Investing can seem overwhelming, especially when you’re first starting. You must navigate confusing abbreviations and complex investment vehicles while determining your financial goals.
It doesn’t have to be that hard. Our guide to investing for beginners makes it easy.
Investing for Beginners
This simple beginner’s guide to investing will teach you everything you need to start earning money through investments. Explore the different types of investments and plans available and discover the best options for beginners. Then, learn how to take those crucial steps to build wealth for your future.
A Quick Guide to Investment Types
You can invest in a wide variety of assets. People invest in gold, utilities, fine art, stocks, bonds, mutual funds, etc.
Beginners don’t need to know all the complex and risky asset classes available (though it’s a good idea to know what investments to avoid). Instead, we will focus on the most common assets you will encounter.
- Individual Stocks (equities)
- An ownership share of a specific company
- Mutual Funds
- A managed fund that includes a variety of individual stocks
- Index Funds
- An unmanaged fund that consists of a variety of individual stocks
- Exchange Traded Funds (ETF)
- A fund that trades on the exchange like an individual stock but that includes multiple companies
- A loan to a government/municipality that’s repaid with interest
- A loan to a company that’s repaid with interest
A Quick Guide to Investment Plans
Financial service companies offer various options to help investors achieve their specific financial goals. These plans hold investment options (like stocks, bonds, and mutual funds listed above) but have special rules to help you achieve specific financial goals.
Do you need an IRA, 401K, 403B, 592, CD, or something different? The variety of plans makes investing seem complicated, but it’s straightforward after you get past the acronyms.
Here’s a quick breakdown of the basic investment plans available:
- IRA – Individual Retirement Account
- Best for people who don’t have access to an employer-sponsored plan or who want to invest outside of it.
- 401k – Employee Sponsored Retirement Account
- Usually, corporations and private companies offer 401Ks
- 403B – Employee Sponsored Retirement Account
- Usually, local governments, charities, and non-profits provide 403B
- TSP – Thrift Savings Plan
- The Employee Sponsored Retirement Account for federal employees and the military
- 529 – College Education Savings
- An investment vehicle allowing you to save for children’s education
If that’s not confusing enough, the plans and investments could come in different investment accounts, like traditional retirement and brokerage accounts.
Novice investors must also understand the difference between the various types of investment accounts. Here are the most common ones you will see:
- Traditional Retirement Account
- Roth Retirement Account
- Brokerage Account
- Savings Account
Investment plans can be held in different accounts. For example, your 401K can be in a traditional or a Roth retirement account. However, some investment accounts only hold specific investments, like cash, stocks, bonds, etc.
Traditional Retirement Accounts
IRAs, 401Ks, 403Bs, and TSPs are typically considered “traditional retirement accounts” unless otherwise stated.
These accounts allow you to invest pre-tax dollars, limiting your taxable income during your working years and allowing your investments to grow tax-free. You must pay taxes on all of your withdrawals, and if you need the money before you reach retirement age, you’ll have to pay both taxes and an early withdrawal penalty.
Roth Retirement Accounts
Most retirement plans (IRAs, 401Ks, 403Bs, and even now the TSP) also offer a Roth option (though not all do – it will vary based on the employer).
Roth IRAs switch the tax burden, offering tax-free withdrawals at retirement age. However, all the money you invest while working is taxable – meaning it doesn’t reduce your tax burden during your working years.
You can withdraw money you put into your ROTH at any time, but you must pay penalties if you want to withdraw any investment gains.
A brokerage account has nothing to do with retirement. These accounts allow you to buy and sell stocks, mutual funds, index funds, and other investments.
You must pay taxes on any capital gains and often must pay a brokerage fee for each trade.
A CD is a Certificate of Deposit. It is FDIC-insured, so you don’t risk losing your money. In a CD, you “loan” your money to a bank and earn interest. The tradeoff is you don’t have access to your money during the deposit period.
Savings accounts aren’t investment vehicles – they’re safe havens for your money. Before investing, you should have an emergency savings account of at least $1000. Keep it in a high-interest savings account to earn a few dollars a month, and add to it with every paycheck.
Investing for Beginners: Your First Investment
A beginner should start investing with an eye toward retirement.
Only 43% of Americans who aren’t yet retired think they will have enough money to live comfortably in retirement. If you want to join their ranks, you must start saving now.
Your first step should be your employer-sponsored account (401K, 403B, TSP).
Many employers offer matching contributions of up to 5%, which is like getting a 5% pay raise. If you make $30,000 per year and contribute 5% to your 401K, you’ll be putting away $1500 annually. If your company matches, that doubles to $3000 per year.
Over the course of 30 years, assuming you don’t ever get a raise, you’d have $125,564 without the match and $301,354 with it (assuming 6% interest).
Individual Retirement Accounts
Regardless of whether your employer offers a plan, you should put money away for retirement. A nest egg of $125,564 is far better than nothing.
Your most significant decision is whether to invest in a traditional IRA or a Roth IRA. Roth IRAs have many complicated rules, but they allow you to withdraw money before retirement and hedge your tax liability in retirement.
