How to Invest Money: The Smart Beginner's Guide

If you’re ready to build wealth, here’s everything you need to know about how to invest money.
Last updated Sep 3, 2020 | By Miranda Marquit
How to Invest Money: The Smart Beginner's Guide

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Stock ownership in the United States has remained fairly steady since 2010, with about 55% of Americans owning stock, according to Gallup.

However, it’s worth noting that those numbers include the stocks owned in retirement accounts, like 401(k)s. When you dig into the data, according to the Pew Research Center, only about 14% of American families are directly invested in individual stocks.

But investing money can be a good way to build wealth for the future. If you’re interested in getting ahead in your personal finances, here’s what you need to know about how to invest money.

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What beginners need to know about investing money

One of the biggest myths around investing is the idea that it’s too risky. While there is some inherent risk involved with investing money, the reality is it remains one of the best ways to build wealth over time.

On top of that, learning how to invest money is easier than it’s ever been in the past. Thanks to technology and the democratization of investing, it’s possible for just about anyone to access investments — even if you only have pocket change.

There are a lot of options available for new investors, allowing you to tailor your investments to your short-term and long-term goals and your risk tolerance. On top of that, it’s possible to find investments that reflect your personal values. Values based investing can allow you to make money while still living your principles.

You can also make investing your money as complicated or as simple as you prefer. You can invest in index investments or individual stocks, depending on your personal style and your comfort level. With the variety of investment vehicles available, it’s no surprise that you can make the most of your money with a few clicks from the comfort of your home.

Now that you know how accessible investing is, let’s look at how to start investing money so you can choose the right investments for you and your financial goals. No matter your investing strategy, it all comes down to just three basic steps:

1. Pick your goal(s) for investing money

Before you start investing money, you need to have an idea of what you want that money to accomplish on your behalf. Figure out your goals for different investment accounts. In fact, you can have different goals. I have long-term, medium-term, and short-term goals for my investments.

For example, I have tax-advantaged retirement accounts set up as long-term investments for my retirement and a 529 set up for a medium-term investment — my son’s college education. I also have taxable accounts set up for short-term goals like spending on spontaneous items and traveling.

Not everyone likes the idea of investing to achieve goals like travel or saving up for a down payment on a house, so those might not be the right moves for you. However, the key here is to review your situation and decide which goals are best-suited to your risk tolerance and investing strategy.

Using the bucket strategy for your goals

One strategy to manage a portfolio is to use bucket strategy investing when deciding where to put your money. I use this strategy with my portfolio, and find it helps me stay focused on the essentials while avoiding panic during a volatile stock market.

Basically, the bucket strategy breaks down like this:

  • Short-term money: If you plan to use the money within the next three to five years, keep it in cash or cash-like investments (like money market mutual funds). These low-risk accounts likely won’t earn you as much, but you have easy accessibility in exchange.
  • Medium-term money: For money you think you’ll need in five to eight years, consider putting it in assets like bonds, dividend stocks, and medium-risk funds.
  • Long-term money: If you won’t need the money for more than eight to 10 years, you can consider putting that money into stocks and stock funds. You have more time for growth and recovery from downturns, so you can take bigger risks.

Start with a budget, and figure out how much you need to set aside in each bucket to have a better chance of reaching your goals. Prioritize your goals so the most important are funded first. For example, I used an online retirement calculator to decide how much I should put into my SEP IRA each month. Then I divide the remaining available funds between my son’s 529 and my travel fund.

Figure out what makes sense for you, and where your money will do the most good so you can create an investing strategy as part of your regular budgeting plan.

2. Decide where to invest your money

Next, when deciding how to invest money, you need to figure out where to put it. When you know your goals and you understand how to access your money, you can work out a strategy for where to keep your dollars.

Savings accounts

For short-term needs, a high-yield savings account can be a good place to put your money and still earn a little due to the interest rate. Savings accounts are highly liquid and allow quick access to money. These can be good options if you want to protect your principal. Savings accounts can be appropriate for an emergency fund or for short-term goals like making a large purchase. You can also get a slightly higher yield in some cases by turning to a money market account. However, you might be subject to account minimums.

