The Beginner's Guide to Investing
Should I be investing? As long as you are free of high-interest debt and have money that is kept liquid, or available, for unforeseen expenses (AKA an emergency fund), it is a great idea to get started investing early. The sooner you start, the more time your money has to grow. It is even OK to get started investing with a small amount of money - nowadays you can easily open a low-cost brokerage account with no minimum investment and no minimum balance.
If you have a plan through your company, like a 401(k), you should contribute at least enough to take advantage of any matched money that your employer offers. After this point, most people elect to open an IRA (Individual Retirement Account). An IRA is just a type of account that has special tax treatment. In most cases, you could buy 1 share of Apple in an IRA, you could buy 1 share of Apple in a 401(k), or you could buy 1 share of Apple in a regular brokerage account (a brokerage is a company that buys or sells stocks for clients - more on that later). Either way, you still own 1 share of Apple - the main difference is just how the account is looked at by the government at tax time.
Why you shouldn't just leave your extra money in a bank The current average one to five year CD ranges from 0.29% - 0.83% interest, and even the best savings accounts hover below 1% interest. However, the most recent inflation rate for the United States is 1.1%!
What does this mean? Most deposit accounts are not keeping up with inflation. But, the long term average yearly return of the stock market (S&P 500) is 11.54%. This figure takes into account major economic depressions like the 2008 recession: meaning: no, your money is not guaranteed to increase every year that it is invested but in the long term, the stock market performs MUCH better than a deposit account.
This type of interest rate environment makes smart money management and investing all the more important. However, if you are unfamiliar with investing, or do not have access to investment advisors, it is easy to feel lost and unsure where to begin. For this reason, many novice investors make the expensive mistakes of individual stock picking, market timing, and chasing hot investment tips.
Why is stock picking bad for beginners? -One reason is the Dunning-Kruger effect: The tendency for unskilled individuals to overestimate their own ability. Beginners often think they have an "edge". In reality, when you try to pick individual stocks you are going up against highly paid, highly skilled professionals who pick stocks every day for a living; not to mention high-speed trading algorithms that increasingly stack the deck against the individual investor (Source: Institutional Corruption in High Frequency Trading - HuffPost Business).
-One, perhaps worse explanation is "stock tip" blogs and newsletters. Many new investors will read and trust online sources touting a particular stock with "explosive growth potential." These are often "pump and dump" schemes. The Internet now provides a cheap and easy way for scammers to reach large numbers of potential investors - by "pumping" the stock (recommending to lots of people), they are able to increase the price artificially so that they can sell at a gain. Most of the investors being taken advantage of end up losing their entire investment.
-The last reason is a simple lack of time and resources. Due diligence done by professional traders involves expensive Bloomberg terminals that monitor and analyze real-time market data, and hours of in-depth research. At best, the online research available to the average beginner investor simply does not stack up; at worst, it is fraudulent and swindling.
Our opinion is that you DON'T want to own individual stocks or bonds; instead, it is advisable to opt for exchange-traded funds (ETFs). This may sound complicated, but at it's simplest, an ETF is just a fund that tracks many different companies. For example, if you bought one share of the popular ETF known as SPY, (which track the S&P 500 stock market index), it would be like owning a fraction of Apple, a fraction of Amazon, a fraction of Netflix, and many other companies that you've likely heard of before and have performed very well over time.
The benefits of this are: 1.) Since it is already set what companies will be included in the fund, you are not paying an expensive hedge fund or mutual fund manager to pick stocks that may or may not even outperform the market. (Source: It’s Time to End Financial Advisers’ 1% Fees - Wall Street Journal). This can mean BIG savings over the years of investing. 2.) When you pick a few stocks, you run the risk that a single company you've chosen will perform poorly or even go bankrupt; which would have a large effect on your portfolio. With an ETF, even if some companies under-perform, your risk is more spread out. This means your money is safer. 3.) You don't have to pay multiple commissions and fees by buying several different stocks - it's all one transaction. 4.) Your taxes are easier, for the same reason. (even mutual funds are liable to incur higher capital gains taxes than ETFs due to more frequent trades.)
**Since 2013, ETFs have been the most popular type of exchange-traded product, primarily due to their tax efficiency and lower transaction costs.**
The next question is which ETFs to pick. This can be a more subjective question, as the answers vary based on a number of factors such as your tolerance for risk and your investing timeline (when you need to take out the money). That is where robo-advisors come in. Robo-advisors leverage both automation and algorithms to automatically manage investors portfolios in the best possible way for the individual. Utilizing this simple strategy, investors can bypass commissions to buy and sell stocks, sales fees and expenses, and unnecessary taxes, which erode overall investment performance. Perhaps more importantly, robo-advisors help avoid the mental biases that often trip up beginner investors.
How to buy ETFs? Buying ETFs is easy. You just need to open up a brokerage account. Our top choice is Betterment; a brokerage that handles more than $4 Billion in assets for over 150,000 clients and has NO minimum to open an account. It's perfect for beginner investors because it's easy to use and understand, requires no time-consuming research on individual stocks, and utilizes robo-advising tools to keep your fees extremely low and your gains as high as possible.
Why do we recommend Betterment for beginner investors? During an approximately five minute-long setup process, you simply respond to a series of short questions about your investment needs, like: Initial deposit: how much do you have to invest right now? Monthly savings: how much can you put into the account in the future? Time horizon: when will you need to take out this money? (retirement, college, down payment on a house, a vacation, etc.)
From this, Betterment will automatically calculate the optimal investments you should purchase, and what percentage to buy of each, for your particular scenario. Betterment's goal is to make investing as easy as opening a regular bank account. You simply deposit funds and Betterment automatically purchases the ETFs best suited for your asset allocations. Dividends (profits that the company pays out to investors) are automatically reinvested, and your ETFs are rebalanced automatically each quarter. Even complicated tax actions like Tax Loss Harvesting are performed automatically. Betterment uses software to automate the same tasks that most brokers charge exorbitant fees for. The portfolio is optimized to give you the best possible performance (in fact, even beginner investors average 4.30% higher returns with Betterment than a typical DIY investor). And it's easy to sell the investments and withdraw the money should you decide to.
All of these things make Betterment the best long-term investing solution for inexperienced investors, young investors, or people who want to get started investing even with a small amount of money. Their robo-advisor software will help even beginner investors average 4.30% higher returns than a typical DIY investor.
--- Please note that this is general financial advice that is applicable to most people, but we have not considered your specific scenario. The information herein it is not a substitute for consulting with a professional financial adviser. Please click here if you would like to arrange a consultation with an independent financial advisor. Your mileage may vary. Although most of the investments recommended are considered relatively safe over a long-term period, investments made at any brokerage are not FDIC insured and can lose value. Affiliate links may be used on this site when they are offered by the service provider, meaning advertising revenue is received if you decide to use a product. This does not have any effect on the pricing offered to you. Read our about us page for further information. Happy investing!