Investing for Beginners: What to Know Before Getting Started
For the uninitiated, the world of investing might seem a little daunting at first. The worst scenario is when you begin investing while the market is crashing. However, some smart investors make a lot of money even when the market crashes. While investing your money wisely is definitely not an easy thing to do, with proper research and due diligence, you should be able to invest wisely and eventually manage to create wealth. In case you were considering investing your money somewhere but didn’t exactly know where to begin, this post has got you covered. Our simple and easy beginner’s guide to investing will definitely give you the initial push towards the life of a successful investor. With these tips, you should be able to step confidently into the world of investing and start the process of wealth creation. If you put in the time and effort and play your cards right, you might even create generational wealth. Let’s get started.
Important Investing Tips for Beginners
1. Decide the kind of investor you want to be
Just like anything else in life, before you start investing, you must decide how you are going to go about it. There are different ways to get started. You can get a hedge fund manager or get your feet wet by passively investing in index funds through a robo advisor. Let’s find out about them in detail.
D.I.Y (Do it Yourself)
While low cost/discount brokerages don’t provide advisory services,they do tend to provide a lot of affordable trading guidelines through online resources like webinars, analyst reports, and market news. For a better commission, full-service brokers offer advice and trade on your behalf. This can actually be cost effective if you don’t trade frequently and need professional guidance.
Hire a Financial Advisor
A financial advisor will assess your risk tolerance and your investment goals and then build and execute an investment plan for you. But it’s not an accessible option for everyone. Typically you would like a minimum investment amount from $250K to $1M or more to get some attention from them.
These are low cost investment tools specifically targeted for the tech savvy millennial investor. They manage financial portfolios using complex and effective algorithms. Robo advisors tend to invest using ETFs based on a client’s risk tolerance, financial goals, and time-horizon. Robo Advisor services are almost always exclusively online and the human contact tends to be minimal. As a result of that, they tend to cost less than traditional financial advisors. However, it’s important to remember that investors also pay the cost of ETFs themselves. Add up the portfolio management fees along with the ETF management fees and the total comes in around 1%—better than most mutual funds, but not super cheap. The big advantage with robo-advisors is that they need few, if any, restrictions on investment size. This makes them ideal investment tools for those starting out their investment journey, with less money to invest.
2. Assess your risk tolerance and choose an asset class based on that
After setting up your account, either with a brokerage or a robo advisor, it’s time to start investing. This might seem a little daunting at first. There are a lot of investing options, depending on your risk tolerance, or how willing you are to lose your money in exchange for a higher return.
Higher the risk, the higher the returns. So they usually seem quite tempting and you should have a portion of your portfolio in high risk stocks, as long as they are offset by safer asset classes. The key to a successful portfolio is diversification. You should always invest your hard earned money in different asset classes.
An “asset class” is nothing but a group of similar kinds of investments. You can invest in one asset class or many. A mix of asset classes, or diversification, gives you a well-rounded portfolio that can weather the ups and downs of the stock market. A good example of a diversified portfolio would be investing in a mutual fund, owning a variety of individual stocks across a number of sectors (like healthcare, transportation, and retail) and also owning and renting out a few real estate properties.
Here are the basic asset classes for investors based on how risky they are:
- Real Estate
- Futures and Other Derivatives
- Commodities and Precious Metals
- Other Alternative Investments
We are not discussing all of them in great detail as it would make the post extremely long. You can read about them individually at a later time.
3. Set a Deadline and Choose an Investing Goal
After deciding your preferred asset classes and how to allocate funds to them, you need to set your financial goals. What are you saving and investing for? How much will you need? For example, if you are saving for buying a new car, the amount will be much smaller than if you are saving for a house. If you’re saving for retirement, it will be a larger corpus than your kid’s education fund. The key terms that arise here, are long term investment and short term investment. Let’s discuss them in a little detail.
What’s the difference between long-term and short term investment?
Here are some popular types of short term investments:
These short term investment tools mature in less than 91 days. These are perfect for investors who want high levels of liquidity.
These funds don’t have any credit risk and exclusively invest in government securities.
Ultra short term Debt Funds:
These usually have a maturity period ranging between 3-6 months and offer better returns compared to other high liquidity funds.
Large Cap Mutual Funds:
As the name suggests, a large chunk of your money gets invested in companies with large market-capitalization. These funds can generate good returns in a short period of just 1-3 years. Large cap mutual funds offer stable returns and come with very little risk as your money is invested in companies that are well established.