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Don’t forget that money market mutual funds can also be a good choice. These accounts are investments and not FDIC-insured. However, they almost never lose money in the long run, and they can also be reasonably liquid. They can offer a higher return than a savings account, which can be a plus when you’re saving for short- to medium-term goals like large purchases, specific vacations, or a home down payment.

Finally, it’s also possible to use certificates of deposit (CDs) to save for short-term goals. You can find them at banks or credit unions. They are usually structured with different time horizons, allowing you some degree of flexibility if you use a ladder strategy. While CDs often come with higher yields than savings accounts, it’s important to note that you give up some liquidity, since redeeming them early can result in penalties.

Online brokers and traditional brokerages

Online brokers and traditional brokerages are more accessible than ever. In the past, high minimums kept some from investing in brokerage accounts, but today, the best brokerage accounts offer products and services for a wide variety of investors.

You can pretty much get any type of investment through an online broker or traditional brokerage, including:

  • Stocks: These are individual equities and what many people think of when they talk about investing. Stocks are shares of ownership in a company. You realize gains if you sell your share for more than you paid. You can usually buy these through a broker on the secondary stock market.
  • Bonds: Rather than being a share of ownership, a bond represents a loan you’re making to the company. You receive interest payments while you hold the bond. Then at the end of the term, you receive the face value of the bond. Most brokerages sell these, although you might pay a higher transaction fee than with stocks.
  • U.S. Treasury bonds: These are bonds issued by the federal government. While you can get these at online brokers and traditional brokerages, your best option is usually to go to TreasuryDirect.gov and buy them from the source.
  • Mutual funds: Rather than investing in individual securities, you can actually invest in hundreds or even thousands at a time by purchasing shares of mutual funds. These are collections of individual investments that share characteristics. They can also be index mutual funds. Some of the more popular options are bond and stock mutual funds. These can only be traded at the end of the day, and sometimes carry higher fees.
  • Exchange traded funds (ETFs): If you prefer funds, you can get ETFs, which are fairly liquid and trade like stocks on the exchange. It’s important to note that you don’t have a direct stake in the underlying assets like you would with a mutual fund. However, it’s possible to find ETFs that offer exposure to stocks and bonds, as well as more exotic investments, like commodities and currencies.
  • Brokered CDs: With a brokered CD, you can often get a higher yield than going through a bank or credit union. The brokerage usually has an arrangement with many financial institutions. For those with more assets, brokered CDs can allow you to have your money spread out among several banks. This helps ensure your money has FDIC insurance, even if you are above the limits cumulatively.
  • Real estate investment trusts (REITs): If you’re interested in real estate investing, but don’t want to buy property, you can buy into a REIT. These offer exposure to different types of real estate investments without the need for a large amount of money or to manage a property yourself.

Robo advisors and investing apps

For beginners looking to learn how to invest money in a simple and straightforward way, there are robo advisors and investing apps that make it easy. However, it’s important to realize there are some differences between the types of platforms.

First, robo advisors are designed to help you manage money according to asset allocation principles. Many robo advisors put together portfolios using ETFs (and sometimes REITs). Some of the more popular robo advisors, like Betterment, Wealthfront, and Wealthsimple, ask a few questions to get an idea of your goals and risk tolerance and then put together a portfolio that fits your needs.

You don’t have a lot of control with robo advisors, but it’s pretty easy to “set it and forget it.” Some robo advisors automatically rebalance your portfolio and make an effort to manage your tax efficiency. For many investors, it makes sense to set aside the same amount each month and invest that into the portfolio.

Some robo advisors, like Acorns, allow you to invest your spare change. You can have them put together a portfolio for you. Acorns also offers a Round-Ups feature that you can use to automatically round up your purchases to the nearest dollar and automatically invest your pocket change. This is one way to build your portfolio incrementally, although you likely need to make regular contributions to your account to be truly effective in the long run.

