Investing can seem intimidating and complex to beginners. You may think you need large amounts of capital or insider knowledge to get started. However, investing is accessible to anyone and an essential tool for growing your money over time. This comprehensive 7,500 word guide covers everything a beginning investor needs to know, including:
- What is Investing and Why You Should Start
- Types of Investments
- Understanding Risk vs. Return
- Building an Investment Portfolio
- Getting Started With Investing Step-by-Step
- Frequently Asked Questions About Investing
Whether your goal is saving for retirement, buying a house, funding an education, or simply building wealth, investing is the pathway to get there. By starting early and making smart decisions, your money can work for you over the long-term through the power of compounding. This guidebook walks through investment basics so you can confidently take control of your financial future.
What is Investing and Why Should You Start?
Investing simply means putting your money to work so it can grow over time. Rather than letting it sit in a conventional checking or savings account earning minimal interest, you invest it in assets that have potential to increase in value. These assets can be stocks, bonds, real estate, or other securities.
As your investments gain value, you earn returns in the form of interest, dividends, rental income, or an increase in the asset’s market price. The combination of returns and compound growth helps build your wealth exponentially faster than saving alone.
Here are 5 key reasons why you should make investing part of your long-term financial strategy:
1. Maximize Your Money’s Earning Potential
Saving money typically involves putting it in a basic deposit account like a savings account or Certificate of Deposit (CD) at a bank. Your principal money is safe and accessible, but it earns very low interest rates – generally less than 1% annually.
Investing opens up assets that offer much higher return potential, often 4-10% yearly or more over the long run. This greater earning potential multiplied over decades results in significantly higher wealth accumulation compared to saving alone.
2. Outpace Inflation
Inflation refers to the rising costs of goods and services over time. It causes your money to lose purchasing power year after year if your assets don’t appreciate at an equal or greater rate.
At recent inflation rates of 2-3% annually, savings lose value. Investing provides an opportunity to not just keep pace with inflation, but surpass it through compound growth. This preserves the real spending power of your money over your lifetime.
3. Fund Financial Goals
Short-term saving is great for near-term expenses, but investing helps fund longer-term goals like retirement, college tuition, home buying, starting a business, and more. The high return potential and compounding of stocks and bonds over decades make it the only realistic way to fund such major endeavors.
4. Generate Passive Income
Certain investments like dividend stocks and high-yield bonds generate interest payments you receive as passive income. You earn this recurring cash flow simply by holding the assets – no active effort required!
Passive income through investing helps supplement employment income. It provides cash flow in retirement and greater financial freedom.
5. Achieve Financial Independence
Investing helps everyday people achieve financial independence – the ability to cover living expenses without active work. After a career of investing, the compound growth and passive income from your assets can fully replace your salary.
Investing makes the difference between having to work for a living your entire life versus having your money work for you. Who doesn’t want financial freedom?
Now that you understand the immense benefits of investing, let’s explore the most common asset classes beginning investors should know.
Types of Investments
There is a vast universe of asset types and specific ways to invest money. Here are 6 major investment categories that every new investor should understand:
A stock represents a fractional ownership stake in a business. When you purchase shares of a company’s stock, you become a part owner. Public companies issue stocks that trade on exchanges like the NYSE and Nasdaq.
- Growth Potential – The value of successful companies can grow very large over decades, multiplying stock prices.
- Dividend Income – Many stocks pay shareholders a portion of profits as dividends.
- Liquidity – Stocks trade daily, enabling instant buying and selling.
- Volatility – Stock prices fluctuate signficantly in the short-term.
- Loss Potential – Stocks carry higher risk than bonds, with potential for complete loss.
- No Guarantees – Dividends can be reduced or suspended at any time.
Stocks are suitable for long-term investors able to withstand volatility in pursuit of higher returns.
Key Terms: Earnings per share, P/E ratio, dividend yield
Bonds are debt investments where you loan money to a government body or corporation in exchange for interest payments. The bond issuer promises to return your principal investment upon the bond’s maturity date, usually 1 to 30 years in the future.
