Whether you're a brand new investor or have years of experience, it's often wise to review your investments and investment goals to ensure your funds are invested wisely. But how exactly do you do that? Let's dig in and learn more about what that means and how to make the best decisions for your investments.
1. Figure Out Which Type of Investor You Are
The first thing to do is figure out your investor type. Some investors don't mind taking on serious risk for a potentially significant reward. In contrast, others couldn't bear the thought of losing money and prefer safe, conservative investments, even with a lower return on investment.
Before you start investing real money, it's wise to figure out which type of investor you are. Sometimes that's a hands-on approach where you pick every investment yourself. But others prefer to hand off their investment decisions to an expert. Here are some of the most common types of investors:
DIY Passive Investor
Most Investor Junkie readers likely consider themselves do-it-yourself (DIY) passive investors. This investor picks their own stocks and funds but mostly leaves things alone with a long-term approach to their portfolio. DIY investors use resources provided by their brokerage, sometimes combined with news and paid investment services to make investment decisions.
Active investors look to profit from short-term swings in the market. This investment approach requires more time and a higher appetite for risk. Active investors often rely on a combination of fundamental and technical analysis when entering trades.
Robo Advising Investor
Many investors are happy to manage their own money but don't have the expertise to build a diverse portfolio. A robo advisor is a digital investment product. When signing up, you enter information like your age, net worth, target retirement age and how you would respond in certain market conditions. Based on that, you are assigned to an expert-designed portfolio for people with similar needs and goals.
Some people don't care to know what “ETF” means (exchanged-traded funds), which stocks are in their funds, or how they allocate between asset classes. They just want their investments to work for them. In this case, you may be a hands-off investor who is best off working with a professional financial advisor for a fee.
If you do decide to work with a financial advisor, it's important that you choose a fiduciary. Fiduciaries are required to act in your best interest at all times. Some investors also prefer to use fee-only advisors or only financial planners who are certified with the CFP Board. If you'd like to find pre-screened financial fiduciaries near you, you can use a matching service like XY Planning Network or Garrett Planning Network.
Unsure which one you fall under? Find out your financial investing traits with Positivly, a platform designed to help you match your financial personality with your investing needs. You can find out more in our Positivly review.
2. Determine Your Risk Tolerance
Some investors have not been in the market long enough to remember what it feels like to see the stock market plummet in value in a short period of time. But it can certainly happen and is likely to happen again at some point in the future. To understand your risk tolerance, think about how you would prepare for a big drop in the markets and how you would respond if it happens.
If you don't mind seeing your portfolio tumble in the short-term because you know you're going to make it back when the market rebounds, you have a higher level of investment risk tolerance. These investors often keep cash ready for when the market drops so they can “buy the dip” in an attempt to earn more. A higher risk tolerance leads to a portfolio heavy on stocks and alternative investments.
If the idea of the stock market diving gives you the same nauseated feeling of going on a mega rollercoaster, you probably have lower risk tolerance. These investors may look to less-risky stocks and more stable investments, such as bonds, to steady their portfolios in the event of a major decline.
Many people find that they fall somewhere in the middle. There's no right or wrong answer when it comes to risk. The best decision is one you're comfortable with and fully understand.
Find out more: Investment Risk 101
3. Decide How Much You Want to Invest
Even Warren Buffett started his massively successful investment career with a single purchase. Most of us don't have millions or even thousands of dollars to sink into the stock market right away. But that doesn't mean you can't start investing. The best investment accounts have no minimum balance requirements to open a new account. And many allow you to begin investing with as little as $5.
For most people, the first place to invest is with a retirement account like a Roth IRA or an employer-sponsored 401(k). Experts often suggest saving at least 15% of your income in a retirement account to maintain the same standard of living in your golden years.
If you can afford to invest more, there are limits to what you can put into a tax-advantaged account. But there is no limit to what you can invest in total. Many investors spread their investments out between retirement and taxable investment accounts in an allocation that makes sense based on their income, expenses and investment goals.
4. Decide What to Invest In
How do you turn risk tolerance into a portfolio? Following are the most common types of investments you will likely encounter and an idea of the risk each entails.
Cash is the closest thing to being risk-free as it gets. And the government even insures cash in bank accounts in case the bank goes out of business. However, your bank account interest rates are likely to be very low compared to income from other investments.
Bonds are relatively low-risk investment assets. A bond is a loan, usually to a large company or government (local, state or federal). When someone buys a bond, the issuer usually makes regularly scheduled payments over the bond's life and then repays the principal at the end. Risk varies by issuer. Most individual investors own bonds only through exchanged-traded funds (ETFs) and mutual funds.