Betterment Benefits

  • Your financial life all in one place
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Other investing apps, like Stash, Stockpile, and M1 Finance, also allow you to invest in individual stocks and ETFs. These investing apps make use of fractional shares, in which you can buy a portion of a stock, rather than the whole thing.

For example, say you’re wondering how to invest in Amazon. If you want to buy a share of Amazon (AMZN), you might not have the thousands of dollars required to buy one entire share. However, you might be able to buy an eighth of a share for a few hundred dollars. You can still potentially benefit from the growth that comes with owning a piece of Amazon, but without the need to have as large a chunk of capital at the outset.

Popular stocks, like Apple (AAPL), Tesla (TSLA), and Google (GOOG) can also be purchased using the best investment apps. When combined with a dollar-cost averaging strategy in which you invest consistently, you can build up to a full share (or more shares) and take advantage of owning some of the most popular and successful companies.

Finally, you can also use trading platforms like Robinhood to get actively involved. With this app, you can use small amounts of money to learn the ins and outs of trading, although it’s important to be careful, since you can lose money in stock trading.

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Retirement

As seen in the research, most Americans involved in the stock market are invested through their retirement accounts. You might not think of contributing to your tax-advantaged retirement accounts as investing money, but it is.

  • 401(k): This is a plan offered through your employer. It’s typically a traditional 401(k), but it’s also possible to get a Roth 401(k). If you’re self-employed, you might be eligible to open a solo 401(k). These plans come with 401(k) contribution limits that are relatively high, with the ability to make catch-up contributions if you’re at least 50. Contributions are usually withheld directly from your paycheck. Usually your investment options are limited to a selection of mutual funds offered by your employer’s plan administrator.
  • IRA: The individual retirement account is one that you open on your own. There is a Roth version of IRA accounts as well. Contribution limits are lower than with 401(k)s, and there are income limits on those who want to contribute to a Roth IRA. Versions of the IRA, the SEP and the SIMPLE, allow business owners to make larger contributions. With an IRA, you may have more control over your investments, including the ability to hold real estate and some precious metals in addition to funds and individual stocks and bonds.

Roth vs traditional retirement accounts

When investing for retirement, it’s important to consider your long-term tax planning needs. Roth versions of IRAs and 401(k)s use after-tax money for contributions. So, you pay income taxes on the money now, but when you later withdraw the money from your retirement account, you don’t have to pay taxes.

On the other hand, traditional accounts come with an upfront tax advantage. You receive a tax deduction or you make contributions with pre-tax money. The investments in your account grow tax-free until you’re ready to withdraw money. Once you withdraw the money, though, it’s taxed at your regular tax rate.

In general, if you think your taxes will be higher during retirement, putting some of your money into Roth accounts may be a good option. If you think your taxes will be lower later, pre-tax contributions to traditional retirement accounts can make sense.

What about rollovers?

It’s possible to move your money by rolling over a 401(k) to an IRA. In order to avoid immediate tax consequences, you should move your money into an account with similar tax treatment. So, if you have a traditional 401(k), you can roll the money into a traditional IRA without paying taxes today.

If you’re interested in opening a Roth IRA, you can actually roll your Roth 401(k) into a Roth IRA without tax penalties. You can also roll a traditional 401(k) into a Roth IRA, but in that case, you would have tax consequences. You’d have to pay taxes because your 401(k) contributions were made with pre-tax money.

Carefully consider your options before you complete a rollover. If you have questions, talk to a tax professional before moving forward.

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Real estate

One popular way to invest, if you have the funds, is real estate. With real estate, you can purchase properties for different purposes and see returns. How much you actually end up making depends on where you buy as well as other factors. In some areas, the returns on real estate can be good when compared to the stock market. In other locations, appreciation isn’t as dramatic.