- Stable Income – Bonds pay fixed, regular interest income over their lifespan.
- Low Risk – Bonds are less volatile than stocks and offer predictable income.
- Diversification – Bonds provide safety when blended with riskier investments.
- Interest Rate Risk – Bond values fall when rates rise.
- Credit Risk – Corporate and local government bonds carry default risk.
- Liquidity – Many bonds don’t trade actively daily.
Bonds are suitable for medium-term investing horizons where you prioritize preserving principal and earning income over growth.
Key Terms: Face/par value, coupon rate, maturity date, yield to maturity
Real estate investing involves purchasing physical property like houses, apartment buildings, land, retail centers, or commercial office spaces. You can invest directly or through real estate investment trusts (REITs).
- Appreciation – Properties can gain value over the long-term.
- Cash Flow – Rental income can be generated from owned properties.
- Leverage – You can finance a portion of purchases to boost returns.
- Tax Benefits – Depreciation and 1031 exchanges help minimize taxes.
- Illiquidity – Physical property can’t be quickly bought and sold.
- Tenant Risk – No rental income if you have vacancies.
- Leverage Risk – Loans must still be repaid if property value declines.
- Maintenance – Owning physical property incurs upkeep costs.
Real estate works for patient investors able to handle management duties and illiquidity. It also serves as an inflation hedge.
Key Terms: Cap rate, cash-on-cash return, appreciation, principal and interest
Mutual funds pool money from many investors to purchase a diversified basket of stocks and/or bonds. Professional fund managers then actively trade the portfolio based on stated investment objectives.
- Diversification – Exposure to many individual stocks or bonds in one fund.
- Ease – Simplicity of purchasing one asset versus many.
- Professional Management – Experienced managers research and trade the funds.
- Indirect Ownership – You own shares in the fund, not the underlying assets.
- Costs – Mutual funds carry higher fee structures than ETFs.
- Manager Risk – Managers may underperform their investing benchmarks.
Mutual funds work well for passive investors who want diversification and simple ownership with minimal involvement.
Key Terms: Net asset value (NAV), expense ratio, turnover ratio, manager tenure
Exchange-Traded Funds (ETFs)
ETFs are baskets of investments like mutual funds but trade intraday on stock exchanges. They track market indexes or sectors rather than relying on managers.
- Extreme Diversification – Many ETFs hold hundreds or thousands of underlying assets.
- Tax Efficiency – ETF structure results in lower distributions and taxes.
- Low Cost – ETFs have minimal operating expenses and fees.
- Liquidity – ETFs trade throughout the day like stocks.
- Indirect Ownership – You own interest in the fund, not the underlying assets.
- Tracking Error – ETF returns may diverge slightly from the market benchmark.
- Price Fluctuations – ETF prices change throughout the trading day as stocks do.
ETFs are great for all investor types – especially index investors and anyone wanting instant diversification on a budget.
Key Terms: Assets under management (AUM), tracking error, authorized participants, bid-ask spread
Robo-advisors are digital investment platforms that use algorithms to automate portfolio management. After answering questions about risk tolerance, timeline, and goals, a computer program provides you with a tailored ETF portfolio to invest in.
- Convenience – Fully automated investment management.
- Low Fees – Robos have minimal account fees.
- Diversification – Computer models create globally diversified portfolios.
- Rebalancing – Algorithms automatically rebalance your holdings.
- Indirect Ownership – You own shares in ETFs, not underlying assets.
- No Human Touch – May lack personal advisor relationship.
- Limited Choices – Less control over investment selection.
Robo-advisors are great for hands-off investors who want automated, diversified portfolio management on a budget.
Key Terms: Advisory fee, account minimum, automated rebalancing, risk questionnaire
Peer-to-peer lending platforms connect individual investors looking to earn interest income with borrowers seeking loans. You provide capital funding personal loans and small business loans while earning much higher returns than bonds or savings accounts offer.
