by Jamie Cattanach for The Penny Hoarder
This article was originally published on The Penny Hoarder
If you’ve spent so much as 10 minutes reading a personal finance blog — and clearly you have — chances are, you’ve heard that investing is one of the best ways to put your money to work for you.
The power of compound interest can turn even modest savings into an appreciable nest egg over time. And best of all, it’s passive income.
But if you’ve never put money into the stock market before, the prospect can be overwhelming. What exactly does “buying stocks” even mean? And what kind of account do you need to get started?
What Is Investing, Anyway?
Investing is a way to build wealth by purchasing assets today that you anticipate will grow in value, yielding a profit over time.
There are many different ways to invest, including purchasing tangible items (like real estate or fine art) with the intent of selling them later. But in this post, we’re going to be focusing primarily on stock market investments.
Investing for Beginners: A Quick Vocab Lesson
One of the first things new investors come to realize is how much lingo there is to know. It’s hard to feel confident about spending your money on stocks, bonds or mutual funds when you’re not even sure what any of those words mean!
The good news is, nobody knows what they’re talking about (or which words to use) when they’re first getting started. Here’s a quick vocabulary rundown.
The stock market is what we call the abstract space where investors buy and sell investments. There are many different types of investments, or “assets,” you can buy and sell on the stock market.
Stocks are shares, or small pieces of asset ownership, of a company. Stockholders earn money when the company performs well and increases in value — but they’re also vulnerable to losses if things don’t go as well as hoped. Thus, stocks can be a relatively high-risk investment.
Bonds are another common type of stock market investment, but they work differently than stocks do. Bonds are actually debts owed by corporations or, more commonly, governments.
When you purchase a bond, you’re essentially lending your money to the bond issuer. Bonds help investors earn money by accruing interest — and because bond issuers are obligated to repay their debts, they’re considered a safer investment than stocks.
What’s more, bonds are repaid after a fixed amount of time and at fixed rates (which is why they’re known as “fixed-income” assets), making them a reliable source of investment return. However, they don’t have the exponential growth potential that stocks do.
Mutual funds are pre-built collections of stocks, bonds and sometimes other types of investment assets, like real estate, which are created and managed by financial professionals.
Investing in mutual funds allows individual investors to buy a diverse segment of the market without doing all the research and footwork to assess individual stocks themselves.
Index Funds and Exchange-Traded Funds (ETFs)
These funds are similar to mutual funds in that they include a basket of different assets, but they’re not generally actively managed by a live human being. Instead, index funds are created based on a specific market index, like the S&P 500 or the Dow.
A market index is a representative collection of stocks that are used to track the performance of an area of the market.
Exchange-traded funds might be collections of companies that share industries, geographical locations or market capitalization — that is, the total dollar amount of the shares of the company available on the market.
Unlike mutual funds, they’re also traded throughout the day on the exchange, which may make them a better option for investors looking to play a more active role in their portfolios.
Your investment portfolio is the collection of all the investments you make and keep, otherwise known as your “holdings.” For example, you may have 12 shares of Corporation X, 27 shares of Corporation Y and 17 shares of an ETF which includes stocks, bonds and real estate.
Phew! It really is a word salad, huh? Now that you’ve got a better handle on basic investing terms, let’s learn more about doing some actual investing of your own.
How to Get Started With Investing
How best to get started investing will vary depending on your personal financial goals, as well as the amount of money you can afford to put toward your growing portfolio.
But if you don’t have a whole lot of extra cash lying around, don’t worry; there are many ways into the world of investing, even if your initial investment is only $100 (or less!).
Saving for Retirement
Aside from building wealth in general, one of the most common investing goals is to save for retirement. If that goal’s on your list, you’ve got lots of investment vehicles to choose from.
For example, if your employer offers a 401(k), contributing part of your wages to that company-sponsored retirement account is a way to get started investing. And if your benefits package includes an employer match, you’ll definitely want to take advantage of that — it’s free money!