A Roth IRA is typically a better option if you expect to pay more taxes in retirement than while working. However, a traditional IRA may be better if you expect to pay less taxes in retirement.
Many people have both – they use their employer-sponsored plans as a traditional IRA and open a ROTH IRA privately for diversification.
Retirement Account Limitations
Both retirement accounts limit how much you can invest, but you can squirrel more away in an employer-sponsored plan than in an IRA. The 2024 deferral limit for a 401K is $23,000 (meaning you can invest up to $23,000 from your paycheck to your plan in 2024), while you can only invest $7,000 ($8,000 if you’re over 50) in an IRA.
Should I Maximize My Retirement Savings?
The limits create a great question: should you max out your retirement savings or invest money elsewhere?
The answer depends on your individual financial goals. If you have kids, you might want to invest in a 529 Education Savings Plan to help them pay for college. You might want to retire early or invest for a significant purchase 10-20 years down the line, but before you reach full retirement age.
Whether you maximize your retirement savings or not is a personal decision. If you need help deciding, talk with a financial advisor who can help you identify your goals.
I’m Already Investing for Retirement – What’s Next?
When you’ve contributed the ideal amount to your retirement accounts to get the match and fund your golden years, you’re ready to invest in other vehicles.
Depending on your goals, you may want to start a 529 plan for your kids or an individual brokerage account for yourself. Either way, you’ll likely encounter the investment types discussed above: individual stocks, mutual funds, ETFs, and index funds.
Finding a Brokerage
The first step is to find an investment company you trust.
Many banks partner with investment firms to help their customers invest. For example, Bank of America offers companies easy access to its investment arm, Merrill Lynch. But you don’t have to invest through your bank.
You can open an investment account with various firms, including Vanguard, Fidelity, and Charles Schwab. Most of these firms offer a wide range of investment types (stocks, mutual funds, etc.), a variety of investment plans (IRA, 529), and basic brokerage accounts. Each company’s specific offerings will differ slightly, so shop around to see what’s best for you.
I prefer Vanguard because it offers some of the market’s lowest-cost index funds. I also hold a brokerage account filled with individual stocks through Scwabb.
You can host all your accounts (excluding your employer-sponsored retirement account) with the same firm or use different firms for different investments.
Investing for Beginners: Should I Buy Stocks?
Beginners should invest in the stock market, but not through individual stocks. Individual stocks create extra risk for people who are unfamiliar with financial statements.
Why Novice Investors Should Avoid Individual Stocks
Individual stocks are great investments for practiced investors who know how to identify solid companies and have the capital to invest large sums.
Beginners should avoid them. With individual stocks, you risk losing big, and if you don’t have a lot of capital to invest, your investments might not grow as much as you would like.
Risk Losing it All
When you purchase an individual stock, you buy a share in the company. When the company grows, your share grows (in theory), but if it goes bankrupt, you lose everything.
You may buy into an insolvent organization if you don’t know how to review a company’s fundamentals.
It Takes Money To Make Money
Another problem with buying individual stocks is it takes so much money to make money. When I first dabbled with investing, I bought individual stocks. I didn’t have much capital, leading to poor choices. I could buy a lot of cheap stocks, or I could buy very few good stocks. I decided to split the difference, investing half my money into cheap penny stocks and the other half into great companies.
I lost most of the money I invested in penny stocks but didn’t fare much better with the great companies.
I bought a single share of Microsoft (MFST) over ten years ago because that’s all I could afford. It was over $100 at the time. MFST trades at over $500, but my investment only grew by $400 over ten years because I didn’t have the capital to buy more.
Individual stocks don’t let you purchase partial shares, so you must have the whole share amount plus the brokerage fee every time you want to make a purchase, which will quickly gobble up the money you have available for investment.
On the plus side, you can invest in stocks without buying individual ones through index funds, ETFs, and Mutual Funds. Beginners should focus on these instead.
Index Funds, ETFs, and Mutual Funds – Which Should I Choose?
The three ideal investment funds for beginners are very similar. They all offer an easier way to invest in the stock market but have a few key differences.
Index funds are my favorite type of investment. They are low-cost funds that track specific market sectors. They usually aren’t actively managed, so whatever companies are tracked in the fund are the ones that you are invested in.
The S&P 500 is one of the most well-known index funds. It tracks 500 of the biggest companies in the US.
Companies offer a variety of index funds, from vehicles that track specific sectors to total market funds, funds dedicated to growth, and funds limited to stable companies with solid fundamentals.
I prefer total market index funds because they track the entire stock market, offering instant diversification and mitigating risk. Vanguard’s Total Market Fund is my favorite, as it provides one of the lowest expense ratios on the market (an expense ratio is what you pay the company to manage your account).
Mutual funds are similar to index funds because they consist of a portfolio filled with different stocks. The key difference between mutual funds and index funds is how they are managed.
With mutual funds, highly paid professionals review the companies included and actively trade in attempts to boost the fund’s performance.
