How to Start Investing: The Ultimate Guide

How to Start Investing The Ultimate Guide

If a limo was traveling the road to financial freedom, earning more money would be in the backseat with sunglasses on.

Earning money gets all the attention.  It’s the celebrity.    Passive income.  Side hustles.  Residual income.  It’s the sexy one on the cover of all the blogs.

You know who’s driving that limo?  The one doing all the work?  Investing.

Investing is the one that’s going to get you to the destination of financial freedom.

Investing is the magic behind an income snowball.

The question people have is: how to start investing?

You grow up with the idea that you have to earn money at some point.  Without earning any money, you wouldn’t be able to buy food.  You wouldn’t have a place to live.

Investing your money never gets talked about.

Stock prices.  P/E ratios.  IRAs.  Roth IRAs. 401k.  So many random letters and numbers.

It’s hard to know where to begin.

This guide will answer a lot of those questions.

Table of Contents

Investing Basics

Let’s start with the basics.  Before you can learn how to start investing, you need to know what is investing?

Investing is taking your hard earned money and putting it somewhere to grow.  Where you decide to put it will depend on how fast it will grow.

It will also determine how likely you are to lose it.

Some investment choices are riskier than others.  Usually, the riskier choices make your money grow faster.

The ultimate goal is to find the fast growing rate with the lowest risk.  That growth rate called the rate of return or interest rate.

There isn’t a one size fits all with risk.  Some people can handle more risk than others.

Types of Investment Accounts

The accounts you should know about when learning how to start investing

Where you put your money to grow is in an account.

The most common types you hear about are:

  • Savings
  • Money Market
  • Traditional IRA
  • Roth IRA
  • 401k
  • Brokerage

The first two are non-retirement accounts.  Traditional IRA, Roth IRA, and 401k are all retirement accounts.

A brokerage account can be either a non-retirement or a retirement account.  It’s a bit messier than the other ones but I want to include it because that’s where we start investing in corporate stocks.

Savings and Money Market Accounts

Savings and Money Market accounts are incredibly safe but also offer you next to nothing in interest.  They are both FDIC insured which makes them as safe as you can get.

FDIC insured means that your money is backed by the government.  Even if the bank fails, you’re still going to get your money.

You might get a slightly higher interest rate on a savings account than a money market account.

It used to be that you had easier access to money in a money market account, but that’s changing.

Both are easy to pull from when you need the cash.

Retirement Accounts

IRA stand for Individual Retirement Arrangements.

Roth IRAs and traditional IRAs are the most common retirement accounts outside of a 401k.

Tax advantages are what make these two accounts so special.

Traditional IRAs are pre-tax accounts.  Meaning you can actually deduct what you put into the account on your taxes.  There is one exception to this.  If wherever you work offers a 401k, you may only be able to deduct a small part.  In some situations, you may not be able to deduct anything.  It all depends on your household income.

Roth IRAs are post-tax accounts.  Meaning you don’t get any benefit during tax season for the money you contribute.

But, when the time comes to start pulling money out, you get to do that tax-free.

While your contributions to a traditional IRA are tax deductible, you still have to pay taxes on the money you withdraw during retirement.

With Roth IRAs, that money is tax-free.

There are pros and cons to both.  There are a lot (a lot!) of variables that go into deciding which to invest in if you don’t have a 401k.

If I didn’t know your situation and had to pick one…I’d go with the Roth IRA.

401k

A 401k is like a traditional IRA.  The money you contribute is pre-tax and subtracted from your taxable income.  Plus, it has a MUCH larger contribution limit than a Roth or traditional IRA.

This year (2017) the limit is $18,000.

Like a traditional IRA, you will end up paying taxes when it’s time to start withdrawing money.

You don’t pass up the opportunity to deduct that kind of money from your taxes, though.  If your work offers a 401k, TAKE ADVANTAGE OF IT.

Brokerage Accounts

This is where we start talking about stock trading.

Brokerage accounts are the places we put money to start trading in stocks.

When you see advertisements for ETrade, TDAmeritrade, Scotts…these are all brokers.