Here are some popular types of long term investments:
Investing in stocks is one of the best ways to generate a good amount of returns. There are numerous stories of investors who bought stocks at very low prices over a few decades ago and have become millionaires as a result of the growth in price. However, you must do your research and properly understand the growth prospects and future potential before putting your hard earned money in the company for a long term. As the stock prices tend to move up and down, a careful approach and guidance is needed when it comes to the topic of holding, buying or selling stocks. The best decisions in the stock market are always the most well researched and well thought out ones.
You can check Best Stocks to Buy Now to find out potential stocks.
Equity Mutual Funds:
Investors with high risk appetites can choose to invest in equity mutual funds especially in mid cap and small cap funds since they can generate higher levels of returns.
Passive Income methods:
Dividend stocks are a great tool for earning passive income. They have been tried and tested over many years by numerous investors. You will need to do much research to seek out good stocks and invest a big amount of cash to receive large dividend checks. However, if you consistently invest money into dividend stocks you’ll amass a pleasant residual income over time.
For any of those investment opportunities, confirm you open an account at the simplest online brokerage, and obtain rewards while doing it.
Peer to Peer Lending
P2P lending is the practice of loaning money to borrowers who typically don’t qualify for traditional loans. As the lender you’ve got the power to settle on the borrowers and are ready to spread your investment amount to mitigate your risk.
A cash flowing rental property is a great way to usher in a monthly income. However, to make it completely passive, you will have to consider outsourcing your property’s management to a dedicated property management company. However, just like with everything else, the advent of the internet has resulted in rental property investment becoming far easier than ever before. There are a lot of ways you can invest in rental properties depending on what your goals and interests are. You can be a limited partner in large residential or commercial properties, otherwise, you can purchase homes and be a landlord – all online!
In case you want the exposure and the income but don’t want to become a landlord, you can consider being a limited partner for a large development. With these options, you’ll invest in multi-family or commercial properties. You get the income and tax treatment a bit like regular land ownership, but you do not do any of the work!
High Yield Savings Accounts And Money Market Funds
In case you don’t want to spend too much time and effort thinking about your money and want the money to do the work for you, you can invest your money in a high yield bank account or money market fund.
The difference is within the account type and where it’s located. High yield savings accounts are offered by top banks and are usually FDIC insured. Money market funds are often offered by both banks and investment companies, and FDIC insured sometimes.
Interest rates have been rising, so putting more money into a savings account can generate a safe passive income stream.
Certificates of Deposit (CD) Ladders
To build a CD ladder, you will need to buy CDs (certificates of deposits) from banks in certain increments so that you can keep earning increasing returns from your money. Most banks offer CDs. These are low risk investment tools, hence the return rates are also low. It’s great for people who are risk averse. In case you find the construction of a CD Ladder a bit too complicated and convoluted, you can choose to stick with a standard high yield bank account or market fund. CDs offer low rates of returns compared to other options on the list, but on the other hand, they also carry very little risk.
Annuities are a type of insurance product that requires you to pay in the beginning but it can provide you with passive income for the rest of your life. Annuities usually have varying terms and don’t always offer a great deal. So before you invest in annuities, you should try speaking to your financial advisor. Annuities are definitely not for everyone as they can come with high fees and might not yield desired returns in the end. However, if your risk tolerance is as low as possible and you want a decent passive income stream, annuities can be a good addition to your portfolio.
Invest Automatically In The Stock Market
If you’re not interested in picking dividend paying stocks (and we can understand that), there are still ways to invest passively in the stock market. You can automatically invest in various ways through what’s called a robo-advisor.
A robo-advisor is quite self explanatory. It’s a robotic financial advisor. You spend about 10 minutes answering a few questions and setting up your account, and the system will take it from there. It will make investments as per your goals and risk appetite, rebalancing your portfolio periodically.
REIT (Real Estate Investment Trust)
If you’re concerned about investing directly in real estate, or maybe you’re not yet an accredited investor, that’s okay. Enter REITs – Real Estate Investment Trusts, which allow you to take advantage of real estate investments. These are investment vehicles that hold property within them – and you as the owner get to benefit from the gains, refinances, sale, income (or loss) on the property.
Refinance Your Mortgage
At first glance, this definitely appears a bit weird in a passive income generation article, but if you refinance your existing mortgages wisely, you can free up a lot more money and save hundreds of thousands of dollars over your lifetime. That is a lot of money.