Active management gives novice investors a good feeling about the fund, as they feel their investments are in professional hands. However, that peace of mind comes with additional costs, as mutual funds typically have higher expense ratios than mutual funds. The fees cover the fund managers’ salaries.
Most mutual funds and index funds allow you to purchase partial shares, meaning you can put $100 a month in them and get exactly $100 worth of shares, even if that means you bought 3.467 shares.
The disadvantage is that many have a minimum investment amount that can be difficult to reach. Your subsequent investments can typically be any amount.
ETFs (Exchanged Traded Funds) contain stocks but are actively traded on the open market, so you can’t buy partial shares.
ETFs are ideal for people with a lump sum to invest or for people who don’t have the minimum investment amount required to purchase a mutual fund or index fund.
For example, if you want to invest in an index fund that requires a minimum initial investment of $3000 but have only $200, you can purchase the ETF on the open market instead. You can continue contributing to the ETF until you have the $3000 required for the index fund and then switch. The only disadvantage is paying a brokerage fee each time you buy extra shares.
Bonds – The Safer Bet
Risk-averse investors may prefer bonds to stocks/index funds. Bonds allow you to loan companies or governments money, and they pay you back with interest.
Bonds still have some risk. If a company (or government) goes bankrupt, you risk losing your entire investment. Companies have to pay bondholders before paying stockholders, but if they don’t have any money, there’s nothing to pay you with.
Though bonds come with less risk, they also come with less reward. You don’t reap the benefits of increased share prices; you only earn money through the interest payments.
How to Invest
The last step to investing for beginners is how to invest. Here are the basic steps to getting started:
- Determine which type of account(s) you want
- College savings
- Individual brokerage
- Determine which company you will use
- Open your accounts
- Link your investment account to your checking account
- Decide how much money to invest
- Decide how often to invest
The first four are straightforward. We covered #1 extensively in this guide while offering a few options for #2. Steps 3 and 4 depend on your platform, but each company makes it easy.
That leaves us with steps 5 and 6.
How Much Money Should I Invest?
How much money to invest is a personal decision. The answer varies considerably based on your budget and your financial goals.
Take time to think about what you want out of life and how your finances contribute to that. Review your budget to see how much money you have for your financial goals. Then, consider our Triangle Method, an approach to determining your budget for investing, debt repayment, and saving based on your individual goals.
If you need help, consult a financial advisor who can guide your decision-making.
How Often Should I Invest?
You should invest as often as possible. Financial influencers love to argue over dollar cost averaging (putting money in regularly each month/week/paycheck) versus lump sum investing (putting a giant sum of money in at one time), but in reality, dollar cost averaging works best for most people.
Most people don’t have a large sum to invest at once, but they have a few dollars each paycheck. Put it in when you have it. Waiting for a lump sum is akin to trying to time the market, which never works.
With dollar-cost averaging, you don’t even have to think about how the market performs. Sometimes, you’ll invest when it’s high, and other times, you’ll invest when it’s low. In the end, it all evens out.
You should be able to set up automatic investments from your bank account to your investment account to put dollar cost averaging on autopilot so you never have to think about it.
Understanding Investment Risk
Before investing, you must understand that all investments come with risk. Some are less risky than others, but there’s no guarantee that even the most stable index funds won’t completely disappear.
You must understand that past returns never guarantee future performance and that you risk losing any money you put into the stock market.
However, beginners must also understand how stock market losses work. Paper losses aren’t always real, so understanding the difference between realized and unrealized gains/losses is essential to successfully investing.
How Does Investing Make Money?
The final thing to understand before investing is how you make money through your investments.
Investing creates wealth in three ways: Dividends, growth, and interest.
The best companies pay shareholders dividends. Think of dividends as a portion of the profits – when companies make money, they pay each shareholder a small portion.
Many brokerage accounts allow you to reinvest your dividends, so you buy more shares each time you get a payout. Reinvesting dividends is the only way to get partial shares when investing in individual stocks. I currently hold 1.38 shares of MSFT via dividend reinvestments.
When starting, you should reinvest all your dividends to watch your investments skyrocket. As your portfolio grows, you can use dividend payments to fund your life without touching your investments.
Companies seek growth. Many people invest in companies hoping that the share price will increase over time, so when they sell it, they’ll make money.
People who bought Apple in the early 1990s saw massive gains as its share price soared from just a few dollars to hundreds of dollars.
Earning money through growth is typically a bigger gamble than earning money via dividends. Stable companies with solid financials don’t typically have massive growth spurts but pay regular dividends.
When you invest in bonds and CDs, you earn money via interest. It’s an entirely different monetization method than stock ownership.
However, sometimes, investors use “rate of return” and “interest” interchangeably when discussing growth.
If you want to see how much your investment will grow using a calculator, you can use the expected rate of return as the “interest.” Though they are different things, they’re calculated the same way mathematically.
Start Investing Now
Despite the risk, investing still reigns supreme as the best way to build lasting wealth. The sooner you start, the more opportunity you’ll have to see massive gains.
Start investing today to build your nest egg.