You put money into an account and then buy investments that trade on the stock market.  Most of these will be stocks in companies, but we’ll talk about some other things you can invest in through brokerages later.

Within a brokerage account, you can open a Roth IRA or traditional IRA account.  This way you get those nice tax advantages while trading stocks.

It can seem a bit confusing.  Just know that not all brokerage accounts are retirement accounts, but retirement accounts can be brokerage accounts.

Types of Investment Products

In order to figure out how to start investing, you need to know what you’re investing in.

When people talk about “investment products” they’re talking about:

From our limo example, the investment product is the engine.

Some engines have more horsepower and have the potential to get you to your destination faster.  Others have less and will get you there slower.

I say potential because the more horsepower an engine has, the higher likelihood of breaking down.  At least for this example.

Ranking the top investment products from highest risk to least risk would look like this:

  1. Stocks
  2. Mutual Fund
  3. Exchange Traded Funds (ETF)
  4. Bonds
  5. Certificates of Deposit (CD)
  6. Money Market/Savings investments

An argument could be made for shifting a few of those around, but most would agree this is the order in general terms.

Details on each investment product would be a massive blog post on its own.  I will get around to writing those, but in the meantime, Investopedia has great write-ups on each one.

Stocks and exchange traded funds are bought and sold on the stock market through your brokerage account.

Mutual funds, bonds, CDs, money market investments, and saving investments are typically purchased through individual firms, banks, or even the US government.

How to Start Investing for Beginners

The first thing I tell anyone when they ask how to start investing is to start as soon as possible.

Why is it so important to start immediately?  Compound interest.

Compound interest is the true power of an income snowball.  It’s the surest way to financial freedom.

Albert Einstein called compound interest the “the eighth wonder of the world.

Compound interest is the eighth wonder of the world

What makes it so powerful and why is it important to start investing as soon as possible?

Take two friends who are the same age: Susan and Bill.

Susan discovered the power of compound interest and started investing $5,000 per year when she was 25 and kept it going until she was 35.

Over the 10 years, she invested a total of $50,000.

Bill wasn’t quite sure about compound interest and didn’t start investing $5,000 per year until age 35.  Thinking he needed to catch up, Bill kept that up for 30 years until the age of 65.

In total, Bill invested $150,000.

Bill and Susan both used the same investment products.  They both had the same rate of return.  Susan started earlier and invested less, but everything else was the same.

Who do you think had more money at the age of 65?

There was a little part of you that thought Susan…and you’d be right.

Susan would have $602,070 by age 65.

Bill would $540,741.  This is assuming both had a rate of return of 7%.

Susan invested $100,000 LESS and still ended up saving $60,000 more than Bill!

What about Chris?

Let’s take our example a bit further.

Say you’ve got another friend named Chris.

Chris started investing $5,000 per year at age 25 like Susan.  But unlike Susan he didn’t stop at 35.  He kept investing $5,000 every year until he reached 65.

Over those 40 years he invested a total of $200,000.  Just $50,000 more than Bill.

How much more do you think Chris had than Bill and Susan?  $100,000 more?  $200,000?

Chris ended up saving $1,142,811!  Over $500,000 more than Susan.

This is the power of compound interest.  So the first thing you need to know about how to start investing is to start right now.

The power of compound interest in a graph

Should I Pay Off Debt First?

This question comes up a lot.

If you have credit card debt, the answer is simple…YES!  Get rid of your credit card debt as soon as possible.

The effects of credit card debt on your household

The interest rate on credit cards will kill your financial future.  Pay them off and never carry over a balance ever again.

Phew, ok.  Another question I hear a lot is around paying off student loans.

This one can go either way.

Take a look at your student loans and see what kind of interest rate you have.

If you’ve got an interest rate below 4%, I’d start investing now.

If your loans have a rate above 4%, I’d try to get them paid off as soon as possible.

It’s a pretty safe assumption that the stock market is going to return at least 7% over the long run.

For loans below a 4% rate, you’ll be at least gaining 3% more than you’d be losing.

Objectives of Your Investments

What is your goal of investing? You need to know that before you can start.

