Investing Basics: A 6-step guide for beginners

How to make smart investments toward your goals

While both saving and investing are two ways to put aside money for the future, the tools of investing tend to be more complex and risky (stocks, bonds, etc.) than an FDIC-insured savings account. Savings tend to be safer, but in the long run, investing has the potential to return at least twice what the best savings accounts can get you. That's why people looking to build wealth make investing part of their plan.

Below are key steps to take advantage of the benefits of investing. We’ll discuss goal setting, your relationship to financial risk and the various types of investments available.

1. Ensure you are ready to invest

Investing works best when you are prepared and consistently contribute to and monitor your investments. To determine if you are ready, check out our post: Are you ready to start investing?

2. Identify your goals

Deciding what you hope to accomplish may help you choose which investment type is best for that goal. Are you investing for a retirement that is decades away? Are you looking to fund a big trip within the next five years? While both are reasons to invest, the strategies to achieve them may be different based on the length of time before the event and your risk tolerance.

3. Gauge your risk tolerance

All investments come with some level of risk. Typically, those with more risk also have the potential to deliver a bigger return. You need to understand how comfortable you will be with your investments’ value frequently changing. If your goal is more than five years away, you may be able to weather the ups and downs in the market, knowing that, historically, stocks have tended to increase over time.

Understanding your timeline and your risk tolerance will help you decide which investments are right for you.

4. Determine your investing style

Would you prefer active investing where you or an advisor actively manages buying and selling your investments? Or, are you more interested in a passive approach where you buy and hold an index fund that mirrors the makeup of one of the stock indexes? An index tracks the performance of a group of assets (like stocks). You may have heard of the S&P 500. This index tracks the performance of 500 of the largest U.S. companies. Another one is the Dow Jones Industrial Average. Both are broad-based indexes that monitor the performance of the entire market.

If you’re going to handle your own trades (buying and selling stocks, bonds, mutual funds, ETFs, and more), you’ll need to open a brokerage account to access those investments. Brokerage accounts are different than standard savings accounts. There is generally a fee that you pay each time you make a trade through your brokerage account.

If you're using an advisor, he or she will make trades for you per the plan you establish. Typically, you pay the advisor a fee to help you manage your assets.

5. Choose your primary investments

The world of investment reaches wide and deep. Better understanding some of the primary types of investments can help you build a diverse portfolio.

Stocks

Stocks are also called equities. When you buy a stock, you own a small piece (a share) of the company that issued it. Publicly traded companies use the money raised by selling their stock to fund company operations and growth strategies – which (hopefully) makes your stock worth more than what you paid for it in the future. In general, stocks can be volatile which means their value (the price people are willing to pay) may go up and down significantly, and frequently.

Also note that when you sell a stock for a profit, you’ll most likely have to pay a capital gains tax. That is a tax on the profit you made. If you have held the stock for less than a year, you’ll have to pay short-term capital gains tax. If you have held the stock for more than a year, you’ll have to pay long-term capital gains tax. The long-term capital gains tax rate is usually lower than the short-term.

Bonds

When you buy a bond, you are loaning money to an issuer, like a company or government body. That issuer promises to pay you back when the bond matures and to pay you interest along the way. Bonds tend to be less volatile than stocks, but they also tend to have less earning potential – another example of the risk vs. reward involved in investing.

Mutual Funds

Rather than buying an individual stock, a mutual fund pulls together a basket of equities. This does two things for you. First, it eliminates the work of researching and buying individual stocks. And second, by bringing together a diverse mix of stocks, a mutual fund typically has built-in diversification. This generally makes them a less risky proposition than buying an individual stock. There are bond mutual funds as well.

Exchange Traded Funds (ETFs)

Exchange traded funds are similar to mutual funds in that they contain a basket of stocks (or bonds). But an ETF generally has a lower minimum investment requirement which could make it easier to buy for investors with smaller budgets. Also, ETFs are often tied to an index and referred to as passively managed. In other words, rather than handpicking individual stocks, the ETF manager buys all the stocks in a particular index (like the S&P 500) or a representative sample. Additionally, ETFs tend to have lower fees than mutual funds.

Real Estate

Investing in real estate often means buying apartments and commercial properties that are then leased. Property values may appreciate over the years and the tenants’ lease payments generate cash flow. Real estate can also be bought through a real estate investment trust (REIT). With a REIT, you buy a share in a corporation that invests in income-producing real estate.

Cryptocurrency

Cryptocurrency is digital money. You can buy it directly through a crypto exchange, buy shares in a crypto fund, or invest in a crypto company. Like stocks, cryptocurrency has the potential to be volatile.

Commodities

Think of commodities as raw products. The asset class can include everything from oil and gas to corn and beef to silver, gold, and platinum. You can buy an individual commodity (like actually buying gold), or you can buy into a commodity-based mutual fund or ETF.

6. Diversify

You know that old saying, “Don’t put all your eggs in one basket”? It also applies to your portfolio. By diversifying what you invest in, you can spread out your risk. With diversification, the hope is that if one of your investments is losing money, your other investments will help offset the loss.

Investing may feel overwhelming, but it doesn’t have to be. Follow these steps, allow your goals to guide your investment strategy, and remain focused on building wealth over time.

For more on investing, check out the free playlist in our online Education Hub. You’ll find valuable insight and guides to begin your investing journey.