Right now, interest rates are still near historic lows, and if you haven’t checked out your mortgage lately, now’s a great time to shop around and compare rates. If you can save 0.50% or more on your loan, you’re potentially adding tens of thousands of dollars back into your pocket. Not many investments can beat that.
4. Outline the budget for your investment
While it might seem boring, budgeting is key to becoming a successful investor. While you are creating your budget, try to allocate a good amount of money for investing. One of the good ways to invest successfully on a budget is value investing or investing in undervalued stocks which are cheap at the moment but are projected to rise in the future.
What is value investing?
Value investing is an investment approach that seeks to profit from identifying undervalued stocks. It is supported by the thought that every stock has an intrinsic value, i.e. what it is truly worth.
Through the fundamental analysis of a corporation, we can figure out its intrinsic value. The idea is to buy stocks that trade at a significant discount on their intrinsic values (i.e. they are cheaper than their true value). Once we buy an undervalued stock, the stock price eventually rises towards its intrinsic value, and makes a profit for us within the process.
Value investing is conceptually simple, though it does require effort to implement. Here are some of value investing’s philosophies:
Component #1: Mr. Market
Imagine you are in a partnership with Mr. Market, where you can buy or sell shares. Each day, Mr. Market offers you prices for shares counting on his mood. If Mr. Market is feeling very optimistic, he will offer very high prices. In this case, an investor should sell the shares. If Mr. Market is in a very pessimistic mood, he will offer low prices, and this is often the time to shop for new shares.
Component #2: Intrinsic Value
Intrinsic value represents the true value of the company based on fundamentals. In the short term, market prices deviate from their intrinsic values thanks to changing market sentiments. In the future, market prices return to intrinsic values. This process allows us to make profits, because we can buy stocks when they fall below their intrinsic values. We then hold them until they return to their intrinsic values in the long term.
Component #3: Margin of Safety
The margin of safety is the essence of valuation. Since the estimates of intrinsic value involve subjective assessments, there is a possibility of being overly optimistic. By adjusting the optimism, the margin of safety can provide a decent cushion.
Component #4: Investment Horizon
Value investing works with an eye on the future, because that’s when prices return to their intrinsic value. Value investing doesn’t aim to predict what stock prices will do 2 days or 2 months from now. Instead, it aims to pick undervalued businesses that will outperform in the long term. This will eventually reflect in the stock price.
Avoiding stock chasing
Never chase a stock. You must take control of your conscience/emotions and stick to your plan and price target you’d like to purchase it at. Stocks rise yes, but they also pullback (meaning fall) as well. We saw this in 2009 with the Great Recession and we saw this in 2020 with the Great Lockdown due to the global Coronavirus pandemic.
Be patient, have cash saved up to wait for stocks to pull back and have cash saved up to buy consistently every month or quarter when stocks are on the way up too.
Those who get too excited, end up buying into a stock at too high of a price out of emotion. Emotions are not good in the investing world. Subdue them.
Those who day trade will echo these sentiments. If you stick to the original plan you have of what price you would like to buy the stock at and what price you want to sell at, then you will see better results.
5. Lower Your Fees and Expenses
Once you start investing, you will find out that a lot of your returns are being eaten up by fees. So make sure you are not getting ripped off in that regard and manage your fees well. When you invest, these are some of the fees you will encounter:
- Account Maintenance Fees: This will typically be an annual fee below $100. However, this fee is generally waived after you cross a minimum balance threshold.
- Commissions: A flat amount per trade or a flat amount plus a percentage per trade. This fee tends to vary with your broker and the type of funds you invest in.
- Mutual Fund Loads: Either front-end, back-end, or a combination of both. However, if the brokers hold the funds in their own brokerage accounts, these charges are usually waived.
- 12b-1 Fees: These are levied internally on your mutual funds. They can slash your fund value by up to 1% every year.
- Management or Advisor Fees: A fee paid to an advisor who manages your accounts. Of course, you can get rid of this entirely if you manage your account yourself. That will take time and effort but once you pull through, you will save thousands of dollars every year.
So those were some important things to know before you start investing. Investing is definitely not the easiest thing for beginners, but remember, even Warren Buffet was a beginner once. It’s possible, so don’t feel daunted by the scale of things at the beginning. It gets easier with time. Focus on sharpening your investing skills over time and create generational wealth for yourself and your family.