Now that you know the basics of investing, there is one more topic to cover before getting into the mechanics of how to start investing: what are your objectives?

What are you investing this money for?  Retirement?  Down payment on a house?  Pay for your children’s college?  Income?

Deciding what the objective is and why you want to start investing is the first question before you begin.

Investing for retirement is going to be different than investing for a down payment on a house.  And both are going to be different than investing for your kid’s college.

Four Buckets

In general, investing should start with 4 buckets.

  1. Emergency Fund
  2. Short Term
  3. Long Term
  4. Retirement

Think of each bucket like an account with a certain purpose.

Four investment buckets to start

Emergency Fund

The emergency fund is pretty self-explanatory: it’s for emergencies.

Unexpected doctors bills, home repairs, car repairs, you name it.  Having some cash set aside for a rainy day will put your mind at ease.

This investment needs to go in a savings or money market account.  It’s not going to gain a lot in interest, but that’s OK.  This is money we’ll need quick access to at any moment.

Short Term

Short term investments are anything you want to save for within the next 5 years.

This could be where the down payment on your house goes.

Money in this account should also be going into a money market or savings account.  Investing in the stock market or an exchange traded fund is a bit risky for something that you’ll need access to in 5 years.

You could also invest in Treasury Bonds to get a little more return on your savings.  In this case, you’d want to decide when you’ll need the money ahead of time.

Treasury Bonds have a maturity date which is when you get your money back.  This is why they have a higher rate of return.  It’s not easy to get your money when you want to.

Long Term

Long term investments are goals that you’ve set beyond 5 years.

If you don’t have a long term goal, I recommend investing for dividend income.

Even if you do have a long term goal, investing for dividend income is a smart choice.

Your money will grow at a rate as good or better than the rest of the market.  Plus, you get the added bonus of receiving monthly or quarterly checks.

Dividends should be reinvested but, at a certain point, you could start using them to pay bills.  You can even live off them if your investments grow enough!

Regardless, dividend investing will grow your savings enough to buy that beach house you’ve always wanted.

Here is where you’d want to open a brokerage account and invest there.

Retirement

We’re all going to retire at some point.  No one wants to be clocking in and clocking out of a job until their dying day.

Your retirement fund is there to cover you when you finally do choose to call it quits…at least from your day job.  Hopefully, you find a hobby that will earn a little residual income on the side.

The retirement fund is something you know you won’t touch for a long time.  It’ll be at least 5 years before we need to touch any money in this bucket.

This is where your work’s 401k comes in handy.

If your work offers a 401k, there is a group of funds already selected for you to choose from.

If your work doesn’t offer a 401k, this is where a retirement account inside a brokerage account comes in handy.  You can open a Roth IRA or traditional IRA and still get the tax benefits.

How to Make Smart Investments

What are some smart investments

Now that we know about the four buckets, let’s talk about some smart investment choices for each of those buckets.

Emergency Fund

How to start investing in an emergency fund is pretty simple.  You can open a savings account with the bank you currently use and start putting money into it for an emergency fund.

If you’re feeling a bit adventurous, you can search for the best high-yield online savings account and start putting your money there.

It might earn you a little bit more interest.  And in the savings game, every bit helps.

Short Term

Follow the same rules as the Emergency Fund.

Long Term

Long term investing is done through individual stocks or index funds.

If you want to invest in stocks, buying stocks from the list of Dividend Aristocrats would be very smart investments.  Build a portfolio of diversified aristocrats and you’ll be all set.

If buying individual stocks sounds like too much work, index funds would be another smart investment.

Index funds are passively managed.  This means they don’t charge high fees to the people investing in them.

Stay away from mutual funds!  Mutual funds are actively managed funds that charge a high fee.  It’s usually 1% or more to the investor.

They do this by making you think the fund can achieve a higher rate of return than an index because it’s managed by someone who “knows better.”  Study after study has proven that’s not true.

Plus, the high fees will kill your return in the long run.  Remember the power of compound interest?  Even a 1% lower return means missing out on thousands of dollars.