- Fixed Income – Earn steady interest on your invested principal.
- Higher Returns – Yields range from 5-12% on average.
- Shorter Terms – Many notes have 6, 12, or 36 month maturities.
- Diversification – You can invest small amounts in hundreds of loans.
- No Guarantee – Higher defaults mean higher risk.
- Illiquidity – Loans are held to maturity, limiting withdrawals.
- Interest Rates – Notes don’t benefit from rate increases like bonds.
- Unsecured – Most loans are uncollateralized.
P2P lending provides an income stream from your capital but has risks requiring appropriate due diligence.
Key Terms: Borrower rate, lender rate, credit score, annualized return
This covers the major beginner-friendly asset classes to build a foundation. As you gain experience, you may branch into alternatives like commodities, derivatives, venture capital, cryptocurrency, collectibles and more.
Now let’s discuss a key investing principle – the relationship between risk and return.
Understanding Risk vs. Return
Risk and return are intrinsically related in investing; you cannot pursue returns without taking on some degree of risk.
Return refers to the money made (or lost) on an investment. It may come from capital appreciation or income generated.
Risk refers to the degree of uncertainty involved in realizing a return on an investment. There are many types of risk that vary by asset class.
As a general rule, assets with higher return potential also have higher risk. The balance between desired return and tolerable risk levels is different for every investor based on factors like:
- Wealth – Wealthy investors can accept higher risk.
- Goals – Short term goals warrant lower risk than long term.
- Age – Younger investors have more time to recover from risk.
- Personality – Your innate risk tolerance also plays a role.
Understanding this linkage between risk and return will help guide you towards smart investments that best match your situation. Let’s examine both in more detail:
Different investments generate returns in different ways. Common return types include:
- Income – Dividends from stock or interest from bonds. Cash flow paid to the investor.
- Capital Gains – Asset appreciates in market value, allowing sell at profit.
- Rental Income – Cash flow from renting out real estate holdings.
To compare returns meaningfully, they must be converted to annualized percentage yields. If you make a 20% return on an investment in 6 months, that equates to nearly 40% annualized. Looking at percentage returns rather than raw dollars better conveys performance.
Aim to maximize returns for a given level of risk you are comfortable with. Reaching for unrealistic returns typically requires excessive speculation.
Every investment carries some degree of risk. Many types exist, but major ones to know include:
- Market Risk – Overall investment declines from economic recession.
- Inflation Risk – Purchasing power declines over time.
- Liquidity Risk – Investment cannot be readily sold.
- Credit Risk – Debt issuer may fail to repay principal or interest.
- Currency Risk – Overseas investment values fluctuate with exchange rates.
- Political/Legislative Risk – Government action impacts investment profitability.
- Event Risk – Unforeseen events like disasters or company scandals cause losses.
Since risk cannot be escaped, the key is mitigating risk types through diversification. Don’t put all your eggs in one basket. With a balanced portfolio, risks offset each other.
Now let’s shift from individual assets to the holistic process of building a robust investment portfolio.
Building an Investment Portfolio
Simply buying one stock, bond, or other asset does little to mitigate risk or smooth out returns over time. Savvy investors utilize portfolio diversification to achieve better risk-adjusted returns.
Your investment portfolio represents your complete collection of assets across accounts and classes. While you may own 10, 20 or more individual investments, they all work together to align to your goals.
Constructing an ideal portfolio involves multiple steps:
1. Determine Your Risk Tolerance
As discussed, your ability and willingness to accept risk is the key factor in driving asset allocation. Tolerance is based on your emotional personality as well as timeline, wealth level, knowledge, and more.
Risk tolerance levels range from conservative (low tolerance) to aggressive (high tolerance). Be honest about your comfort taking on volatility and loss potential.
2. Choose Your Investment Style
Your risk tolerance and philosophy will help dictate your investing style, such as:
- Active vs. passive – Actively managed or index strategy?
- Growth vs. value – Focus on accelerating earnings or undervalued assets?
