You probably have a savings account where you can put your money and earn a little bit of interest. But if you’ve taken care of essentials including setting aside money in an emergency fund, and for short term savings, you may be ready to start investing. That means purchasing assets including stocks, bonds, mutual funds, or exchange-traded funds (ETFs).
Here’s a look at some basics about investing, such as when you should get started, how much you need to get started, and the different types of investments to consider.
How much money do I need to start investing?
You can start investing by opening a brokerage account in which you can buy and sell stocks and other investments. You may also have a retirement account, such as a 401(k) or IRA where you can invest.
Theoretically, you can start investing with almost any amount of money—some stocks cost just a few dollars. However, in reality, when you open a brokerage account, that account may have an account minimum, which can vary in size. As a result, you may be required to start off holding a certain amount of money inside the account, which you can then use to invest. Retirement accounts, on the other hand, don’t have account minimums.
What’s more, some investment vehicles, such as mutual funds, may have investment minimums. And to buy shares of stocks or ETFs, you may need to have at least the price of one share.
That said, some brokerage firms offer fractional shares. These firms buy whole shares on the market and then sell pieces to investors, giving them access to investments that might otherwise be out of their price range.
Account minimums and share prices aside, take a look at your budget to help you determine how much money you have available to invest. Start with your monthly after-tax income and subtract necessary expenses such as rent, utility payments, insurance payments, student loans, food. What’s left represents your disposable income, and you can decide how much of this money you want to start investing.
Investment amounts can also be closely tied to your goals for the money. You can establish how much money you’ll need to reach your goal and work backwards to understand how much you need to save each month to meet it. Consider tools such as a retirement savings calculator to help you determine how much to save.
Once you determine how much you need to meet your investment goals or how much you have in your monthly budget to save, you can start investing regularly.
When should I start investing?
Generally speaking, the longer you keep your money invested, the more time your investments have to grow. Consider that for 2019, the projected compound return for large U.S stocks is about 5%. That means $1001 invested for one year with a 5% return could become $105 the following year. If you leave that money invested for longer, however, you could possibly make a greater return.
In the second year, with the same return, you could add 5% of $1051, and with a 5% average annual return, you would possibly double your investment in a little over 14 years. This principle is known as compound interest, and it can make investing a powerful tool for saving.
To take maximum advantage of compound interest, investors may want to start investing as soon as possible. The longer the time horizon you have before you need your money, the more time it has to potentially grow.
What investments should I make?
When you start investing, you have a wide variety of choices. Most investors create a mix of investments—typically stocks, bonds, and cash —called a portfolio. How much of each type of asset an investor holds—also known as their asset allocation—will likely be based on an investor’s financial goals, time horizon, and tolerance for risk.
When you buy stocks, you purchase a small amount of company ownership. When you buy bonds, you are essentially loaning money to a company or government in return for interest payments.
In general, stocks provide the potential for greater long-term growth than bonds. However, stocks are considered more risky and tend to be more volatile in the short term. Bonds generally provide lower returns, but are less risky.
When you invest, it’s important to consider diversification, which means you’re not putting all of your eggs in one basket, so you can better weather the stock market’s ups and downs. That means you won’t put all of your money in too few stocks, bonds, or funds. When you’ve diversified your portfolio, it will hold a variety of investments that are not all subject to the same market risks, including stocks, bonds, and cash, as well as mutual funds and exchange-traded funds (ETFs). By diversifying, you’ll also be choosing investments in numerous economic sectors—not just the hot industry of the moment—as well as in different geographies around the globe.
Many investors opt to invest through mutual funds and ETFs, which hold a variety of assets. If you buy a share of a mutual fund or an ETF, you buy the equivalent of a small share of all securities in that fund, which can include stocks, bonds, or a mix of both. Both mutual funds and ETFs can provide a good way to diversify your investments, which can help reduce some of the risks associated with owning any individual stocks or bonds.
Before you decide which investments to include in your portfolio, it’s important to think about why you’re investing, and your goals. Are you saving for long-term goals like retirement? Or nearer-term goals like a down payment on a house or a child’s college education. These goals will help determine your asset allocation, as well as the type of investment account you may choose.
If you’re saving for long-term goals your portfolio may contain a greater proportion of stocks so you can access their long-term growth potential. A long-time horizon can give you time to ride out any short-term volatility in the stock market.
When saving for goals in the nearer-term your portfolio may contain a greater proportion of less risky assets, such as cash and bonds. A larger allocation of bonds can help protect you against short-term market volatility, helping ensure that your money is there when you need it.
How should I invest?
Your goals for specific investments will also help determine what investment account you choose. You can build your portfolio using a taxable brokerage account for near-term goals, like a down payment for a house, for which you need easier access to your funds.
When saving for retirement, consider tax-advantaged retirement accounts such as 401(k)s and traditional or Roth IRAs. These accounts can help you increase your savings and earnings. Pay close attention to the rules for each type of account.
Tax-advantaged retirement accounts set strict limits on how and when you can withdraw your funds. For example, if you withdraw funds from a traditional IRA before age 59 ½, you will owe income tax on your withdrawal and be subject to a 10% early withdrawal penalty.
If you’re saving for a child’s education, you may consider a 529 plan, which offers tax advantages that are similar to an IRA. Be aware that 529 plans also have strict rules about withdrawals, which can only be made to cover qualified education expenses.
Your goals, timeline, and tolerance for risk will help determine the types of investment strategies you’ll use to invest. If you’re saving for a large long-term goal, such as retirement, you may consider an aggressive investment strategy that includes a portfolio built with a large proportion of stocks. The long time horizon gives you a chance to take advantage of stocks’ growth potential and ride out short-term market volatility.
If you are approaching a near-term goal, you may consider a more conservative investment strategy that includes a higher proportion of bonds in your portfolio to help protect you from short-term volatility that might make meeting your goal difficult.
When building a portfolio, you have the option to buy single securities, such as stock in an individual company. Or you can invest in funds, such as mutual funds and ETFs, which offer a diverse basket of stocks, bonds, or other investments. Be aware that investing heavily in a single investment can open you up to market risk. After all, if that investment performs poorly, it can have an outsized impact on the overall performance of your portfolio.
Investing in funds can help mitigate this risk, as the performance of any individual holding has less of an impact on the overall fund. That said, funds are not immune to risk. For example, they may suffer from market risk if a sector they are heavily invested in performs poorly.
Common questions about investing
Is investing in the stock market risky?
Investing in stocks always involves risk. While you can make money by investing in stocks, bonds, funds, and other securities, you can also lose money, especially if your investments lose value. By diversifying and doing careful research before you purchase securities, you can reduce your risk.
How do I invest money in the stock market?
You can invest in the stock market by purchasing stocks, bonds, mutual funds, and exchange-traded funds (ETFs), as well as other securities. You can make these purchases by setting up an investment account with a brokerage, either online or through an investment app.
How much money do you need to invest in stocks?
You can buy individual stocks, or shares of multiple stocks and bonds through a mutual fund or ETF. But some stocks and funds have more expensive prices than others, so the actual amount you need to start investing varies. If you have a small amount of money to invest, some brokerages offer what’s known as fractional shares. As their name implies, these are fractions of full shares that can help you start investing, sometimes with just a few dollars.
What is the difference between trading and investing?
Trading is the process of buying and selling stocks, which usually takes place over the short term. Investing generally implies buying stocks or bonds and holding onto them over a longer period of time.
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