The impact of fees on your long term investments
Source: Vanguard

Ok, back to index funds being a smart investment.

Index funds are bought on a whole range of areas.  Funds that follow the S&P 500, S&P 1500, international markets, emerging markets…pretty much anything you can think of.

Vanguard index funds are always a great choice because the founder, Jack Bogle, hates fees.

Retirement

Retirement follows the long-term investing guidelines.

You can open a Roth IRA or a traditional IRA and start investing in stocks or index funds.

The 401k your work offers can vary.  Usually, they offer a select group of funds for you to choose from and invest in.  Sometimes they’ll even allow you to invest in individual stocks.

Not knowing what those funds will be, try to stick with index funds.  These are going to have the lowest fees and FEES MATTER.  Remember, fees are a four letter word.

I recommend going with index funds over investing in individual stocks in your 401k.

Best to set your 401k on autopilot and forget it.  This way you only need to check in once or twice a year and be on the path to a safe retirement.

A Simple Investing Strategy

A simple investing strategy

Your buckets are in place.  Your accounts are set up.  You’ve got an idea of what kind of stocks and funds you’re going to invest in.  Now it’s time to get detailed about how to start investing.  You need a simple investing strategy for each bucket.

Emergency Fund Investing Strategy

This is the first bucket you fund.  Because you don’t need to choose funds or stocks, the strategy is simple: put cash into a savings account and leave it.

Save up to at least 3 months worth of expenses in your emergency fund.

You never know what is going to happen on the road of life.  This money is going to give you peace of mind that you’ll be able to financially handle whatever comes along.

Retirement Fund Investing Strategy

Next up in your investment strategy is tackling the 401k.  If you’ve got a 401k, there is a good chance your work also has a matching program.

Most will match up to a 5% investment.  Some will do weird things like matching up to 50% of a 6% investment.

Either way, find out what that smallest investment required is to meet the company match and start investing!  You’re missing out on free money if you don’t.

It’s like work is offering you a raise and you’re not picking up the check.

Now once you’ve set up that automatic deposit into your 401k, you need to choose what to invest in.

Since I don’t know what funds you have access to, you’ll have to do a little research.

In his book Money: Master the Game, Tony Robbins interviewed David Swensen.  Swensen is the Chief Investment Officer of the Yale Endowment Fund.  The top name in the college endowment arena.

He recommends global diversification across many assets.  This creates a resilient portfolio that isn’t wholly dependent on the US stock market.

The Swensen’s portfolio looks like this:

  • 20% Domestic Stocks
  • 20% International Stocks
  • 10% Emerging Markets
  • 20% REITs
  • 15% Long Term Treasuries
  • 15% TIPs (Treasury inflation-protected securities)

David Swensen's recommended retirement portfolio

This is a fantastic portfolio that covers a lot of the market, reduces risk, all while still giving you a lot of upsides.

Since I don’t know what funds you have available in your 401k, I can’t tell you which ones to specifically invest in.

Look at the list of what you have available.  The names of the funds should give you some sign of which one of these 6 criteria it falls into.

Just remember…FEES ARE BAD.

Retirement Redux or Longterm or Short term

And now it’s time for you to decide which is most important.

Since the emergency bucket is full and you’re getting all that free money from work, it’s time for to decide where to go next.

Do you want to save more for retirement?  Try to retire early?  Then I’d say open up a Roth IRA or long term account.

Want to buy a house soon?  Go after that short term bucket.

If you’re leaning towards short term, follow the strategy for an emergency fund.  Start stowing away as much cash as you can in a savings or money market account.

If you know you’re not going to need the money for exactly 5 or 6 years, purchasing treasury bonds might be a good way to go.

Retirement Redux and Long Term

Investing long term and investing more for retirement can go hand in hand.

You may have a dream in mind that is 10 or 15 years out in the future.  Dreams can change, though.

What you thought was savings for a long term purchase could turn into helping pay for retirement.

That’s OK!  Having more money than you know what to do with is a great problem to have.  Maybe the best.

What you need to decide is whether you want to start investing those long term monies in a retirement account or a brokerage account.