- Core vs satellite – Simple foundation plus specialty holdings?
Your style will steer construction of your portfolio. Don’t try mimicking someone else’s style if it doesn’t fit your personality.
3. Establish Your Asset Allocation
Asset allocation means assigning percentages of your portfolio to each asset class based on your risk tolerance and investment style preferences.
A moderate example allocation may be 50% stocks, 30% bonds, 15% real estate, and 5% alternatives as a starting point. You can then customize around your preferences.
Balancing more volatile assets like stocks with stable ones like bonds smooths out returns over time.
4. Choose Your Investments
With your target percentages set, it’s time to select specific investments in each bucket.
For core portfolio holdings, look for low-cost, diversified index funds or ETFs that capture entire swaths of each asset class in a single ticker. Supplement with a few actively managed funds or individual picks where you identify opportunity.
5. Implement Your Portfolio
Now execute your asset allocation by buying your selected investments accordingly. You likely need multiple accounts like 401(k)s, IRAs, and taxable brokerages to accommodate different assets and maximize tax efficiency.
Try to establish your portfolio systematically over weeks and months – don’t try to do it all at once. Regularly contribute to purchase more assets until you get to your targets.
6. Monitor and Rebalance
As markets fluctuate over time, your portfolio allocation percentages will shift. For example, a stock boom may take your equities above 60%.
Rebalancing involves selling assets that have grown too large and using proceeds to buy more of those under target to restore your original allocation. Rebalance about once annually.
Building and actively managing a solid investment portfolio takes work, but pays off in the long run. Now let’s shift gears to the practical steps to getting started investing.
Getting Started With Investing Step-by-Step
Investing can certainly feel daunting as a total beginner. Where do you open accounts? What do you actually buy? How much money do you need?
Use this step-by-step guide to go from investing novice to having your money work for you in no time:
Step 1: Define Your Investing Goals
First and foremost, get crystal clear on why you are investing. Determine the specific financial goals investing will help you accomplish.
Common goals for investing include:
- Saving for retirement
- Building an emergency fund
- Funding college education
- Saving for a home downpayment
- Starting a business
- Achieving financial independence
Having clear goals not only motivates you, but gives you a roadmap to know how much to invest, your needed returns, and acceptable risk levels.
If you simply want to build wealth generally without a specific monetary target, that also works. The key is to define “success” from the start to guide your efforts.
Step 2: Fund Your Investment Account
Once you’ve defined your goals, the next step is funding your investment account(s). Most beginners start by opening a retirement account like an IRA and also a standard taxable brokerage account.
Contribute as much as your budget allows on a consistent schedule, like $500 per month. Monthly recurring contributions help through a strategy called dollar cost averaging.
You can open accounts at reputable investment platforms like:
- Charles Schwab
- Merrill Edge
- TD Ameritrade
Look for low (or no) minimum balances and commission-free trading when selecting brokerages. Some also offer signup bonuses.
Step 3: Choose Your Investments
Now comes the fun part – picking your investments! Stay diversified across stocks, bonds, real estate, and cash equivalents based on your risk tolerance.
As a beginner, opt for mutual funds and ETFs over individual stocks so you gain instant diversification. Index funds like S&P 500 ETFs are great core holdings.
If you want a hands-off approach, consider a robo-advisor like Betterment or Wealthfront who will manage your portfolio allocations automatically.
Step 4: Make Your Purchases
Purchase your selected mix of investments to build out your portfolio. Invest new cash monthly by dollar cost averaging into the same assets rather than trying to time the market.
Stick with your target allocation rather than chase hot trends. Consistency and discipline are key.
Step 5: Monitor Performance
Check the performance of your portfolio at least quarterly, but avoid obsessing over daily fluctuations. Assess if you’re earning expected returns while staying within your risk comfort zone.
Periodically revisit your original goals and reallocate assets that have drifted too far from targets. Rebalancing once a year is generally sufficient unless markets become highly volatile.
