For many new investors, the hardest part is simply getting started.
However, after you conquer your fears by doing your own research and taking the plunge to being your investing journey, you will find the amazing financial freedom that comes from having your money work for you.
Virtually every experienced investor remembers the moment they bought their first stock or mutual fund. While the whole investing process can be intimidating, you can overcome your fear of investing and begin building wealth over the coming years and decades.
Whether young or old, you can take control of your financial future by implementing these steps to begin your investing journey.
Get Comfortable Before Investing Your First Dollar
Before you invest even $1, you should be comfortable with where your money goes and how it will be invested.
While learning about investing from scratch can be time consuming, the first step to take should be to educate yourself about the different types of investments available.
If you are a new investor, spend time listening to personal finance podcasts, read business news articles from Yahoo Finance, or hire a financial expert to guide you in the right direction.
If you enjoy reading, consider picking up various books on investing to further your own knowledge.
Learn about Mutual and Index Funds
Mutual funds and index funds represent the best option for the vast majority of investors but especially, beginners. These funds offer diversification because hundreds of stocks across a variety of industries typically comprise the funds.
Because diversification reduces volatility, you stand a greater chance of steady appreciation in your portfolio and less downside risk.
By automating your investment contributions, you will dollar-cost-average into the fund you choose. This results in you buying a greater percentage when the market falls and a lesser amount when the market skyrockets. Ultimately, your average cost average will be somewhere in between.
What are the Differences in Index Funds and Mutual Funds?
Mutual Funds
Mutual and index funds differ based on how the stocks in the portfolio are chosen.
For mutual funds, a portfolio manager picks the stocks in the fund based on the prospectus or guidelines issued by the fund’s overall objective.
For instance, a mutual fund’s goal may be to outperform a certain benchmark such as the S&P 500, Russell 2000, or its peers in a particular segment of the market.
Mutual funds typically make their money through management or transaction fees that you pay for upon purchase or through their expense ratio.
Generally, new investors should look for no-load (fee) mutual funds with a lower expense ratio of under 1-2%. Often, justifying expenses greater than 1-2% becomes difficult since most mutual funds do not outperform the overall stock market and you would be better off investing in a broad-based index fund.
Both mutual and index funds settle upon the close of the trading day which contributes to the expense ratio. This means the stocks in the portfolio may re-balance to ensure the day’s gainers do not comprise too much of the portfolio and the day’s losing stocks do not comprise too little of the portfolio. Any time a mutual or index fund sells a stock, the fund must recognize capital gains and losses which pass through to the owners via the expense ratio. Therefore, investors benefit from choosing low-turnover mutual funds to limit the overall expenses and maximize total returns.
Often, finding investments that outperform a certain benchmark can be difficult. However, mutual funds exist that have consistently beaten the S&P 500. You may wish to consult with a fee-only financial planner to filter through these funds.
Index Funds
Similar to mutual funds, hundreds of different stocks also comprise most index funds. Unlike mutual funds which invest based on management’s guidelines and limits, index funds track a particular benchmark such as the S&P 500.
Index funds often have low turnover and expense ratios and offer a steady way to capture the overall market’s return. Unlike mutual funds which rely on fund managers to pick winning stocks, index funds simply buy and sell proportionate amounts of stocks that make up a certain benchmark.
With index fund, you never need to worry about a specific fund manager or rely on their expertise to pick the next winner. Instead, simply set your contribution amount and make steady investments each month.
Invest in a Workplace Retirement Plan
Investing in a 401(k), 403(b) or other workplace retirement plan represents the initial place most investors get their start.
New investors will probably be most comfortable starting their investing journey with their current employer. Typically, employer plans are highly regulated and subjected to a vast amount of oversight and scrutiny by various government agencies and outside auditing firms. Generally, investors can be confident that their broker and plan custodian has been vetted and their processes are secure.
Thanks to automated contributions through payroll deductions combined with a set number of available options, many new investors find their retirement plans a straight-forward place to start their wealth-building journey.
