A friend recently told me she was considering investing now that she had started working full-time. Me, thinking I was being a helpful friend, started to suggest some strategies which I thought would suit her, until she stopped me — “Wait, can we backtrack for a minute? What’s a portfolio?” It was those three words, ‘what’s a portfolio’, that have inspired me to write this guide for beginners looking to get into investing their money.
The past three years of my life have revolved around finance. It’s become so integrated into my every-day that it was only after a conversation I had with my non-finance related friend (I’ve three total) did I realise what I consider to be assumed knowledge, might as well be a foreign language to others.
Nobody’s born knowing how to invest — it’s not some skill we magically acquire when we start earning. It can be a complicated and difficult concept to fully grasp, especially when there’s so much information out there — it’s easy to become completely overwhelmed by it.
So, I have compiled all of the information that is essential for any beginners looking to start investing money. Everyone deserves to be confident when starting their financial journey and with this foundation of knowledge, you can be.
I’ve divided this guide into the following sections;
- Glossary of key investing terms
- Commonly asked questions
- How to start investing
- Tips and tricks for choosing your investments
- Useful resources for investors
So without further ado, here is – Investing Money for Beginners; The Essential Guide.
1. Glossary of key investing terms
At first, beginners may get lost in the endless list of terms used in the world of investing money. So, I took the time to pull together the ones used most often. Although you don’t need to be able to perfectly define each of these terms, you should be aware of them as you’ll see them used frequently.
Types of Securities
- Security: A tradable claim on the assets of an institution or individual
- Debt security: A negotiable or tradable liability or loan.
- Bonds: Long-term debt securities issued by corporations, governments, or other institutions.
- Treasury Bills: Debt securities issued by the U.S. Treasury of the federal government.
- Equity securities (stock): Ownership of part of an entity (a company, partnership or trust), realized in the form of shares. Held in the form of common stock or preferred stock.
- Derivative securities: A security whose value depends upon the value of another asset.
- Options: A derivative that grants the owner the right to buy (call option) or sell (put option) an asset at a specific price on or before a specified date.
- Futures contracts: A derivative that makes the owner obliged to either purchase (long position) or sell (short position) a given asset at a specified price on the future settlement date of that contract.
- Swaps: A derivative that provides for the exchange of cash flows associated with one asset for the cash flows associated with another asset.
- Mutual Fund: A portfolio (collection of assets/securities) that pools money from multiple investors to purchase securities i.e. The fund holds the individual stocks and you invest in the fund
- Index Fund: A mutual fund constructed to match the market, allowing an individual to invest in an index e.g. S&P 500.
- Hedge Fund: An investment partnership where partners will pool money from investors and engage in a wide range of investing activity e.g. taking short or long positions.
- Exchange-traded funds (ETFs): Like mutual funds, except that they trade throughout the day on stock exchanges as if they were individual stocks.
- Real estate investment trust (REITs): A publicly-traded company that owns, operates or finances income-producing properties. REITs are a way to invest through real estate without purchasing properties.
- Asset allocation: The way you divide your portfolio i.e. your investment strategy
- Fundamental analysis: A method of measuring a security’s intrinsic value by examining related economic and financial factors.
- Value investing: Involves buying securities that appear underpriced by some form of fundamental analysis.
- Growth investing: Focused on capital appreciation, involves investing in companies that exhibit signs of above-average growth, even if the share price appears expensive based off analysis.
- Technical analysis: A method of evaluating investments and identifying trading opportunities by analyzing statistical trends gathered from trading activity, such as price movement and volume. Different from fundamental analysis as it focuses on stock price rather than the actual business results.
- Income investing: Involves buying securities that generally payout returns on a steady schedule i.e. provide a steady income stream.
- Momentum investing: Aiming to capitalize off trends, involves buying securities that are rising and selling them when they peak. It relies on technical analysis.
- Dollar-cost averaging: Aims to reduce the impact of volatility by spreading out the amount you invest through purchasing at regular intervals and in roughly equal amounts.
- Index investing: Involves purchasing index funds to generate returns equal to the market.
- Bear Market: A market in which share prices are falling, encouraging selling.
- Bull Market: A market in which share prices are rising, encouraging buying.
- Balance Sheet: A report of a company’s assets and liabilities i.e. what they own and what they owe, as well as the amount invested by shareholders.
- Blue Chip: A company that has a history of solid earnings, increasing dividends, and a great balance sheet.
- Capital Gain: The profit made from the sale of an investment.
- Dividend: A sum of money paid regularly (typically annually) by a company to its shareholders out of its profits (or reserves).
