Investing isn’t just for the uber-wealthy and Wall Street suits. In fact, investing in the stock market is one of the most common ways average Americans become millionaires.
Learning how to invest for the for the first time can feel intimidating, but it’s not nearly as scary as you might think. Here I’m going to show you the best ways to start investing and point out a few things that you should consider learning next.
Am I ready to start investing?
Before you start investing, it’s important to have the rest of your financial house in order. You should:
- Be comfortable with your budget – how much you earn, spend and save each month.
- Be in control of your debt – free of high-interest credit card balances and working a plan to pay off student loans and other liabilities.
- Have clear goals defining what you want your money to allow you to do in the future.
You don’t have to wait until you are debt-free to start investing (in fact, you shouldn’t wait this long!) But if you have any doubt about whether you’re ready to start investing, refer to my article on the 7 steps to financial stability before returning to this guide.
Why you should invest
Investing is essential if you want your savings to grow over time. Although keeping money in a savings account appears safe, the interest you’ll earn isn’t enough to keep up with inflation over many decades.
While riskier in the short-term, over the long-term the stock market delivers compound returns that not only keep up with inflation, but outpace it. If you take a minute to learn how compound growth works, you will quickly understand why you simply must start investing today.
Say you got a small inheritance and you decided to invest it—if you put $5,000 in an account with an interest rate of 7% and contribute an extra $200 a month, after 30 years you’ll have a little over $284,000.
Where to invest – the best ways to invest money
Personal finance is personal. The best way to invest money for you is going be different than the best way to invest money for me.
Some things, however, are universal. Everybody should invest money for retirement that you won’t touch for many decades. It can be difficult to feel the need to plan for retirement when you’re in your 20s or 30s. But we need to take care of our future self and squirreling away enough to live a comfortable retirement is no easy task. The sooner you start investing, the easier it will be.
Investing for retirement at work
The easiest (and, arguably, best) way to start investing is to enroll in your employer’s 401(k) or similar retirement saving plan, if they offer one.
You specify how much money to invest, and your employer deducts the amount directly from your paycheck. There are tax benefits to these accounts and, sometimes, your employer may match a percentage of your investments.
You will have the opportunity to specify how you want this money invested, which I’ll cover in a later section.
Be aware that money you invest in a 401(k) or similar retirement account is not supposed to be withdrawn until you retire (after age 59 ½). Withdrawing money earlier may require paying income tax and a 10% early withdrawal penalty.
Investing for retirement on your own
If you do not work at an employer that offers a retirement plan, you can still take advantage of retirement tax incentives by investing in an individual retirement arrangement (IRA) account.
Like 401(k)s, IRAs allow your investments to grow tax-free but funds cannot be withdrawn without penalty before age 59 ½. You can open an IRA at any stock brokerage, roboadvisor, or mutual fund company. Most investors can invest up to $6,000 in an IRA in 2021 (up to $7,000 if you’re over 50), but IRA eligibility phases out for taxpayers with high incomes.
If you’re thinking about opening an IRA, your next step should be to learn about the tax difference between traditional IRAs and Roth IRAs.
Investing for short-term goals
Everybody should invest for retirement, but you will likely have some short-term financial goals, too.
In general, don’t invest money you want to use for a goal that’s less than 5 years away. All investing involves risk. The stock market goes up and down like a roller coaster – sometimes violently – but smooths out over time. The longer you stay invested, the better your probability of strong returns.
Keep money you want to use within the next few years in a high interest savings account like Chime (Chime’s APY is 0.50% where there’s no minimum balance required and no monthly fees). Compared to what your money can earn investing, savings accounts do not earn much interest. But – importantly – money you put into a savings account is insured by the government and cannot lose value.
Chime Disclosure – Chime is a financial technology company, not a bank. Banking services provided by, and debit card issued by, The Bancorp Bank or Stride Bank, N.A.; Members FDIC.
Investing for long-term goals (besides retirement)
Let’s say you have some non-retirement goals that are more than 5 years away. Should invest the money you’re saving for them?
Yes!