Certainly, new investors should be contributing in their employer-sponsored retirement plan – especially if the employer matches their contributions.
Most financial planners recommend contributing at least 15% of your gross salary into tax-advantaged retirement accounts up to the contribution limit of $19,000 for individuals under 50. By investing 15% of your gross income, you build wealth over the long run that will result in a portfolio that can generate enough gains and dividends to replace your salary in perpetuity.
When it comes to enrolling in a workplace plan, most employer plans are fairly straight forward to set up. Generally, two options are available – Traditional or Roth option.
Traditional vs. Roth Option
When you set up your employer-sponsored plan, you must decide whether to enroll in a Traditional or Roth plan.
In a Traditional 401(k), you are permitted to deduct contributions on your current taxes. In addition to the tax deduction, the gains from your investments are tax-deferred, and you will not pay taxes on the balance until you begin making withdrawals after age 59 1/2.
By contrast, the Roth option disallows tax deductions on the contributions. However, the entire balance grows completely tax-free. You will never pay taxes on your gains in retirement after age 59 1/2.
Depending upon your time horizon, the vast majority of your balance will be comprised of capital gains and dividends. Therefore, for most investors, the best option may be to select the Roth option to shield your retirement balance from as much tax as possible. This allows you to build the most wealth and have the largest balance possible in retirement.
However, you can view the pros and cons of both types of accounts here.
Other Retirement Accounts
If your employer does not offer a 401(k) or 403(b), you can still invest for retirement if you have an earned income by opening an Individual Retirement Account (IRA).
Just like an employer-sponsored plan, IRAs come in the two flavors – Traditional and Roth.
However, contributions are limited to much lower amounts compared to employer-sponsored plans. For 2020, contributions are limited to $6,000 for individuals 50 and below. For individuals over age 50, you can contribute an extra $1,000 into an IRA.
Invest for the Long Run
By far, the primary goal and mentality new investors should implement would be to invest for the long-term.
Over short periods of time, investors may experience volatility and even lose money in their portfolios. For this reason, investors who need their money within the next 5-years, most financial advisers recommend not investing that money in the stock market. However, over the longer-term of 5+ years, the stock market generates positive returns 85% of the time and offers a fairly safe place to grow your wealth.
When the market does dip and lose money, your mentality should be to take advantage of the market “on sale.” During volatile markets, you should be willing to buy more depending upon your time horizon.
In the words of Warren Buffett, “Be fearful when others are greedy and greedy when others are fearful.”
Investing in down markets may be rewarded by greater returns when the market bounces back if you can simply hold onto your investments and not sell in panic.
Investing Outside of Retirement Accounts
After securing their retirement future, investors may want to invest for other longer-term needs.
Ordinary brokerage accounts offer the most options and least amount of restrictions. While you do not receive the tax-sheltered status of retirement plans, no stipulations exist on the money invested in an ordinary brokerage account. This gives you choices and freedom for how to spend your money.
Within a brokerage account, you have the option to buy thousands of mutual funds, index funds, exchange-traded funds (ETFs), as well as individual stocks. For this reason, countless options exist so that you can find the best investments to maximize returns based on your goals.
While plenty of brokerage companies exist, consider researching which brokerage platform may be best for your particular goals here.
Make the Choice to Start Investing Today
While making the choice to invest for your future can be daunting, begin your investing journey today by furthering your knowledge about the markets. Learn more about the most tax-efficient accounts to build wealth and accomplish your savings goals. Finally, open an account and begin making investment contributions.
If you cannot seem to gain comfort or an understanding about investing, consider seeking advice from a trusted financial adviser who can walk you through the process and provide invaluable expertise. Join an investing group or find a group of friends and mentors to guide you along the way.
Even if you make a mistake or two in your investment decisions, you have the ability to make corrections throughout your investing journey. In the long run, investing generates returns far beyond the actual dollars. By building wealth through your decades of investing, you take control of your financial future.