- Index: An indicator or measure of something, and in finance, it typically refers to a statistical measure of change in a securities market e.g. the S&P 500 and the Dow Jones Industrial Average (DJIA)
- Stock Exchange: A market in which securities are bought and sold e.g. the New York Stock Exchange (NYSE) and the National Association of Securities Dealers Automated Quotations (NASDAQ).
- Stock Broker: Buys and sells securities on a stock exchange on behalf of clients. Can be an individual or an institution.
- Taxable accounts: An account for which the default IRS (international revenue service) tax rules apply e.g. brokerage account. Generally, investors are required to pay taxes on interest, dividends, and capital gains earned within a taxable account in the year they are earned.
- Tax-advantaged accounts: An account that is either exempt from taxation, tax-deferred or offers other types of tax benefits e.g. individual retirement account (IRA) or a 401(k).
- Volume: The number of shares being traded in the entire market during a given period of time.
- Volatility: The rate at which the price of a security increases or decreases for a given set of returns.
2. Commonly asked questions
Why should I invest?
Money loses value over time due to inflation. Therefore by not investing, you are essentially losing money in the long-run.
You want your money to grow at the same rate as inflation. However, investing also opens you up to the opportunity to increase your wealth beyond that.
Is investing risky?
There will always be some degree of risk involved in investing money, especially for beginners. But does that make investing risky? Not necessarily.
The level of risky involved depends on how you choose to invest. Some securities, such as Treasury Bills, are considered to be virtually risk-free. Whereas stocks can be very volatile.
So, is investing risky? It depends — you decide how risky you want it to be. That being said, usually more risk means more potential return. Therefore, only engage in the level of risk you consider worthwhile for the return.
What are the main rules for investing?
Investing is by no means an exact science, although there are some practices people generally try to stick to;
- Be clear about your financial goals: Know what you want from your investments.
- Know your net worth: Calculate your own assets and liabilities before you decide how much you want to invest.
- Do your research before you invest: Know who you’re investing with, what you’re investing in. Read the fine print.
- Don’t try to time the market: There’s no point in guessing which way the market will go, all you can control is your time horizon.
- Don’t invest in businesses you don’t understand: Investing in industries you’re familiar with will make for better decisions.
- Diversify your portfolio and spread your risk: Invest in multiple types of securities, don’t put all your eggs in one basket.
- Track and review your portfolio: Keep an eye on how your portfolio is performing and make adjustments when necessary.
- Factor inflation into returns: Calculate the real return from investments to ensure you’re actually making worthwhile investments.
- Start early and spread your investments: Investing is a marathon, not a sprint.
- Don’t mix emotions and investing: Beginners beware – Hot tips, gut instincts, hope and spur of the moment decisions aren’t wise when it comes to investing money. Although you can’t predict the market, you should still aim to make informed decisions.
How does investing affect my taxes?
Depending on how you make money from your investments, you will be taxed differently. For example, you will only be taxed on capital gains once they are realised i.e. when you sell the investment. However, if you earn dividends you will be taxed on them regardless of if you sell or don’t sell your stock.
The way you are taxed also depends on your account type. Certain accounts such as IRAs and 401(k)s have tax advantages which you can benefit from.
What if I don’t have much money to invest?
Even if you don’t have a lot of money there are still options — not every type of investment requires large fees and initial deposits, handy for those of you on an irregular income. Take Lending Club; their minimum deposit is $25.
No matter how small your initial investment may be, you can still earn. We all start from somewhere.
3. How to start investing
Before investing any money, it’s important, especially for beginners, to deploy a strategy that aligns with your financial goals. Be it for a retirement fund or as a means of passive income — apply these steps in a way to that fits with your targets.
1. Determine what type of investor you are
Depending on the level of risk you are open to, you will tend to favour certain investing strategies over others. For example, an aggressive investor would be open to a very high level of risk and would tend to favour very active investment strategies — like hedge funds. On the opposite end of the spectrum, a defensive investor would want to primarily invest in risk-free assets.
You can seek out a financial advisor to get a proper assessment of what type of investor you are. However, if you don’t want to go to those measures there are multiple tests available online such as this one or this one.
2. Decide your investment strategy
Based on what type of investor you are, you can find a strategy that suits your needs. Different strategies involve different securities and which have varying degrees of risk.
Your investment strategy also depends on your financial goals. You need to consider your time horizon, your return requirements, your constraints and even your tax goals.
You don’t necessarily need a financial advisor to help you plan your investment strategy but it is something to consider depending on how significant your investment is.
3. Open an investment account
The type of investment account you open depends on the type of investment strategy you’re interested in.
If you choose to open an investment account using a robo-advisor (an online financial advisor that manages your investments using algorithms and mathematics) these are your best options.