The retirement account is most likely going to be a Roth IRA which means you can’t withdraw money until age 59.  If you do, you’ll have to pay a penalty and taxes.

Whether you decide to go with a retirement or long term brokerage account, the simple investing strategy here is to invest in dividend stocks.

The simplest approach would be to invest in the dividend aristocrats.

They usually beat the return of the S&P 500 AND have a lower risk.  Plus, there is the added benefit of receiving dividend payments throughout the year.

Simple Long Term Investing Strategy

Download the list of dividend aristocrats.

Each company falls into a sector.  There are 11 sectors.

To get plenty of diversification and lower risk, you want to pick companies from various sectors.

A manageable portfolio of 30 stocks has almost as low a risk as investing in the entire S&P 500.  30 is a lot easier to keep track of than 500.

Try to pick three stocks from each sector.  If you can’t, that’s OK.  Some sectors don’t have three dividend aristocrats to choose from.

Track how much you invest in each sector and stock.  Make sure that one stock or sector doesn’t get overweight compared to the rest.

If you’ve got $1,000 invested in a portfolio and $900 of it is in one stock, you’re in trouble if that stock goes down.

A 10% loss in that one $900 stock would cost you $90.

Say you had an even distribution of that $1,000 across all 30 stocks.  Each one with an investment of $33.  That 10% drop is only going to cost you $3.30.

Behold the power of diversification!

That’s it!  You’ve got a simple investing strategy for your long-term dividend account!

This isn’t to say there aren’t more sophisticated stock picking methods out there.  The dividend aristocrats have consistently beaten the market over the long term.  Creating a portfolio invested in those stocks is going to be a safe and simple strategy.

How to Open an Investing Account

You’ve got to open a brokerage account before you can start trading though.

With so many options out there, it’s hard to know which one to choose.

I’m partial to Robinhood.  You might be thinking “I’ve never seen any commercials for Robinhood.”  And that’s not surprising.  You wouldn’t

Robinhood is a fairly new player in the game that offers free trades!  This is a huge deal.

My other recommendation, Charles Schwab, costs $4.95 per trade.  That means if you invested $495, you’d already be at a 1% loss because of the $4.95 fee.

When Robinhood wasn’t available, I couldn’t invest $50 or $100 each month.  Those $5 fees would add up quick.

This is why I’m such a huge fan of Robinhood!  No fees!  That means you can invest as little as you want per trade.  There is no worry about fees eating into your returns.

Now, it’s not all roses and sunshine with Robinhood.  They currently don’t offer the ability to set up a Roth IRA or a traditional IRA.  If that’s the route you want to go, I definitely recommend Charles Schwab.

Maybe Robinhood will get around to that feature soon (@Robinhood: Hint hint).

If you decide Robinhood is right for you, setting up an account is easy.

Setting Up a Robinhood Investment Account

Go to Robinhood.com and click the “Sign-Up” button in the top right.

How to set up an investment account

Fill in all your basic information to set up an account.

Basic info to set up an investment account

Next up is your contact info.

Contact info to start an investment account

In order to keep money laundering from becoming an issue on the stock market, federal law requires anyone trading stocks to verify their identity.  Since you’re about to start trading stocks, you need to verify who you say you are by submitting your social security number.

Verify identity to open an investment account

Verifying identity form to start an investment account

Once your identity is verified, you’ll set up a bank account that will be used to fund your brokerage account and that’s it.  You’re now the proud owner of an investment account!

You’ll download the app from the iTunes store or Google Play, login and be trading in minutes.  All commission free!

Hopefully, this massive guide answered most every question you’d have about how to start investing.  There is a lot to cover in the world of investing, though.

Starting Investing Books to Read

Investing isn’t just nuts and bolts, though.  It’s not just about understanding diversification, what stocks are, and what type of accounts to open.

There is a lot of psychology that goes into investing.  The better you understand how the market works, the easier it will be to ride the ups and downs.

Or maybe the nuts and bolts weren’t enough.  Maybe you’ve gotten a taste and want to know more about different investing strategies.