When it comes to how to invest in real estate, there are a variety of options that could suit a variety of goals and budgets. Here are some ways you can invest your money in real estate:

  • Rental property: Buy property and rent it to others. The revenue from renting can cover the cost of the mortgage and maintenance, and potentially provide income on top of that. Later, when you sell, the equity has been built by renters covering your costs.
  • Real estate flips: Some investors find success buying low-cost homes that need work, doing what’s needed to upgrade them, and then selling them at a profit. There’s a lot involved when it comes to how to start flipping houses, but for some people, it’s an enjoyable form of investing.
  • Real estate crowdfunding: If you don’t have enough capital to buy a property, real estate crowdfunding websites can help you access real estate deals at a relatively low cost. Some of the more popular sites include Fundrise, DiversyFund, and CrowdStreet.
  • REITs: Finally, if you want exposure to real estate, but want the ease of trading on the exchange, REITs can be a reasonable choice.

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3. Align your investments with your risk tolerance

As you consider which types of investments to include in your portfolio, you want to consider your risk tolerance and what matters to you.

Some types of investments — or asset classes — are viewed as riskier than others. For example, individual stocks are considered fairly risky. However, bonds, especially U.S. government bonds, are considered less risky. In general, the greater the risk that you could lose your principal, the riskier an asset is. With a diversified portfolio, the idea is to make sure you aren’t relying too heavily on any one investment. If one investment loses value, you still have other assets to provide a backstop in your portfolio.

One way to reduce your risk is to diversify your investment portfolio. There are different ways to do this. Asset allocation is one of the most popular ways to manage risk. The concept of asset allocation as being more important than the actual individual investments you choose was put forth by Harry Markowitz, who later won a Nobel prize for his efforts.

Your risk tolerance is determined by factors like your age, financial situation, when you’ll need access to the money, and other items. For example, I’m relatively young and have a fairly high risk tolerance for most of my portfolio. I can afford to see losses in my portfolio now, if it means I can buy more assets at a lower price and reap the gains later.

My retirement portfolio is 90% stock funds and 10% bond funds because I know I won’t need the money for a long while. On the other hand, I adjusted the asset allocation in my son’s 529 so that about half is in money market mutual funds, so I can access it quickly to pay for his schooling in the next couple of years. The remaining half is divided between bond funds and stock funds.

Many investors like using funds because it’s an easy way to get instant diversity. While individual equities can provide you with diversity when you buy them across different industries, the reality is that it can be harder to build a diverse portfolio with individual stocks when you have limited money to invest. It will also take a lot more time to build diversity into your portfolio by purchasing individual stocks on your own.

A special note on the FIRE movement

If you’re interested in the FIRE movement — financial independence, retire early — it might make sense to rely on stock index funds to help grow your portfolio and reach your FIRE number. But as you actually approach FIRE, it can make sense to shift away from that.

Some of those in the FIRE movement like using real estate to create passive income, or they build dividend portfolios to use dividend income later. Consider your individual circumstance and goals to figure out what makes the most sense for you.

Do-it-yourself vs. getting professional help

Thanks to modern technology, it’s possible to invest on your own or with the assistance of robo advisors. On top of that, it’s nice to know there are ways to get started even if you don’t know a lot or have a lot of money. When you start with index funds and ETFs, you can at least get your dollars in the market while you learn more about how to invest money.

If you’re struggling with how to start investing, it might make sense to get professional investment advice. A good investment advisor or certified financial planner (CFP) can help you pinpoint your goals and create an investment strategy. Some fee-only financial advisors charge a fee to help you create a plan, and then offer recommendations that can help you make the most of your money.

Additionally, some robo advisors will help you build a portfolio, but also provide add-on services that allow you to talk to a human financial advisor for a fee. No matter your needs, it’s possible to find someone to help you navigate all your investment decisions.

Bottom line

In today’s world, you need to learn how to invest money — even if it’s just passively with the help of index funds and ETFs — in order to build wealth over time. While savings accounts are an important part of finances, relying on them alone probably won’t help you beat inflation and build an adequate nest egg. But you don’t need to be a stockbroker on Wall Street to start investing, thanks to modern technology. Use this guide to start investing money, and you’re more likely to reach your long-term and short-term financial goals.

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