability for later in life (such as when you’re retired) or make as much money in the short term as possible?
- Time Horizon – How long do you plan on investing: 30 years? 10 years? 1 year?
- Risk Tolerance – Would you lose sleep at night if the market crashed and your portfolio dropped by 25 percent over the next year?
- Diversification – What is the right mixture of stocks, bonds, and other assets to ensure that your earnings goals and risk are optimized?
What Are My Investment Options?
The following are some of the most common types of assets that new investors purchase:
- Stocks – A share of ownership in a company. As the company does well, the price of its shares goes up and can be sold for a profit. Some stocks also pay their shareholders dividends, a cut of the profits that it's generated.
- Bonds – An instrument of debt. Bonds are issued by governments and companies to raise needed capital. In return, they agree to pay back the bondholder the principal plus interest.
- Mutual Funds – A pooled collection of stocks and bonds over many investors. Mutual funds are an easy way for investors to diversify over hundreds or even thousands of different securities with less risk and steady returns.
- Exchange-Traded Funds (ETFs) – ETFs are similar to mutual funds but traded in the open market like stocks. ETFs have become an extremely popular choice for new investors thanks to their low cost and ease of usage.
- Real Estate Investment Trust (REITs) – A company that invests in large-scale real estate projects using pooled money from many investors. REITs pay at least 90 percent of their profits to shareholders through dividends.
Investment Commissions and Fees
Another factor to consider when investing is how much it will cost. Here are some terms to become familiar with:
- Commissions – A fee that’s paid each time a stock or ETF is traded. Thanks to recent competition, many brokers now offer commission-free trading.
- Load – A fee that’s paid when buying a mutual fund. If someone picks a “no-load” mutual fund company like Vanguard or Fidelity, then they can buy mutual funds without paying anything in advance.
- Expense Ratio – This is an administrative fee charged by mutual funds and ETFs. For example, an expense ratio of 0.25 percent means the fund charges $25 every $10,000 invested to cover its operational costs. Investors should always look for funds that have the lowest, most competitive expense ratios.
The Simplest Way to Invest – The Index Fund
For anyone who may be confused or unsure of what their first investment should be, there’s an easy solution: Buy an index fund.
Index funds, particularly those which follow the S&P 500 stock market, have gained a lot of notoriety over the past few decades for their performance, low cost, and simplicity. Basically, an index fund is just an investment that mirrors a major market index. It’s a convenient way for an investor to capture the return of the entire market in just one purchase.History has demonstrated that 80 percent of fund managers failed to beat their respective market index. In fact, Warren Buffet made a bet (for charity) against a hedge fund company in 2007 that they couldn’t outperform an index fund, and ten years later he was right! This just goes to show that despite all the complicated strategies and tactics that go into hedge funds, a simple index fund is still the better option.
The Best Investment Platform for Beginners
For anyone just getting started, here’s where they can make their investment.
Online Brokers and Trading Apps
Long gone are the days when a person has to physically meet face to face with an investment advisor at a local branch or call their broker on the phone. Trading has gone digital, and most people now invest using online brokers and trading apps such as:
The reason these types of platforms have become so popular is that they’ve made investing incredibly simple. Many have low fees, no account minimums, and the opportunity to invest with almost no money. Some even offer educational materials to help their users become more knowledgeable.
Some digital brokers have completely cut humans out of the process entirely. These so-called “robo-advisors” are a relatively new breed of investment platform where users can answer a few questions about their goals and tolerance for risk, and a computer algorithm will make recommendations about what to buy. Companies like Betterment, SoFi, and Wealthfront are all considered robo-advisors.
Most charge an administrative fee of 0.25 to 0.50 percent of the investor’s account balance per year. Just like online brokers and trading apps, there are often no account minimums and users can invest with very little money.
Another smart place for a beginner to start investing is by using a retirement account. Retirement accounts are tax-advantaged making them ideal for long-term investing.
Here are two popular types of retirement accounts to consider:
- 401k – A 401k or any workplace retirement plan (such as a 403b or 457) allows you to automatically contribute a portion of their paycheck to the plan tax-deferred. Contributions can be invested in funds from a list of pre-approved options.
- Roth IRA – This is another type of retirement plan that savers can open themselves with nearly any broker. The account owner is free to invest in anything offered by the broker, and all contributions plus future earnings will be available to withdraw tax and penalty-free after age 59-1/2.
How to Start Investing as a Beginner
Now that we know the principles of investing, what to invest in, and where to look, here’s how a beginner can start investing today.
1. Define What You’d Like to Accomplish
Investing should start with the end in mind. If the goal is to build long-term wealth for retirement, then a retirement account with good long-term prospects will be the way to go. But if someone would rather dabble in the markets, then maybe a trading app be better suited.
2. Determine How Much You’d Like to Invest
Thinking about your goals, how much will you need to invest to get to where you want to be. For instance, if you want to retire with $1 million, how much would you need to contribute with each paycheck, and what investment options will provide the optimal rate of return to get you there?
3. Find a Reputable Investment Platform
When a person opens a brokerage account, they’re putting their life savings and personal information in the hands of complete strangers. So common sense says you shouldn’t trust just any provider!
Users need to do their due diligence and research which investment platforms are the best ones to use. Look at user reviews and find out which one’s other people are consistently ranking in the top 10 and why.
4. Open an Account
Once you’ve got your choices narrowed down, it's time to take some action. Open an account with the investment platform by creating a user profile and connecting your bank account. Don’t forget to also set up your beneficiaries.
5. Purchase Your Securities
After your bank account connects to your chosen investment platform, the last thing to do is start investing. Buy the stocks or funds that you wanted, and check in every couple of months to see how they’re performing. If they’re not doing what you expected or not keeping up with your other investment choices, then consider trading them for something different.
Every Investor Started as a Beginner
To a beginner, the world of investing can seem like a confusing and intimidating place. But it doesn't have to be. By following just a few simple principles, anyone, even novices, can make some incredible money by investing.
To choose the right investment, investors need to consider several factors such as their goals and tolerance for risk. They'll also want to think about which investment products best fit their needs. To keep it simple, I always recommend that beginners start with one of the best products you can own: an index fund.
Additionally, investors will want to choose a platform that helps them to meet their goals such as an online broker or retirement fund. For the person who wants to be completely hands-off, they can even go with a robo-advisor.
Investing is certainly not without risk. However, when done right, it’s also one of the easiest ways for a casual saver to become a millionaire over time. It all starts with that first investment, so don’t sit on the sidelines. Take some action and find out how different your life and finances can be.