How to Start investing for Beginners
Investing is a way to set aside money while you are busy with life and make that money work for you so that you can fully reap the rewards of your labor in the future. Investing is a way to a happier ending. Legendary investor Warren Buffett defines investing as “the process of setting aside money now in the expectation of receiving more money in the future.” The goal of investing is to invest your money in one or more types of investment vehicles with the hope of increasing your money over time.
Let’s say you have $1000 set aside and you are ready to enter the investing world. Or maybe you only have an extra $10 a week and want to invest. In this article, we’ll walk you through the first steps as an investor and show you how to increase your returns while reducing costs.
- Investing is defined as the act of committing money or capital to an endeavor with the expectation of obtaining additional income or profit.
- As opposed to consumption, investing money intended for the future, with the hope that it will grow over time.
- However, investing also comes with a risk of losses.
- Investing in the stock market is the most popular way for beginners to gain investment experience.
Click play to learn how to start investing in stocks
What type of investor are you?
Before you commit your money, you have to answer this question: What kind of investor am I? When you open a brokerage account, an online broker such as Charles Schwab or Fidelity will ask you about your investment goals and the level of risk you are willing to take.
Some investors want to take an active role in managing the growth of their money, while others prefer to “set it and forget it.” More traditional online brokers, like the ones mentioned above, allow you to invest in stocks, bonds, exchange-traded funds (ETFs), index funds, and mutual funds.
Brokers are either full service or discount. Full-service brokers, as the name suggests, offer a full range of traditional brokerage services, including financial advice for retirement, health care, and everything related to money. They usually only deal with higher net worth clients and can charge significant fees, including a percentage of your transactions, a percentage of your assets they manage, and sometimes an annual membership fee. It is common to see minimum account sizes of $25,000 and above at full-service brokerages. However, traditional brokers justify their high fees by providing advice tailored to your needs.
Discount brokers used to be the exception but now they have become the rule. Online discount brokers give you tools to define and carry out your own transactions, and many of them also offer an automated advisory service. As the financial services space advances in the 21st century, online brokers have added more features, including educational materials on their sites and mobile apps.
In addition, although there are a number of discount brokers with no (or very low) deposit restrictions, you may encounter other restrictions, and certain fees are charged for accounts that do not have a minimum deposit. This is something an investor should take into consideration if he or she wants to invest in stocks.
After the 2008 financial crisis, a new generation of investment advisors was born: the robo-advisor. John Stein and Eli Bruverman of Betterment are often credited as the first team in space. Their mission was to use technology to lower costs for investors and simplify investment advice.
Since the launch of Betterment, other robo-first companies have been established, and even online brokers like Charles Schwab have added bot-like consulting services. According to a report by Charles Schwab, 58% of Americans said they will use some form of bot advice by 2025. If you want an algorithm to make investment decisions for you, including loss tax harvesting and rebalancing, then an automated advisor might be right for you. Also, as the success of index investing has shown, you may work better with an automated advisor if your goal is to build wealth in the long term.
Investing through your employer
If your budget is tight, try to invest just 1% of your salary in the retirement plan available to you at work. The truth is that you probably won’t miss even a small contribution.
Work-based retirement plans deduct your contributions from your paycheck before taxes, making the contribution less painful. When you feel comfortable with a 1% contribution, you can probably increase it as you get annual increases. You are not likely to miss additional contributions. If you have a 401(k) retirement account at work, you may already be investing in your future through allocations to mutual funds and even your company stock.
Minimum to open an account
Many financial institutions have a minimum deposit requirement. In other words, they will not accept your account request unless you deposit a certain amount of money. Some companies will not even allow you to open an account with an amount as small as $1,000.
It’s a good idea to shop around for some and check out our broker reviews before deciding where you want to open an account. We include the minimum deposit at the top of each review. Some companies do not require a minimum deposit. Others may often reduce costs, such as trading fees and account management fees if you have a balance above a certain limit. Still others may offer a certain number of commission-free trades for opening an account.
Commissions and Fees
As economists like to say, there is no such thing as a free lunch. Although many brokers have recently been racing to reduce or eliminate commissions on trades, and ETFs offer index investment to everyone who can trade with an overdraft brokerage account, all brokers have to make money from their clients in one way or another.
In most cases, your broker will charge a commission every time you trade stocks, either through buying or selling. Trading fees range from a minimum of $2 per trade but can be as high as $10 for some discount brokers. Some brokers do not charge any trading commissions at all, but they make up for it in other ways. There are no charitable organizations that operate mediation services.
Depending on how often you trade, these fees can increase and affect your profitability. Investing in stocks can be very costly if you frequently jump in and out of positions, especially with a small amount of money available to invest.
Remember that a transaction is an order to buy or sell shares in one company. If you want to buy five different stocks at the same time, this is seen as five separate trades, and you will be charged for each.
Now, imagine that you decide to buy shares of those five companies for $1,000. To do this, you will incur $50 in trading costs – assuming the fee is $10 – which is 5% of your $1,000. If you were to invest the entire $1000, your account will be reduced to $950 after trading costs. This represents a 5% loss before your investment has a chance to profit.
If you sell these 5 shares, you will again incur the costs of the trades, which will be another $50. Making a round trip (buying and buying) on these five stocks will cost you $100, or 10% of your initial deposit of $1,000. If your investments don’t earn enough to cover this, you lose money just by entering and exiting positions.
Mutual fund loads
Besides trading fees for purchasing a mutual fund, there are other costs associated with this type of investment. Mutual funds are professionally managed pools of investor funds that invest in a focused manner, such as large-cap US stocks.
An investor will incur many fees when investing in mutual funds. One of the most important fees to consider is the management expense ratio (MER), which the management team charges each year based on the number of assets in the fund. The market exchange rate ranges from 0.05% to 0.7% per annum and varies by fund type. But the higher the market exchange rate, the greater its impact on the fund’s overall returns.
You may see a number of sales fees called loads when purchasing mutual funds. Some of them are front loads, but you’ll also see money with no load and back loading. Make sure you understand if the fund you’re considering has a sales load before you buy it. Check your broker’s list of no-load funds and funds without transaction fees if you want to avoid these additional fees.
For a novice investor, mutual fund fees are actually an advantage compared to stock commissions. This is because the fees are the same no matter how much you invest. So, as long as you meet the minimum requirements to open an account, you can invest as little as $50 or $100 per month in a mutual fund. It’s called Dollar Average Cost (DCA), and it can be a great way to start investing.
Diversify and reduce risk
Diversification is the only free lunch in investing. In short, by investing in a group of assets, you are reducing the risk of performance of an investment severely detrimental to your overall investment return. You can think of it in financial terms like “Don’t put all your eggs in one basket.”
In terms of diversification, the biggest difficulty in doing so will come from investing in stocks. As mentioned earlier, the costs of investing in a large number of stocks can be detrimental to the portfolio. With a $1,000 deposit, it is almost impossible to have a well diversified portfolio, so be aware that you may need to invest in one or two companies (at most) in the first place. This will increase your risk.
This is where the focus is on the main benefit of mutual funds or ETFs. Both types of securities tend to have a large number of stocks and other investments within their funds, making them more diversified than individual stocks.
It is possible to invest if you are just starting out with a small amount of money. It’s more complicated than just choosing the right investment (a challenging enough feat in and of itself), and you need to be aware of the limitations you face as a new investor.
You will have to do your homework to find the minimum deposit requirements and then compare the commissions with those of other brokers. Chances are that you will not be able to cost-effectively purchase individual stocks while still diversifying for a small amount of money. You will also need to choose the broker you wish to open an account with.