If you decide to invest your funds independently you’ll usually use a brokerage account. You should shop around to try and find the best brokerage for you by comparing fees, seeing what investments they have available and so on. This list of online brokerages is a good starting point.
4. Fund your account
You’ll need to make an initial deposit when starting your account. There can be a minimum amount you must deposit, a contribution limit or both.
Once you’ve made that deposit set up an automated transfer to your account. The amount you should transfer can be determined through your budget. It tends to be good budgeting practice to allocate 20% of your income to savings. Regardless, whatever amount you decided to save, determine the amount you want to transfer using that.
And whatever you do, do not transfer all your savings. Keep a rainy day fund — no matter how confident you are in your investments, there’s always a risk.
5. Start building your portfolio
With your goals established, your strategy in place and your account set up, it’s time to actually start investing.
Again, the level of involvement you have with buying and selling securities depends on your strategy. How you buy and sell them also depends on who you set up your investment account with. And that’s pretty much it — you’ve started investing!
4. Tips and tricks for choosing your investments
You may be asking, “How do I know what to invest in?” Unfortunately, there’s no single answer to that — one person may tell you your best option is to focus on S&P 500 Futures, while someone else will tell you to go for penny stocks. What you decide to invest in is entirely subjective.
That being said, there are some tips and tricks you can employ as beginners to help you in the decision-making process in investing your money;
1. Analysing stocks
When analysing stocks it’s good practice to look at the P/E ratio (price-earnings ratio) of the company. A high ratio means that investors expect high earnings from the company, however, could mean that the company is overvalued. A low ratio may indicate that the company is undervalued, making it a good opportunity to buy the stock at a discounted price. To determine whether or not the stock is under or overvalued, you should compare the P/E ratio with other companies in the same industry.
It’s also a good idea to analyse the company’s balance sheet. Companies with more cash tend to be a better investment than ones with high debt burdens. You can also compare liquidity ratios (the current ratio, the quick ratio, the cash ratio and the working capital ratio) amongst the companies in the same industry to get an idea of how safe the position of a company is.
All of this information and more should be available in the company’s report. You can find the reports through a quick Google search. There are some companies that don’t offer reports and a bit more digging will be required but generally, you’ll find the information you need online.
2. Choosing industries and companies
To have a diversified (and therefore less risky) portfolio you’ll want to choose companies from multiple industries. When deciding what industries to pick companies from the best thing you can do is be informed. Read up on markets and know what’s going on in the world — be generally aware of which industries are growing and which are lagging.
If you find that you’re particularly interested in a certain industry but don’t know what company to choose you can use ETFs which track that particular industry to see what stocks they’re investing in. You can do this by simply looking up ‘your industry of choice X ETF’.
3. Using derivatives
Being generally more speculative than stocks, you’re usually taking on more risk when you invest in derivatives. Therefore it’s imperative that you know exactly what you’re getting yourself involved with when entering into a derivative contract.
You’ll get the most transparency by using derivatives traded on the major stock exchanges. It’s also important that you are extremely tuned in to the market conditions before entering into a derivative contract. If you have confidence in the market sentiment of the asset that the derivative is based on you’ll want to use the derivative to expose you to that asset.
4. Staying safe
Excluding your rainy-day fund, you can still choose certain investments to act as a safety blanket. Investments such as Government-Backed securities guarantee future return and, virtually, no possibility of loss — it would take the collapse of the Government in order for them to default. You can assess your guarantee for future return (specifically for a bond) by looking at its credit rating.
Generally, people tend to invest at least some of their budget into risk-free assets, however, it’s up to you to decide. If you do want to be involved in investing in risk-free assets it can be a good idea to take part in capital preservation funds as they expose you to multiple risk-free securities — these are three-popular choices.
5. Useful resources for investors
The following resources can be helpful throughout various stages of the investment process.
- A collection of sample portfolios
- Popular robo-advisors
- Popular online brokerages
- A list of retirement accounts
- The bond credit rating system
- Yahoo Finance
- The Financial Times
- The Motley Fool
- Seeking Alpha
- Risk profiling questionnaire
- Budget planner
- A list of podcasts for investors
- Selection of books on investing
- A list of blogs on investing
For beginners, investing money can be daunting and it’s most certainly not simple — some things you can only learn through experience. However, the longer you avoid it, the less you benefit from it.
Following this guide will give you a solid foundation for investing but you’re never done learning. Just as you should invest in securities, invest in knowledge. Try to find ways to incorporate finance into your every day — even if it’s only reading a tweet from a financial blogger.
That being said, you’re still in the position to start investing. There’s going to be a lot of ups and downs but it’s part of the journey, embrace the experience. So good luck and enjoy earning!