Investing for Beginners

Prudently investing your money can help you accumulate wealth and achieve major life goals, such as buying a home, paying for a child’s college education and funding your dream retirement lifestyle. Unfortunately, when it comes to investing, there is no one-fits-all approach. Investing is a highly personal endeavor, and the optimal investment program depends on your objectives and tolerance for risk, which is largely dependent on your time horizon.

How Do I Start Investing?

When you start investing, you first need to determine what you hope to accomplish and how much risk you are comfortable assuming along the way. Your risk-adjusted objectives will dictate the amount of money you deploy, the types of assets you buy and the duration of your positions (short-, intermediate- or long-term).

Factors to Consider when Investing

• Your age
• The extent and consistency of your income
• Your financial goals and their time horizons
• Your tolerance for risk

Most people that invest are focused on building an adequate nest egg for retirement. However, many people do so for additional reasons, including buying a home, starting a business, putting children through college and providing a legacy to loved ones.

Putting your money to work via an investment program is a smart way to achieve all these goals. However, the approach you embrace should reflect your goals and their associated time horizons.

One of the significant financial challenges facing younger clients is the realization that they should be investing to save for the future, but they don’t know where to begin. With the understanding that perfection is the enemy of good, it’s more important to just start investing and reap the rewards of compounding than to try to determine what’s currently the best investment (which is often thought of as the one everyone seems to be talking about).

Toby Walters, CFA®, CFP®Senior Financial Analyst

Toby Walters, CFA®, CFP® is a senior financial analyst with over 25 years of experience in financial research. His knowledge spans researching and analyzing financial data to developing a one-of-a-kind viewpoint on money-related topics.

Long vs. Short Investing Time Horizons

The longer your horizon, the more market volatility you can endure. A long runway allows you to look past near-term market ups and downs and focus on long-term performance. In this scenario, an investment portfolio comprised primarily of growth-oriented assets is sensible.

The shorter your horizon, the less market volatility you can endure. A short runway means you must prioritize liquidity and stability over growth. In this scenario, an investment portfolio comprised primarily of highly liquid, stable-value assets is sensible.

Fundamental Investing Principles

Anchoring an investment program based on your objectives and tolerance for risk is essential, but an understanding of foundational investing concepts is just as important. Three of the most important concepts are described below.

Risk-Return Tradeoff

The risk-return tradeoff holds that in order to achieve increasingly higher potential returns, an investor must assume increasingly greater levels of risk. Conversely, if an investor wishes to minimize his or her risk exposure, he or she must forgo potential return.

Along this continuum, there are various asset classes with distinct risk profiles. At the lowest-risk/lowest-returning end of the spectrum, you will find cash equivalents, such as certificates of deposit (CDs), U.S. Treasury bills and diversified money market funds. 

At a moderately higher level of risk, you’ll encounter an array of bonds with diverse credit qualities, including both investment-grade and non-investment-grade, along with varying maturity tenures. 

At the highest-risk/highest-returning end of the spectrum, you will find domestic and international stocks.

Savvy investors often include a variety of assets in a well-structured investment portfolio to achieve an optimal risk-reward tradeoff.

Diversification

Diversification is the key to optimizing investment performance. When you combine different types of assets in a portfolio, you can improve its efficiency (potential return per unit of risk assumed).

The strategy involves investing in assets with different risk profiles that tend to move in uncorrelated ways. This means when one asset moves in one direction, others move in a different direction – providing a balance in the overall portfolio. The rationale is that a diversified portfolio will maintain a relatively stable, upward trending value over time, enabling you to achieve superior long-term returns.

Time Value of Money

In addition to understanding the risk-reward tradeoff and the benefit of diversification, an appreciation for the time value of money is paramount for investors. Essentially, this concept asserts that a dollar today is worth more than a dollar tomorrow, because it can earn interest and grow with time.

For financially-minded individuals, this means striving to invest as early and for as long as possible. Doing so allows you to capitalize on the power of compound interest and amplifies your ability to accumulate wealth in a passive manner.

It is important to establish an adequate emergency fund before launching an investment program. For most people, this means setting aside six to twelve months of living expenses. 

Tax-Advantaged Retirement Accounts

Taxation is always a hot topic, and it is especially prominent when it comes to retirement. This is because the Internal Revenue Service (IRS) encourages saving for retirement by offering individuals attractive tax advantages associated with certain investment accounts, including employer-sponsored 401(k) plans and individual retirement accounts (IRAs).