Step 6: Form Good Investing Habits
Cultivate habits to make investing easier and more automatic:
- Set up recurring contributions from your paycheck or checking account
- Reinvest dividends and interest to compound returns
- Increase contribution amount annually by 1-2% to combat inflation
- Don’t panic during market downturns – stay the course!
- Learn continuously to become a better investor
The key is consistency. Investing modest amounts regularly over decades yields significant wealth.
Follow these steps and you’ll be on your way to investing success. But don’t just take our word for it – read answers to common investing questions below.
Investing may seem complicated at first, but taking it step-by-step makes getting started attainable for any beginner. The key is focusing your efforts on maximizing returns within your risk comfort zone and investing consistently over long time horizons.
Your ideal portfolio will evolve over time as your goals change and investing knowledge grows. The most important first step is simply getting started! Implement the basics in this guide and investing will quickly become an empowering lifelong habit.
Frequently Asked Questions About Investing
What is the best way to start investing?
The best way for beginners to start investing is contributing to a tax-advantaged retirement account like a 401(k) or IRA. Open one with an established low-cost brokerage like Fidelity or Vanguard. Invest in a target date index fund matching your expected retirement timing. Then build out your portfolio adding stocks, bonds, and real estate over time.
How much money do I need to start investing?
You can begin investing with very little money – even just $100. Many online brokerages now offer free or reduced minimum balances to open new accounts. With fractional share investing, you can invest in stocks and ETFs with less than the normal per share price. Start small and increase your contributions over time.
What percentage of income should I invest?
A good rule of thumb is to invest 10-15% of your gross income annually. Contribute at least enough to get any employer matching funds in retirement accounts. If you can invest more when you’re young through accounts like IRAs, it will really pay off long-term due to compound growth.
How long does it take to see returns on investments?
You may see very rapid returns in days or weeks with risky assets, or it could take many years for more stable investments to begin churning out consistent gains. The key is not obsessing over short-term fluctuations. With a buy and hold strategy, even modest returns compound substantially over 5, 10, or 20 year periods into serious portfolio growth.
What is the best investment for a beginner?
The best investments for beginners are low-cost, diversified index funds and ETFs like S&P 500 and total stock market funds. They offer built-in diversification and market exposure for long-term growth. Pair index funds with some bonds for stability. As you gain experience, you can add individual stocks with bigger potential upside and downside.
What percentage of portfolio should be stocks vs bonds?
A good starting point is 60-70% stocks and 30-40% bonds by portfolio value. Adjust based on your risk tolerance. Conservative investors may flip that to 30% stocks and 70% bonds. Aggressive investors may go for 80% stocks and 20% bonds. Rebalance annually to stay at your targets as markets shift.
How many stocks should I own?
While owning just a handful of stocks is very risky, owning too many can also dilute returns. Shoot for 10-20 stocks spread across sectors to balance diversification with impact of best performers. One S&P 500 index fund instantly provides exposure to 500 large US companies already.
How quickly can you become a millionaire investing?
Becoming a millionaire just through long-term investing is very possible, but takes time and consistency. If you start investing $400 per month at a 12% annual return, it will take about 35 years to reach millionaire status. Boost your returns to 15% and you could get there in 25 years. Increase your monthly contributions and the timeline speeds up as well.
What should I invest in to become wealthy?
Focus on maximizing long-term returns responsibly to build wealth through investing. Construct a diversified portfolio centered on stocks, mutual funds, and ETFs taking advantage of compounded growth. Add in real estate, peer-to-peer lending, and other alternatives over time. Wealth is built slowly but surely through consistent, smart investing.
How can I start investing with no money?
If you don’t have extra cash to fund an investment account, you can start investing in your company’s 401(k) through automatic paycheck deductions. Many plans offer an employer match to jumpstart your savings. Set aside a small percentage of each paycheck to build the habit. Once your pay increases, boost the savings rate. Slow and steady investing funded through cash flow is powerful.
In another related article, Best Short-Term Investments to Consider in 2023