How to Invest Money Wisely
Want to invest your money and don't know where to start? Read on for our top tips.
Investing may seem daunting at first, especially if you get started when the market is experiencing a crash, but it doesn't have to be a terrifying ordeal. If you do your research and due diligence, you should be well on your way to a healthy and robust financial future. Do you want to learn how to invest money but don't know where to begin? We've put together this guide for beginners to help you grow your hard-earned money, even when the market gets rough.
How to Invest Your Money?
Step 1. Understand Which Type of Investor You Are
There are generally three types of investing styles.
1. DIY Investing
DIY or “Do-It-Yourself” investing is a more hands-on approach. It requires you to do all of the research yourself. You will also have to keep track of your stocks regularly, which can be time-consuming. On the other hand, it means you have total control over what is in your portfolio.
If you prefer to invest yourself, then find a stock broker and open a brokerage account. E*TRADE is our recommended stock broker, as it offers low fees and excellent service. Once you have an account open, you can begin buying and selling individual stocks on your own. You can also invest in an index fund, which tracks a stock index like the S&P 500.
2. Passive Investing
This “set-it-and-forget-it” approach to investing is for people who don't have the time or interest to do all the heavy lifting themselves. There are a lot of options out there if you want to hire someone to invest for you. You can invest in mutual funds or invest in exchange-traded funds (ETFs) through a robo advisor.
If you'd rather not be too involved in the investing process, then you'll probably prefer using a robo advisor. These platforms do all the work for you, once you've answered a few questions about your investing goals and how much risk you want to take. Betterment is the biggest robo-investing platform in the industry, and it's a good starting point for beginning investors and a useful platform for more experienced investors.
However, there could be a limit in what you can invest in. You can also use a service such as the Paladin Registry to locate a fiduciary investment advisor who'll act in your best interest.
3. Getting a Stock Advisor
The third style is a cross between DIY and passive investing. Hiring a stock advisor or signing up for stock picking services can be a way to pick and choose stock on your own while getting the insight of an expert. You will still need to have your own broker account, but you can leave the time-consuming research to others.
Step 2. Choose an Asset Class that Suits Your Risk Tolerance
Generally, the more risky an investment is, the higher the return is. While it might be tempting to invest in riskier stocks, the best thing is to invest in a variety of different asset classes.
An “asset class” is a group of similar kinds of investments. You can invest in one asset class or many. A mix of asset classes, or diversification, gives you a well-rounded portfolio that can weather the ups and downs of the stock market. An example of a diversified portfolio is investing in a mutual fund, owning a variety of individual stocks across a number of sectors (like healthcare, transportation, and retail) and also owning and renting out a few real estate properties.
Here are the basic asset classes for investors based on how risky they are:
- Cash: This also includes cash equivalents. Cash is considered the safest investment because its value is usually steady, even when taking into account inflation. For an easy way to expand your cash reserves, invest in an interest-paying savings account like Betterment Cash Reserve .
- Bonds: Also known as debt or fixed income. This is when you lend money to a government or institution and are paid interest in return. Examples include mutual bonds and certificates of deposit.
- Real Estate: This is when you own physical property. You can also invest in a REIT and own a portion of a property. However, keep in mind that real estate can be a big-time commitment. Find out how to invest in real estate here.
- Stocks: This is also known as equities or when you own shares in a company. This is probably what most people think of when they think of investing. However, keep in mind that the riskiness of stocks varies significantly by company. Younger companies might be riskier, but a well-established company could also go bankrupt due to unexpected changes or sudden lawsuits. If you want to know more, then read our guide on how to invest in stocks.
- Futures and Other Derivatives: This is when you speculate on the future price of an underlying asset. It can be rather complicated, but essentially it's a contract that obliges the parties involved to buy and sell an asset (such as oil) for a predetermined future price and date.
- Commodities and Precious Metals: Just like with real estate, commodities are to own a physical thing — be it gold, oil, or pork bellies. You can trade them, but thankfully, you rarely have to take possession of them. There are a lot of different ways to buy and sell commodities, including futures contracts, or investing in an ETF. Read more about how to invest in commodities.
- Other Alternative Investments: Since you need to have a diversified portfolio, you can also consider alternative investments like fine art on platforms like Masterworks, or lending to small companies via a peer-to-peer lending platform. These can be an excellent addition to your portfolio, although they have their own set of risks to consider.
Step 3. Set a Deadline and Choose an Investing Goal
Now that you have a better idea of the type of asset classes you can invest in, it's time to determine your financial goals. What are you saving and investing for? How much will you need? If you're saving for your kid's college, you'll need a different amount than if you're just saving for retirement.
Short-term investing
If you know you're going to need the money in a few years, then your strategy is going to be a bit different. Usually, this is when you buy stocks whose earnings are expected to outpace the market as a whole in a short amount of time. This is also known as growth investing. Some of the short-term investing strategies include investing in a peer-to-peer lender or putting your money in a savings account.
Pros of Short-Term Investing
- High-liquidity. Your money is not stuck in an account for a set amount of time, making it easy to withdraw the funds when you need them.
- It can be low-risk. Depending on the type of investment, short-term investing can be low risk because it has less time to be impacted by a sudden drop in markets or interest rates.
Cons of Short-Term Investing
- Low-return. Because your money has only been invested for a short amount of time, you're unlikely to make a big return on your money.
- Higher tax bill. Depending on the investment, you may have to pay more taxes than if you had left the investment in a longer-term account.