Over time, the cost of everything slowly goes up. Just ten years from now, one dollar will buy you less than it does today. In 20 years, one dollar will buy you a lot less. This is inflation, and it’s almost as guaranteed as death and taxes.
The interest rates banks pay on savings accounts are almost always much lower than the average inflation rate. As I’m writing this, most banks pay 0.5% interest or less while inflation is running at 2 or 3%. This means that – in terms of real value – money sitting in a savings account is losing somewhere between 1.5% and 2.5% a year!
In order to build wealth, you need your savings to grow at a rate that not only keeps pace with inflation but beats it. In the long run, a well-diversified stock portfolio should provide average annual returns between 5 and 8% (more if you’re lucky). There will be years when stock gains are much higher and years when stocks lose money and deliver a negative return. But if you assume a 7% average annual return and a 2.5% average inflation rate, the real value of your money will grow by 4.5% per year.
What do we mean by ‘portfolio’?
- In the investing world, a portfolio is any collection of stocks, bonds and other investments. Whether or not you hold these investments in the same place, your portfolio refers to all of the investments you own.
- To invest for long-term goals, you can create an account at a stockbroker like Robinhood or E*TRADE or a robo-advisor like M1 Finance or Betterment. Rather than buy shares of individual stocks, it’s best to invest in a diversified portfolio containing hundreds of stocks and bonds. A robo-advisor account will do this for you. At a brokerage, you will want to purchase special exchange-traded funds (ETFs) called index funds that track either entire markets or large sectors of the market in one investment.
What about mutual funds?
Mutual funds are similar to ETFs; both package dozens or hundreds of individual securities into one investment. Mutual funds differ from ETFs in how they are priced and sold. ETFs work like individual stocks. When the market is open, their prices change in real time and you can trade them as often as you want. Mutual funds are priced just once a day and there may be limits on how frequently you can trade them. Sophisticated investors will have reasons for preferring one over the other but, in general, ETFs are easier to trade for new investors.
How do I invest in bonds?
Buying individual bonds is an advanced investing strategy. You can add bonds to your portfolio with a bond index fund (either an ETF or mutual fund). If you invest in a robo-advisor or diversified fund, that will include bond exposure according to the product’s goals and risk profile.
Investing for fun
What if you want to make a bet on the stock of a company you love? Or try to ride the latest /r/wallstreetbets meme stock to the moon?
Over the last few years, stockbrokers have eliminated trading fees and made it easy to buy fractional shares of stock. In the past, if a stock cost $500 per share you would need to have $500 in order to buy one share. You might also be charged a commission of $5 each time you bought or sold stock.
Today, you can invest as little as a few dollars in any stock without paying a commission. If you have $50, you can buy one-tenth of a share of that $500 stock.
Research shows that the very best way to invest is to buy index funds and hold onto them for decades. This strategy beats even the smartest Wall Street traders nearly every time. It’s also painfully boring.
This is how I suggest you invest most of your money. But it’s fine to set aside 5 or 10% of your money to “play” with by making more frequent trades. I do it myself. It allows you to have fun and learn by making more frequent trades without jeopardizing your wealth. The beauty of diversification is that you can benefit from any stocks that do well, but a few losing stocks won’t bankrupt you. If you pick your own stocks and pick wrong, it’s quite possible to lose most of your hard-earned money.
Choosing an investing account
To start investing on your own (outside of a work-based retirement account), you should decide whether you want to buy index funds and hold them for years, trade individual stocks frequently, or do both.
Some investment platforms allow you to do both. Others are best suited to one or the other.
Robo-advisors
If you want to keep things as simple as possible, look at a robo-advisor. Robo-advisors use technology to invest your money in a broadly diversified portfolio of stocks and bonds that’s tailored to your goals and risk tolerance. Opening an account is as simple as answering a 10-question quiz.
Unlike financial advisors, robo-advisors are inexpensive and don’t have minimum balance requirements.
