New to Investing? Here’s What You Need to Know
If you are new to investing, you may find yourself hesitating to even get involved in it. That’s a natural response anytime we are confused about anything. But almost ironically, one of the biggest obstacles to investing is simply getting started. You don’t have to be a master investor at the start, but the only way that you will ever learn to be one is to start doing it.
You may take some bumps and bruises along the way, but eventually you’ll get the hang of it. The big rewards will come over time.
The Basics of Investing
Investing is mostly about increasing the value of your money over time. Where the basic goal of traditional savings is capital preservation, when it comes to investing you’re looking to grow your money so that it will have a bigger positive impact in the future.
There are two basic ways to benefit from investing, and each serves a different function:
• Creating passive income streams – With this strategy you’re focusing on buying investments that will provide a revenue stream. This can be in the form of interest and dividends. Most typically, you will be looking for securities that will pay above average rates of return.
• Growing your money – This is about investing your money in growth type assets, primarily equities (stocks) and often real estate. The basic idea is that you buy an investment today for $10, and 10 years from now it’s worth $100.
In an optimal investment strategy, you will be accomplishing both objectives to some degree. Though the conventional wisdom is that you should pursue growth when you’re in your twenties and thirties, then gradually shift to income as you move into your forties and fifties and are preparing for retirement.
Why You Should Invest
Investing is all about putting your money to work for you. Early in life, you need to work to earn money – which is to say that you will work for everything you get. But as you accumulate investment wealth, the income and growth from your portfolio should begin to gradually replace your income. By the time you reach retirement, your investment income should completely replace your earned income, enabling you to enjoy comfortable retirement.
But there are other reasons for investing beyond retirement.
• Inflation is one of the biggest reasons. Particularly for people in the middle class, wages typically do not keep pace with the rising cost of living. Investing money is one of the best ways to offset that imbalance. As your wealth grows, and you begin to rely increasingly on the income that it generates, the extra income enables you to better cope with rising prices.
• Preparing for contingencies is another important reason. A large investment portfolio is one of the best protections you can have against a job loss, a business failure, or even a medical catastrophe.
How to Invest
Though investing can seem somewhat exotic if you’ve never done it before, the process is very basic. For the most part, you are saving money, but you are doing so primarily for the purpose of growing it for future needs.
The best way to invest is through automatic payroll deductions. This removes the need to budget investments into your overall spending plan. The money simply goes into an investment account without any effort on your part, and builds over time.
Using payroll deductions for a retirement plan, such as a 401(k) plan, is very common. But not as many people are aware of the fact that you can use payroll deductions to fund just about any kind of investment plan that you want, including those that are not earmarked for retirement. You can simply have an equal amount deducted from your paycheck each pay period, and sent into a savings account, a mutual fund, or a brokerage account.
What you are doing is automating the investment process in such a way that it will require no time or effort on your part.
Where to Invest
You should start by opening an investment brokerage account. There are plenty of them available, including and especially online. They charge minimal fees for trading, and offer a wide assortment of tools and training that will help you with the whole process.
A brokerage account can be set up for retirement contributions, such as an individual retirement account (IRA). You also set up a taxable account. In either case, you can hold a variety of assets in each account, including stocks, bonds, mutual funds, and exchange traded funds (ETFs).
A brokerage account for an IRA will obviously be targeted for your retirement. But a taxable brokerage account will help you in dealing with inflation and in preparing for contingencies, such as an income disruption or loss. Under ideal circumstances, you should have both types of accounts, since you’ll be dealing with a variety of challenges at one time or another in your life.
You can also hold certain investment securities directly, such as stocks or mutual funds. But the disadvantage to doing so is that it is more difficult to sell the securities and then to immediately move the money into a different investment. This is why an investment brokerage account is so important if you want to be a serious investor.
On the more conservative side, you can also invest money in certificates of deposit at your local bank. These securities pay very low interest rates in the current interest rate environment, but they are more for capital preservation than anything else.
What You Need to Know About the Mechanics of Investing
Thus far we’ve talked primarily about the theory of investing, so now let’s get into the basic nuts and bolts of investing:
Start with an emergency fund
Before you put money into an investment of any sort, you should first start by accumulating an adequate emergency fund. Generally speaking, the fund should include a sufficient amount of money to cover at least three months of living expenses. This will provide you with the cash that you will need to cover contingencies, so that you will not need to liquidate investment assets. Invest it in nothing more risky than a savings account or bank money market fund, so that it will be immediately available when needed.
There’s no such thing as an all weather investment so you will need to diversify. That means that you will have to have a mix of stocks, fixed income investments, cash type assets, and even certain tangibles, such as real estate and precious metals. Stocks essentially represent your core growth investments, while fixed income investments represent your income investments. Cash is the extra capital that you have available to take advantage of investments as they present themselves. And tangibles have a way of performing well when other asset types don’t.
Stay away from exotic investments
If you are a beginning investor, you will want to stick with the basics as listed above. Stay away from any temptation there may be to engage in options, day trading, or any other investment strategies that represent significantly higher risk.
Go with funds when ever possible
The stars of Wall Street are the expert stock pickers. But you don’t need to be one to be a successful investor. Rather than getting into individual stocks, hold mutual funds and ETFs instead. They do the stock picking for you, and you pay a lot less in transaction fees than if you try to assemble a large portfolio of stocks yourself.
Add to your portfolio on a continuous basis
Investing isn’t about reaching a certain portfolio size. It is a process of continuous growth. That growth should come from two directions: from investment earnings, and from additional contributions. Make sure that you continue to fund your portfolio on a regular basis. That will be especially important to the growth of the portfolio during times when the stock market is doing poorly.
Adopt the long-term view
No matter what, you have to adopt a long-term view when it comes to investing. There will be times when your investment portfolio is down, and you will need to look past the moment and continue to focus on long-term growth. Virtually every bear market in history has eventually turned into a bull market. That’s exactly what you should be waiting for anytime the market is down. The biggest benefits always come from those who invest for decades, and not years or months.
Investing Involves Risk
We’ve talked some about how investments, particularly stocks, can go through down cycles. This is part of the risk that is inherent in investing of all types. Unless you are investing your money in fixed income assets, there are no guarantees that any single investment will be profitable.
Coming to grips with this risk is an integral part of the investing process. You can’t panic anytime an investment is down, or even when your entire portfolio is down. Recognize that declines are completely normal with investing.
In fact, some of the very best investing opportunities will come on the heels of major stock market declines. At that point, you’ll be buying up stocks at depressed prices because everyone else has sold out. Once the market begins turning up again, you can be on a virtual elevator ride to the top.
But risk is also the primary reason we need to diversify. It would be great to have 100% of your money invested in stocks during a bull market. But when the market turns negative, you will be completely exposed to the risk of declines. For this reason, at least some of your money has to be invested outside of stocks.
Understand the risks of investing, but also the necessities that we discussed earlier. Start small, and continue building your nest egg. Diversify into multiple investments, and be prepared to ride out the rough spots. Always continue adding to your portfolio, and looking for new investment opportunities. Investing is nothing more complicated than that.
If you can get a handle on that process, you’ll be well on your way to become a successful investor.