How to Start Investing
Investing and saving both involve setting money aside for later, but there’s a key benefit to the former: In an investment account, your money is working to unlock valuable gains available in the market.
Buying a rental property is a tangible form of investing because you can collect rent. However, it can also require a substantial initial investment, research, and time. Often, the easiest and best way to start investing is to buy stocks and bonds.
Learn About Stocks and Bonds—Two Common Types of Investments
Stocks and bonds can seem like abstract concepts if you’re new to investing. But these common types of investments are relatively simple to understand once you get beyond the jargon.
Stocks Represent Ownership of a Company
A public company (meaning, a company that you can buy stock in) is owned by its shareholders. When you buy a company’s stock, also known as a share, you’re investing in the company and technically become a partial owner.
Owning a few shares doesn’t mean you get to control what the company does or who it hires. However, you can receive a portion of the company’s earnings, which it can pay out as dividends. Additionally, if the company’s overall value increases, perhaps because it released a new product that’s selling well, the value of your shares also increases.
You can earn returns on your investment from the dividends, and by selling your shares for a profit after they increase in value.
Bonds Are a Type of Loan
Governments and companies can borrow money by selling bonds. Similar to how you can take out a student loan and then repay the loan plus interest. A city might borrow money to build a new school, and then repay the loan plus interest. In these cases, the loan is called a bond, and the interest payments are called coupon payments.
When you buy a bond, you’ll know the interest rate and maturity date. The rate determines how much you’ll receive in coupon payments. And when the bond matures, you’ll receive the amount of money you lent (i.e., how much you bought the bond for) back from the company or government.
Mutual Funds and Exchange-Traded Funds Can Help Limit Risk
All types of investments involve risk. Think of large companies that were once successful and then went bankrupt. If you bought the company’s stock, you could lose money as your company’s value decreases. Or, perhaps you lent the company money, but it’s not able to repay the bond.
One way to limit your risk is to buy a mixture of different stocks and bonds rather than investing in a single company or loan. You can do this by buying mutual funds and exchange-traded funds (ETFs).
There are many funds available, including funds that try to replicate the value of every public company and funds that focus on a particular type of company or industry. Your overall investment could still go up or down depending on what’s in the fund, but you won’t be putting all your eggs in one basket.
Open an Investment Account
Before you can start investing, you’ll need to move your money into a type of investment account. Often, these are retirement accounts, as many people invest their money to help fund their retirement. However, if you want to save money for big purchases that you’ll make before retirement age, like buying a home or a child’s college fund, here are a few types of accounts you can use:
- Brokerage accounts: Many companies, including large banks, offer brokerage accounts. Once your money is in a brokerage account, you can use it to buy stocks, bonds, mutual funds, ETFs, and other investments.
- Individual retirement accounts: An individual retirement account (IRA) is a type of tax-advantaged retirement investment account. You may be able to save money on taxes by investing through an IRA. However, there could also be penalties if you want to withdraw the money before you retire.
- Employer-sponsored retirement accounts: Many companies offer retirement plans, such as a 401(k) or 403(b) plan, to their employees as a benefit. These accounts offer similar tax benefits (and drawbacks) to an IRA.
When you’re deciding how to start investing money for retirement, an employer-sponsored account is often the best option—if your company offers a match. This means that the company will match a portion of your contributions and send extra money to your account, immediately increasing your balance.
However, an IRA could be a better option if your employer doesn’t offer a match because some have lower fees than employer-sponsored accounts. Or, if you don’t have access to a tax-advantaged account from work, an IRA may be the best retirement-focused account.
There are limits to how much you can add to each tax-advantaged account every year. When you reach the limit, or if you want to invest for non-retirement goals, look for a brokerage account with low fees. There are even options that have $0 minimum account balances and let you buy and sell investments for free.
Choose Your Investments
Getting money into an investment account is step one. Then you’ll need to decide how to begin investing the money.
With an IRA or employer-sponsored account, you might be able to pick a few funds when you first open the account. (Don’t worry, you can make changes later.) With a brokerage account, you might have to open the account, transfer your money, and then choose your investments.
Many people get stuck at this stage, as you can quickly become overwhelmed by the options. There are thousands of stocks, bonds, mutual funds, and ETFs to choose from, and it’s hard to know what’s best for your situation. Even if you only have a dozen options with your employer-sponsored accounts, you might not know which to choose.
Here are a few things to remember:
- Risk often correlates with investment returns. The greater your risk of losing money, the greater the potential gain from your investment.
- Stocks tend to be riskier than bonds, and individual investments tend to be riskier than funds.
- Diversifying your investments by buying a mixture of stocks and bonds can help increase your returns while minimizing risks.
- If you need the money in the next few years, focus on low-risk investments. However, if you’re investing for a long-term goal, a risky investment might offer a bigger return overall.
You can learn more about managing risk and investing money for beginners if you want to become a hands-on investor. Your employer might be able to arrange a meeting with a financial advisor, and there’s a wealth of free information and classes online.
However, these fundamentals are also important if you’d prefer to put your investments on autopilot.
Simplicity Beats Being Overwhelmed
Getting started is important, even if you don’t find the “perfect” investment. If you’re feeling stuck, the best way to start investing may be to choose a target-date fund.
You can find these target-date funds from a variety of investment companies, and they’re often options within tax-advantaged accounts. The funds have years associated with them, which is the year you hope to retire.
Target-date funds consider your timeline and contain a mixture of stocks in bonds that can limit your risk while increasing your long-run returns. Over time, the funds will automatically sell stocks and buy bonds to further decrease your risk as you near the target year.
If retirement isn’t your goal, you can still start investing with a target-date fund by choosing a fund with a year that aligns with your goal. Also, look into robo-advisors, which offer tax-advantaged and regular brokerage accounts and can automatically manage your investments based on your goals and timeline.