Why should I invest my money? How do I get started with investing? What is compounding? If you've ever wondered about these questions, specifically when it comes to investing in the stock market, you are in the right place!
In this post, you’ll learn everything you need to know about investing, along with some excellent tips to get you started. And finally, we’ll go over some pitfalls and things to avoid—no matter what your well-intentioned friends might tell you!
Why should you invest your money?
Investing is how you grow your money. Simple and short. Putting money in a savings account is great for the short term. It’s a great way to save for things like your emergency fund, a down payment on a home, or money you need easily accessible (within 5 years or so).
However, if you’re looking to save money for the long-term (such as for retirement), investing your money is the way to go. This is especially true given the very low-interest rates on today’s savings accounts (less than 1% on average in the US). If you strictly use traditional savings accounts, you won’t make any money at all!
What is it about investing that grows your money?
Investing will allow you a higher rate of return compared to a regular savings account, plus the power of compounding, which is what grows your money. The average rate of return on the stock market since 1929 has been around 7%. So assuming you earn the same average return of 7% on your retirement investments over the next 20 to 30 years plus compounding, we are talking about quite a large nest egg! Now wouldn't that be great?
So how does compounding work?
Compounding is the process by which your money grows from reinvesting your earnings over time. Let’s look at a very basic example. Let’s say you invest $1,000 today and you earn 10% on it. At the end of one year, you’ll have $1,100.
If you leave the $100 that you earned alone and don’t invest anything else, at the end of the 2nd year at 10%, you will have $110 in earnings with an overall total of $1,210. If you leave it for 10 years, you’ll have $2,593. Over several years, it adds up nicely. That is the power of compounding.
But what if you don't want to invest in the stock market?
If for whatever reason you decide the stock market is not for you, there are other avenues to invest your money. For instance, investing in real estate or in business. But again, these should be for the long term.
Important things to keep in mind
When it comes to investing in the stock market (or any other avenue for that matter), the past performance of the market is not an indication of future performance. That said, historical trends matter.
Also, keep in mind the stock market and other avenues have their cycles; markets go up and down, there are recessions and depressions (imagine LOSING 50%+ of your portfolio) and booming economies as well (imagine GAINING 50%+ on your portfolio).
Investing should be for the long term, I cannot repeat this enough. Investing for the long term allows you to grow your portfolio, weather the storms and make gains. This is why investing for retirement if it is several years ahead of you, is ideal.
Also, it is super important that you DO YOUR RESEARCH. Understand any and every investment you are making, any regulations or limitations around it, the risks involved, any associated fees, etc. That way, you can make informed investment decisions.
Before you take the plunge into investing, you first need to open a brokerage account. Here are some tips to help make that process quick and painless:
How to choose a brokerage account
You see commercials for them all the time, but what makes one investment service better than another? The simple answer is that it all depends on you. Only you know how much of your savings you’re willing to trade, but also keep in mind that your age and risk tolerance are important to consider as well.
Depending on the situation, you should keep a range of 15%-30% of your total brokerage account in cash. This way, you have enough money on the side to make trades for whatever you want. With this in mind, the following is a rough estimate of how much money is required to open a brokerage account with the following trading platforms:
What makes one better than the other? Again, it depends on how much and how often you plan to trade. The higher account minimums usually offer the first x-number of trades for free because they assume you will be doing a lot of trading. Make sure to determine what you can afford and how often you think you will be making trades.
Important features needed in a brokerage account
I do not advise one account over another, but I think it is important that any account you chose provides three things. First, they have a proven ability to execute trades – buys and sells – both quickly and at a decent price. Most of the well-known brokerage firms are good about trading stocks at the price you want, and most trades settle within 72 hours, but it is always good to check.
Secondly, see that the brokerage firm provides users with access to tools and educational information to help you make investment decisions. Lastly, you want to be able to check your account on the go, so having a great app for your smartphone or tablet is vital.
Look to buy stocks where you already spend money
So you have a brokerage account all set up and you’re ready to make your first trade – awesome! Before you go reading all kinds of big complicated reports and expert advice, ask yourself this question: where do I already spend my money? Everyone knows what brands they are drawn to because of product and service quality – if you already do business with them, and like them, you should own their stock. For example:
- Do you buy Nike shoes for your spouse, your kids, or yourself? Consider adding Nike (NKE) to your portfolio.
- If every car your family has ever owned was a Ford, you should be buying shares of Ford Motor Co. (F).
- Are you a bigger user of Macs than PCs or vice-versa? Make sure you look to add Apple (AAPL) or Microsoft (MSFT).
By now you’re probably feeling pretty fired up about this investing thing. Maybe you’ve already begun! But before you get too far along, I’d like to share some of my most useful tips for investing. Hopefully, these will make your experience that much smoother.
My top investing tips for beginners
1. Focus on the economy of you
Before you worry about what's happening in the world, you need to worry about what's happening in your personal and family financial situation. This is how you should always make your financial decisions.
- Do you have an emergency fund in place?
- Do you have debt you need to pay off?
- What are your personal financial goals?
- What are your long-term investment objectives?
- What is your risk tolerance?
These are all things you need to consider when it comes to your investing decisions.