Investment funds are divided into two categories: ETFs and mutual funds. While there are some important differences, they work similarly in most ways. When you buy shares of an ETF or mutual fund, you're purchasing into a big bucket of investments that may include stocks, bonds and other holdings. Funds have varying investment goals and fees. So it's good to shop around to choose the best funds for your goals. And fund risk varies by the investments it holds.
Stocks are arguably the most well-known type of investment and for a good reason. A diverse portfolio of stocks tends to perform well over a long period of time. Some investors buy single stocks. But others prefer to buy a diverse fund with dozens, hundreds or even thousands of stocks in one purchase. Stocks are riskier than bonds in most regards but tend to offer a higher return.
Real estate has performed well for many investors over time. In addition to investment properties, some investors prefer to invest in a real estate investment trust (REIT) or a managed real estate fund from a service like Fundrise. Risk and return vary by investment.
Derivatives are investments that derive their value from some other underlying asset. Common derivatives are investments like options and futures. These are considered riskier investments and are suitable only for experienced investors.
Commodities are physical investments in bulk wholesale products like gold, oil, pork bellies and corn. Many investors access commodities through options, futures or investment funds.
Cryptocurrency has outperformed almost everything else (depending on when you bought in), but it's very risky. And then there's artwork investing, such as through the Masterworks platform. Risk varies when you get farther from the regulated investment markets. So invest here with care.
5. Open an Investment Account
Now that you know the basics of what to buy in an investment account, it's time to open that account so you can get started with your investment plan. Most brokerages in the U.S. make it easy to open an account yourself online in just a few minutes.
Choose Your Brokerage
For anyone wanting to know how to get started investing, the first step is finding the best brokerage for your needs. The best modern brokers offer free stock and ETF trades and low costs for other services, like E*TRADE. When choosing a stock brokerage, pay attention to fees, available investments and tools to help you analyze and understand your investments. You can find our stock broker recommendations in our Best Stock Brokers Guide.
Open an Account
Click on the button to open an account. This generally requires entering your personal information, including a Social Security number for tax reporting. Make sure to pick a secure, unique password you don't use anywhere else. And add two-factor authentication if available. In many cases, you can open an account online instantly, often taking as little as five or ten minutes if you have all of your information available.
Fund Your Account
Next, link your new brokerage account to your bank account. Your brokerage's online system could make this happen instantly or it could take a few days to confirm test deposits. Once linked, you can transfer funds from your bank account to your investment account. Some brokerages let you send a portion of your direct deposit straight to your investment account, helping you create an automated investment plan where you add a little bit more to your account every payday.
Make Your First Investment
Pick that first stock or ETF, do your research, load up the trade form and click the buy button. Depending on the investment and brokerage, you may see your trade complete near-instantly. You can view the pending and completed trades screen through your brokerage. And keep an out for a trade confirmation notification. Once the trade goes through… Congrats! You're officially an investor.
Types of Investment Accounts to Know About
The steps above work with nearly any kind of brokerage account. But not all accounts are the same. Each type of brokerage offers unique features that could help you save on taxes. And some even pick your investments for you. Here's a look at various types of brokerage accounts you may come across:
Taxable Brokerage Account
If there's a “standard” brokerage account, it's a taxable brokerage account. This type of account gives you the ability to buy and sell stocks, ETFs, mutual funds and other supported investments. Profitable investment sales are generally taxable in this type of account.
Employer-Sponsored Retirement Account
401(k), 403(b) and 457 accounts are tax-advantaged retirement accounts. In this type of account, you can invest for the future automatically, often earning a match from your employer. If you can get an employer match, you probably don't want to leave that free money on the table. These accounts have certain restrictions and typically offer a limited menu of investment choices.
Self-Directed Retirement Account
Outside of work, you can open an individual retirement account (IRA) where you can invest in anything you choose. Annual contribution limits apply, and tax savings vary depending on the type of retirement account you choose. If you're self-employed, you have additional options when choosing a retirement account.
A robo advisor is a type of account where a computer picks your investments for you. No, there's not an actual robot sitting at a desk picking stocks. Professional investors create model portfolios for a range of investment goals, and you're assigned to one of those portfolios based on your age and investment goals. This is an easy way for beginners to invest without having to worry as much about which investments to buy. Here are our top recommended robo advisors.
The Bottom Line
There are plenty of excuses for putting off getting started, but there's a popular investment adage that “time in the market beats timing the market.”
So don't sit around and wait for some sign from the universe. Consider this that sign! Today is a great day to get started with your first investment.