The downside is that you’re limited to a handful of investment strategies. With most robo-advisors, you can’t customize your portfolio beyond their recommended portfolios. You also cannot purchase individual stocks.
| How much do I have to invest? | Where should I invest? |
|---|---|
| Beginner: I have less than $500 to invest | Betterment |
| Intermediate: I have more than $500 to invest | Wealthfront |
| Advanced Intermediate: I have more than $1,000 to invest | M1 Finance |
| Advanced: I have more than $3,000 to invest | Vanguard Digital Advisor |
Stock brokerages
If a robo-advisor is like a restaurant that serves a menu of prepared meals, brokerages are like investment supermarkets; you can buy anything you want, but you must know how to cook. When you want to buy a lot of different stocks or you’re looking for a specific investment, this is a good thing. If you don’t know what you’re looking for – or you can’t cook — it can be overwhelming.
With a stock brokerage, you can design your own buy-and-hold portfolio with a few exchange-traded funds. Of course, you can also trade individual stocks as often as you want.
MU30 Tip
Brokerages vs robo-advisors for buy-and-hold investing
If you want to be a straightforward buy-and-hold investor, why choose a brokerage?
Two reasons: Customization and cost.
- If you feel comfortable choosing index funds, you can build a portfolio that’s more customized to your goals than you can buy at a robo-advisor.
- Doing this will cost you less. Investment funds (ETFs and mutual funds) charge annual fees as a percentage of how much you invest. Good index funds cost very little – as little as a few hundredths of a percent (for example 0.05% would cost $50 per $10,000 invested). But robo-advisors charge slightly higher annual fees on top of the fund fees. For example, a robo-advisor might charge 0.15%, or $150 per $10,000 invested, in addition to the fees charged by underlying funds. Buying funds directly with a stock brokerage can avoid this additional cost.
There are dozens of stock brokerages to choose from, including some apps that are possibly best-suited for frequent trading. Unless you’re a power user looking for specific features to help you with advanced trading strategies, it’s hard to go wrong. We’ve also compiled this list of brokerages to consider (including links to our editors’ reviews).
| Brokerage | Highlights |
|---|---|
| Public | Fractional share investing No commission fees or account minimums Learning community of other investors |
| Robinhood | Commission-free investing Free first stock with sign-up No minimum account balance Fractional share investing |
| TD Ameritrade | Commission-free online trading No minimum investments Active trading platform |
Real estate investing
Real estate can be a great investment, too. To be clear, you shouldn’t consider your primary residence an investment. Real estate investments refer to apartments or commercial buildings that you own and then lease. Although most real estate appreciates over years and decades, the power of real estate investing lies in the cash flow from tenants.
If you can charge more rent than you pay in mortgage, taxes and maintenance, owning real estate can create income you can put in your pocket or reinvest.
Learning how to invest in real estate is a much larger topic that we can cover here, but there are ways to get started quickly on a modest budget. Fundrise and Roofstock are two real estate investment platforms that crowdsource investment opportunities. You can invest as little as $5,000 alongside other investors and share in the profits coming from large, multi-unit apartments or office buildings.
These investments are not without risk, and the companies’ fees eat into returns. But they may be attractive if you want to add real estate exposure to your portfolio without taking on the work and expense of buying and managing properties yourself.
DIY investing vs working with a financial advisor
For most new investors, a do-it-yourself approach is best. Hiring a financial advisor is a significant expense. Also, many advisors only want to work with clients who have 6- or even 7-figure amounts to invest.
On the other hand, if you have a significant amount of money and are anxious about how to manage it, there’s no substitute for a professional. A good advisor will take the time to understand your needs and help you design and execute a tailored investment plan.
How do you find a great financial advisor? One way is with a company like Paladin that matches you with qualified financial advisors based upon your needs and location. Another place to look for an advisor is through Facet Wealth. They’re an online financial planning firm that offers financial help for anywhere between $1,200-$6,000 each year.
Finding an advisor is an important decision but can be easier when you know the right questions to ask.
Where to learn more
Take learning how to invest one step at a time. Investing information overload is a real risk; you want to avoid “analysis paralysis”.
Finally, if you’re already socking a lot of money away toward retirement every month, choose an online self-directed brokerage account to make some fun trades or learn to invest in the stock market your own way.
