The idea of making your money work for you through investments has an obvious appeal to it. However, investing—especially for beginners—can be tricky. Here are four questions to help get you started.
1. What are the most important things that beginning investors need to know?
As an early investor, how and how much you invest should be based on your goals and the time horizons associated with those goals. Many young investors are eager to invest, but after watching their parents go through two market crashes in the last 15 years, this generation may err on the side of caution and invest too conservatively for fear of losing money in the short run. Additionally, having investments commingled for different goals can lead to unintended losses in the short term, or a shortfall on gains in the long run. For instance, if you have just one investment account for both retirement (in 30+ years) and for buying a home (in 5 years), then you are likely not investing appropriately. How can early investors overcome this? It is best to have separate accounts for each goal, or at least a separate account for goals with the same time horizon. For example, use Roth IRAs for retirement and taxable brokerage accounts for shorter term goals.
2. What types of investments are the best to start with, for beginners?
Choosing investments can be confusing and scary for many investors. First off, I want to make sure investors understand the difference between saving and investing. Saving is the act of putting money aside for future use. Too often, young investors put off saving for fear of not knowing how to invest. It’s imperative that you save over your lifetime because at some point you’ll need that money (for buying a house, college tuition, retirement income, etc.).
Investing is the growth of your savings. Ultimately, the better you do with investing, the less you have to save, or the more you can enjoy those savings. Investors who fear research and don’t feel like they’re doing all the work may be best suited choosing mutual funds. For example, you could buy a low-cost index fund like the S&P 500 and get exposure to 500 U.S. companies—no research is needed and yet they will have exposure in the broad U.S. market. Young investors also hear they should be diversified (don’t put all your eggs in one basket). Spreading your money between U.S. and foreign stocks as well as some real estate and bonds can help achieve that. Many mutual fund families have made this easier by offering funds that are balanced between all these investments so the investor only needs to pick one fund, but can achieve that same diversification.
3. How much money should you have available before you start investing?
Investing can happen with as little as a few hundred dollars, so really any amount of money is good to invest. However, it’s important to not invest every last dollar as you should also have an adequate emergency fund set aside. With investing comes risk, which is why the time horizon is so important when choosing your investments. Generally, the longer the time horizon, the more growth-oriented you can be. Growth-oriented investments tend to have more volatility (ups and downs over time). Unfortunately, we can’t predict when emergency situations will arise, but regardless of when, you cannot afford to have volatile investments if you may need the money, say tomorrow. Therefore, monies that are for emergencies should be kept in cash savings, money markets or short-term CDs. Also, it’s good to separate that from other accounts so as not to get commingled with another goal. A good rule of thumb is 3-6 months of expenses, but some have even started recommending more depending on the individual financial situation.
4. What are some of the most common mistakes made by new investors?
I can sum this up by saying that everyone should be saving (probably 10-15% of their gross income) for various goals. Investing should be in direct line with each respective goal(s) within the same time horizon. Lastly, write out your goals. Investors have a significantly higher chance of reaching their goals if they are written down and separated out.