Fully funding these vehicles is highly recommended by nearly all financial advisors. To mitigate longevity risk, which is the possibility of outliving your savings, experts suggest investing 10% to 15% of gross income in a retirement savings vehicle.

Types of Retirement Accounts

A traditional retirement account allows for tax deductions in the years contributions are made. The contributions are invested and allowed to grow on a tax-deferred basis during your working years. Then, in retirement, all withdrawals are taxed at your current income tax rate. However, penalties can be levied on withdrawals made before the age of 59 ½.

A Roth-style retirement account does not provide tax deductions on contributions. Instead, contributions are made with post-tax dollars, and these funds are then invested and allowed to grow on a tax-exempt basis moving forward. In retirement, all withdrawals are free from taxation. However, taxes and penalties can be levied on withdrawals made before the age of 59 1/2.

Key Asset Classes

The universe of investable assets is continually expanding – with increasingly granular distinctions. For novice investors, it is counterproductive to try to be aware of all of them. A more sensible approach is to gain an understanding of the foundational asset classes, which are briefly summarized below.

Cash Equivalents

A cash equivalent refers to a stable-value financial instrument with a maturity of 90 days or less. As mentioned earlier, examples of cash equivalents include short-term CDs, U.S. Treasury bills and diversified money market funds. These instruments offer modest returns relative to other asset classes and are largely risk-free.

Read More: What Is a Certificate of Deposit?

Bonds

A bond is a financial security that represents a loan made by an investor to an issuing entity. When you buy a bond, you are lending money with the expectation of getting paid back your initial loan at a specified future date with interest. An exception is a zero-coupon bond, which entails a discounted purchase price and a lump-sum payment at maturity that includes accumulated interest and principal.

Bonds are frequently issued by companies, sovereign governments, states and local municipalities to finance their operations and special projects. They are usually structured for relatively long terms, typically 5 to 10 years.

Stocks

A stock is a financial security that represents a proportionate ownership interest in a company. The primary reason most people buy stocks is to generate superior, long-term investment returns. This is achieved via the receipt of dividend payments and the recognition of price appreciation, which is when the price of a stock increases after purchase.

Annuities

Technically, annuities are not investment instruments. They are insurance products that entail upfront purchases in exchange for a series of immediate or deferred income distributions, which can be customized – in terms of size, timing, variability and duration.

Common types of annuities include fixed annuities, indexed annuities and variable annuities. Fixed annuities are the safest of the three, because they offer stable, guaranteed rates of interest. Indexed annuities are modestly riskier, because their returns can fluctuate. Variable annuities are the riskiest type of annuity, because they entail assuming investment positions in stocks and bonds.

Investment Help

There is a lot to learn when you start investing. Even the savviest investors have knowledge gaps, given ever-evolving macroeconomic theories, new financial products, tax law changes and other regulatory developments.

Fortunately, you don’t have to navigate this complexity on your own. Consider engaging the assistance of a fiduciary financial advisor. These credentialed financial professionals are legally and ethically committed to always act in their clients’ best interests. However, their services come at a cost, but the expert guidance and educational benefit they provide can be invaluable, especially, for novice investors.

Marguerita M. Cheng, Chief Executive Officer of Blue Ocean Global Wealth, believes there is great value in working with a financial advisor if you are new to investing.

“For our clients, we address both short-term savings for any emergencies or opportunities that arise and a long-term investing plan for their life financial goals,” says Cheng. “This gives them peace of mind and allows them to avoid making emotional decisions with their investments.”

Other Advisory Options

Full-service financial advisors are not the only channel of support available to new investors. If you are comfortable with technology and have a limited amount of money to invest, leveraging a robo-advisor or a micro-investing app could be sensible (and cost-effective).

Robo-Advisory Platforms

A robo-advisor is an automated investment management service that uses in-depth, online questionnaires and AI-powered algorithms to assess risk tolerance and build and maintain an appropriate investment portfolio for you. Betterment, Wealthfront and Ellevest are popular solutions.

Micro-Investing Apps

A micro-investing app is a type of robo-advisor that allows you to invest money in very small increments. Funding procedures vary. Some micro-investing apps round up purchases made via linked credit cards or debit cards and accumulate investable funds for you. Others allow for payroll deductions and periodic transfers from your checking or savings accounts. Acorns and Stash are two well-known micro-investing apps you may want to consider.

Frequently Asked Questions