Long-term investing
This is also known as buy-and-hold investing and is probably the most common investment for things like retirement. You know you're in it for the long run. This strategy involves buying stocks now and holding them for years when they will hopefully be worth more. Other long-term investing strategies include real estate, investing in a certificate of deposit and
Pros of Long-Term Investing
- Less Risky. Holding onto a stock for a long time means you have more time to recover from a sudden dip in the stock market.
- Less Stressful. Longer investments are often less stressful because you don't need to follow markets as closely on a day-to-day basis.
Cons of Long-Term Investing
- You Need Patience. It takes a long-time to see a good return on longer investments, so you'll need to be patient.
- Less Control. Because your money is invested for a longer time, it will be a long time before you will see your money again.
Step 4. Define Your Investment Budget
Now, there are plenty of methods for setting up and maintaining a budget. It doesn't have to be rocket science. You can use a spreadsheet and just paper and a pen. Or you can use one of the helpful online services that do the heavy lifting for you. Personal Capital has free budgeting and personal finance software that we particularly like. It's also robo advisors, so you can start investing right away at the same time!
It's also a good idea to think about saving money on the side to invest eventually. You can easily put extra money into a cash account like Wealthfront, where you can earn interest on your savings.
Step 5. Reduce Fees and Fund Expenses
There are many different kinds of fees — everything from account maintenance costs to mutual fund loads. And there are many ways to cut back on them or even avoid them altogether!
Every type of investment carries its own set of fees. However, here are the most common fees you'll see:
- Account Maintenance Fees: Typically, an annual fee below $100. This fee is often waived once you hit a minimum balance in your investment account.
- Commissions: A flat amount per trade or a flat amount plus a percentage per trade. This amount will vary depending on your broker and the funds you invest in.
- Mutual Fund Loads: Either front-end, back-end, or a combination of both. These can sometimes be waived if the funds are held in brokerage accounts with the same broker.
- 12b-1 Fees: Internally charged fees on mutual funds. This will reduce the value of your fund by up to 1% and will be deducted automatically every year.
- Management or Advisor Fees: A fee paid to an advisor who manages your accounts. This could add up to thousands of dollars per year, all avoidable if you manage your own account instead.
We've reviewed several products that are fee-free. In fact, one of our favorite robo advisors, Wealthfront, is free for accounts under $5,000. That makes it a great place to get started.
And if you're looking for a fee-free stockbroker, you're in luck. The competition in this space is heating up, which means some brokerages are slashing their fees to zero. Robinhood has been a trailblazer, but even old favorites like Firstrade are now fee-free. Public.com is another broker to check out, especially if you want to add a social element to your investing.
Consider These Factors Before You Start Investing
- Get an Emergency Fund– Having a fully stocked emergency fund in an accessible savings account is a huge financial priority. You want to have three to six months' worth of living expenses tucked away. Emergencies happen all the time, and having the capital to deal with them is a necessity. You don't want to have to tap into your investments to deal with a car repair or a hospital bill. Don't have an Emergency Fund? Start saving for one with Radius Bank's high-yield savings account.
- Pay High- Interest Debt – Other financial priorities could include paying down high-interest debt. If you have a debt that has a higher interest rate than your investment return, you're losing money each day you carry the debt. So it works in your favor to pay down high-interest debt as soon as possible.
- Age – Another significant factor is your age.
- If you're 30 years old – You've got a few decades before you retire. You can play with long-term investments such as stocks that would be too risky for someone on the cusp of retirement. After all, stocks can lose their value quickly, but if you have 30 more years before you need that cash, you can afford to take that gamble.
- If you're closer to retirement age – you want to focus on maintaining what you've already got. Safer, steadier investments — especially where there are dividends involved — are a better choice for you.
- Compound Interest: Time is on your side
It's essential to keep in mind that investing comes with a risk, so make sure only to invest money that you know you won't need in a few months' time. The stock market can be volatile day-to-day, but you're more likely to make higher returns in the long run if you invest than if you don't invest.
Start Investing Today
You might think that now isn't a good time to invest because of all of the uncertainty around the coronavirus pandemic.
Instead of thinking about how much value stocks are losing today, think about investing in the long-term. On average, the stock market has a return of 10%. That amount does vary by year and by the type of stock of you invest in, but if you diversify your investments and keep investing, you're more likely to see a better return on your money then if you didn't invest. And as history shows us, stock prices eventually go up after they crash.
A Few Terms Investors Should Know
Whether you choose to hire a robo advisor or go it alone, there are a few investment terms you should know when you start investing.
- Stock: A stock is a share of ownership in a company. It represents a claim on that company's earnings and assets. Generally, when a company performs well, the value of the stock grows. And when the company doesn't meet expectations… well, it goes down.
- Bond: Buying a bond is lending money to a company or government (federal, state, or municipal). Bonds have maturity dates, at which time you can cash them in and collect interest money.
- Mutual Fund: A mutual fund gathers money from a lot of investors and invests it in assets such as stocks and bonds.
- Cash: Yeah, it's the green notes in your wallet. But in portfolio terms, cash usually refers to CDs (certificates of deposit), money market accounts, or Treasury bills.
- Expense Ratio: You'll see this term when it comes to mutual funds. “Expense ratio” refers to the expenses of owning a fund, including annual maintenance and administration fees, as well as the costs the mutual fund takes on for advertising.
- Price-to-Earnings Ratio: When looking at a stock's fundamentals, the price-to-earnings ratio (or P/E ratio) is essential. It examines a company's stock price as it relates to its earnings. A low P/E of 10 or less means the company isn't doing so well. But higher is not necessarily better — a ratio of over 25 may be a sign that the industry is about to have its bubble burst.
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