2. Understand your fees
Fees, also known as your investment expenses, can add up over the lifetime of your investment if care is not taken. I'm talking tens or even hundreds of thousands of dollars depending on how much you have invested. So it's important to understand the different fees associated with your investments and shop around to ensure you’re getting the best deal.
Fee types include:
- Brokerage commissions for buying and selling your investments (One type fees)
- Annual maintenance fees on your investment accounts (Typically based on a percentage of your portfolio)
- Management fees for any investment advisors managing your portfolio (Typically based on a percentage of your portfolio)
3. Invest in funds instead of individual stocks
Unless you have several hours each day to monitor your stocks or have a strong understanding of the stock market, it's a better idea to invest in funds (i.e. mutual funds, index funds or ETFs). Investing in funds can help you create a well-diversified portfolio, as they typically include a wide variety of stock or bonds. You know, don’t put all your eggs in one basket, right?
Keep in mind that you may have to pay additional fees for investing in a fund vs individual stock, especially if the fund is actively managed. It is also very important that you do your research to understand the composition and objectives of the funds you invest in.
4. Determine your risk tolerance
When you invest your money, you assume the risk of losing part of your investment. So it's a great idea to determine your risk tolerance to make sure your tolerance level is in line with your investment objectives. That way, you don't lose sleep every time there is a market dip.
The longer you keep your money invested, the longer it has to grow and the longer it has to recover in the event of a market downturn like a recession. Take this quiz to determine your risk tolerance. You should never take on more risk than you can personally handle.
5. Rebalance your portfolio
To be sure you are staying on top of your investment objectives and timeline, set reminders to rebalance your portfolios every quarter or at least every year. As the market changes and fluctuates, you'll want to ensure that your investments are balanced according to your long-term strategy.
6. Educate yourself
Do not, under any circumstance, invest your money in any stocks or funds or business idea that you do not understand. Do your research, learn as much as you can and understand where you are putting your money before you make any investing decisions. The more you know, the less you fear.
7. Pay debt, save for a rainy day
Pay off any recurring debt you might have and build up your emergency fund before you invest in anything. Why? Because the interest rates on debt can sometimes be much higher than any returns you would make investing. Also because investing should always be for the long term, you want to make sure you have a solid emergency fund in place in the event of unplanned life occurrences. This way, you don't have to tap into investments when those life events come up.
8. Plan for the short term
Put any money you need in the short term (less than 5 years) in more stable investment vehicles like certificates of deposits and savings accounts. This money should not be in the stock market right. Also, create a plan to recession-proof your finances.
9. Diversify your portfolio
It's important to have a well-diversified investment portfolio. Why? To spread out the potential risk of investing and to hedge your portfolio as best as possible from severe losses. That means your investments should not all be tied up in one stock or in one real estate property.
You want to make sure your investments are spread across multiple industries and areas so that if one industry or area experiences a decline, it doesn't completely sink your entire portfolio.
10. Focus on long-term investing to build lasting wealth; Don't try to time the market
Think 10 to 15 years or more. Remember, Rome was not built in a day and Warren Buffet did not become a billionaire overnight. Market corrections happen. The DOW will decline. Timing the market is a fool's errand.
When you give your money time to work for you in the stock market, it can take advantage of the power of compounding. And remember, the average rate of the return of the stock market over the long term has been ~ 8% regardless of the market dips… but the key here is "long-term."
What Not To Do (Investing mistakes to avoid)
If you want to build serious wealth then you need to be investing your money. However, when it comes to investing, there are a lot of mistakes that investors make. Let’s talk about some of the most common mistakes investors make and how you can avoid them.
1. Waiting to Invest
When it comes to investing, time is your biggest asset. Starting sooner rather than later gives you a better chance of greater returns. Not only do you have more time to contribute to your investments you also have more time for your investments to grow over time and benefit from the magic of compounding.
Not sure how or where to invest? Educate yourself, pick a sector, do your research and talk to an expert who is not trying to sell you anything.
2. Investing with emotion
Want to know how NOT to invest? Watching every dip and climb the stock market makes every day. Investing because your boyfriend said so and you are so in love. Instances like this are recipes for disaster. Investing requires you to be objective and put emotions aside.
You’ll need to ask yourself questions like: does this investment make sense? Do I understand it? What is the level of risk? What is the rate of return? How much time am I able to invest? Put emotion aside and make your investment decisions with a clear head.
3. Trying to time the market
Your focus should be on understanding your investments and creating a long-term plan that aligns with your life and financial goals. Once you have a solid long-term investment plan, you can become more conservative as you approach the time when you'll need your money.
4. Expecting overnight returns on your investments
There's no such thing as overnight returns! If anyone is trying to sell this ridiculous notion to you, run! Investments require time to perform and grow in value.
5. Not considering taxes in your long-term plan
Understanding what your potential tax burden will be is critical to your plan. You'll need to make sure you factor into your plan how much in taxes you will have to pay on your earnings. This way, you can ensure you are achieving your financial goals from investing in addition to your tax burden.
Remember, investing is how you build real wealth, not something to be afraid of as long as you stick with it for the long term and you do your research. So if you've been wanting to invest your money, start now while you still have time on your side!