Continued reading and education never hurt anyone!

Here are a few great books that I recommend for people starting their investment journey.  Not all of them are about the details of investing.  They will all make you a better investor, though.

The Little Book that Still Beats the Market

Verifying identity form to start an investment account

A fantastic book that you could read in a few hours.  It’s that little.  Joel Greenblatt outlines an incredibly simple formula for investing.  It’s a bit more complicated than investing in dividend aristocrats, but still really simple.

Plus, it’s just a fun read.

Unshakeable

Unshakeable: A how to start investing book

Tony Robbins isn’t known for his financial advice but he’s written a great book about the psychology of investing.  A shorter companion to his previous best-seller Money: Master the Game, Unshakable is about being fearless while investing.

Understanding that things are going to go up and down but all will work out in the end.  You’ve got to be patient and see things through.

He also pulls back the curtains on some real shady stuff that financial advisors have been doing for years.

It’s an all around great book to get you started on an investing journey.

Think and Grow Rich

Think and Grow Rich: A how to start investing book

First published in 1937, this one is a classic.

It doesn’t involve investing advice but talks more about wealth advice.  Napoleon Hill lays out the steps to wealth.  There are stories from millionaires like Andrew Carnegie, Thomas Edison, and Henry Ford to illustrate his point.

This is another one that gets you into the right mindset to be an investor.

The Intelligent Investor

The Intelligent Invest: A How to Start Investing book

Another classic by Benjamin Graham.

Here are the nitty gritty details of value investing.  A system that Warren Buffett uses.  He has called this “the best investment book ever written.”

Value investing is not for the day trader.  Which is good, you don’t want to be a day trader.

Value investing is all about the long term and using disciplined analysis to pick your investments.

The Intelligent Investor has a place on EVERY serious investor’s bookshelf.

Money Master the Game

Money Master the Game Book

I know I already put a Tony Robbins book on here, but this one is just too fantastic not to include.

It’s a long one.  If you can get through Intelligent Investor, you can get through this.

Money Master the Game is so great because it walks through so much.  While it won’t talk about investing in individual stocks, this book will set you up on a path to financial freedom.

It goes quite a bit more in depth than Unshakeable.  So if you read that and still want more, this is one to definitely pick up.

A Reading Guide

Start with Think and Grow rich to get yourself in the right mindset.

Then read Unshakeable and Money Master the Game to get your general finances in line and put a plan together to gain financial freedom.

Finally, read The Little Book that Still Beats the Market and The Intelligent Investor to get a good foundation for investing in stocks.

That’s it!  No more excuses.  You’re all ready to start investing.

Investing as a Young Person

A person is never too young to start investing

Alright, let’s put to rest just one excuse people have about investing: “I’m too young.”

That’s a HORRIBLE excuse.  If anything, investing while you’re young is the best thing you can do.

Remember compounding interest?  That “eighth wonder of the world” doesn’t care about how old you are.  It works just as well when you’re 8 or 80.

People think of investing as something you do when you’re retired.  Or about to retire.  Or have a steady career and family.

Nope.  Do it as early as you can.

Imagine that summer job you had as a teenager.  Making minimum wage 5 days a week for the three months you were out of school.

In Oregon, the minimum wage is $9.75.

$9.75 x 40 hrs per week x 12 weeks in a summer = $4,680

Now let’s say you are 15 years old and start investing that much every year until age 30.

Your investments would have grown to $138,748!  Sounds like a pretty nice down payment on a house.

Or you could not touch it and keep investing.

Keeping up with $4,680 a year.  $90 a week.  You’d be a millionaire by age 55!

You’re never, EVER, too young to start investing.

Conclusion

Hopefully, you haven’t fallen asleep by now.

The world of investing can be complex, but it can also be simple.

Don’t let investing scare you.  Dip your toes in and start learning.

Enjoy it!  Once you see compound interest start pushing that snowball down the hill faster and faster, you’re hooked.

Did I miss anything?  If you’ve got a question about how to start investing that I didn’t cover, please let me know!

Leave a comment below.

 

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