Depending on your plan, you may have just a few curated investment options to choose from or access to a wide variety. (Psst — we’ll talk more about some basic investment skills in a second, so don’t hit that “buy” button just yet!)
Types of Investment Accounts
Even if you don’t have access to a 401(k), you can open a retirement plan like a traditional or Roth IRA — that is, individual retirement account.
These are investment accounts designed specifically for retirement, which are governed by special rules and tax incentives. For instance, contributions to a traditional IRA are taken pretax today, but they’re later taxed upon withdrawal; Roth IRA contributions are taxed now but grow tax-free.
And in both cases, it’s not as simple as pulling your money out whenever you want; except in specified circumstances, you’ll need to wait until you reach age 59 1/2 to fully access that money.
IRAs are available through a huge range of financial firms, from nationwide banks like Chase to brokerage firms like TD Ameritrade. Financial companies like these may also offer brokerage accounts, which aren’t subject to the same special rules and regulations as investment vehicles built specifically for retirement.
A brokerage account allows you access to a trading interface where you can purchase individual stocks, bonds or ETFs, creating your own portfolio from scratch. But if you’re not feeling up to DIYing your investments, you can also use a robo-adviser, which will allocate your assets for you.
Apps, ETFs and Automatic Contributions
Only have a few bucks to spare? Apps like Stash and Acorns make it easier than ever to get started investing with as little as $5, and they offer curated ETFs to help you diversify your holdings.
If you’re like most of us and wish your money would just take care of itself, consider starting an investment account through Acorns.
You can start small and stack up change over time with its “round-up” feature. That means if you spend $10.23 at the grocery store, 77 cents gets dropped into your Acorns account. Then, the app does the whole investing thing for you.
Acorns is $1 a month for balances under $1 million, and you’ll get a $5 bonus when you sign up.
The Stash app curates investments from professional fund managers and investors and lets you choose where to put your money — but it leaves the complicated investment terms out of it.
You just choose from a set of simple portfolios reflecting your beliefs, interests and goals.
Basic Investing Strategies to Know Before You Go
Now that you’re versed in the lingo and you’ve got the lowdown on a few accessible investment options, there are just a few more things you need to know before you take the next step and become an investor yourself.
Since all investments involve some risk, it’s imperative to be prepared and informed on how to best mitigate those risks ahead of time.
Perhaps the most important investment strategy is one you’ve doubtless heard before: diversification. Diversifying your portfolio means purchasing a wide range of assets, including different types of holdings and different issuers.
Why is diversification so important? Well, it’s just like that old saying about not putting all your eggs in one basket. If you drop that over-laden basket and don’t have any other eggs in reserve, you’re in a messy situation.
Similarly, when market values fall, your portfolio will have a lot more margin for error if you’ve got a variety of holdings. If one of the companies you own stock in goes under, for instance, you won’t be entirely sunk if you own shares of other firms — and some government bonds, for good measure.
Diversification is one of the reasons mutual funds, index funds and ETFs are so popular among new investors.
However, some of these funds do come at an additional cost — particularly mutual funds, which are actively managed by a financial professional. That’s why it’s important to check out the expense ratios before making your purchase decision, especially if you don’t have a lot of investment capital to work with.
Do Your Homework
No matter what types of investments you’re most interested in owning or how you go about getting started, research the assets you’re considering, keeping both historical performance of interest rates and current events in mind.
Consider hiring a financial advisor to help you make your decisions.
Although no investment is a sure thing, putting your money in the market feels a lot less like a harebrained bet when you have evidence and reason behind your choices. Investment advisors can help you assess your risk tolerance and make more informed investment decisions.
Keep Calm When the Market Gets Rough
And finally, keep in mind that investing is a long game, and market fluctuations are an everyday reality. Although it can be tempting to rip your money out of the market as soon as you see a scary headline, if you diversify your holdings and sit tight through the lean times, the market usually corrects itself.
Even taking major recessions into account, the market’s overall growth curve is historically positive — and stashing your cash under the mattress (or even in a traditional savings account) can’t come close to the earnings you can glean through compound interest.
Good luck, new investor!