6 Basic Steps on How to Invest Money for Beginners
This post was originally published on The Money Mix.
So … you’d like to learn how to invest your money, but are afraid the concept is out of your reach. Indulge me here for this next one — because you may be surprised!
You have a great job and make a good income. Your student loans are long gone, and you’ve even obliterated all of your credit card debt. Now you’re ready to save and invest.
But you’re not quite sure how to invest your money.
Well, I have good news. Because I’m going to introduce you to six simple steps on how to invest your money. It’ll be unlike many of the other “how to” articles on investing. In fact, this might just be your favorite one, because it’ll be so super-easy to follow and then implement.
But wait —
Before you even think about investing a dime, we need to set the foundation. Because without that, it’ll be somewhat difficult (if not totally impossible) to have a successful investment strategy.
So first I’ll list out the basic steps of investing, and then we’ll get into further detail to help you work through each one.
Here are the 6 steps:
- Work from your budget
- Determine how much you can save
- Decide on the best accounts to start with – taxable vs. tax-deferred
- Find the best investment options
- Monitor and rebalance
Okay, so some of the above terms may seem a bit — intimidating.
I get it. I’m not exactly a financial wizard either.
I mean, someone throws out a phrase like “index funds“, and my eyes immediately start to glaze over.
But have faith. Because there’s a method to the madness. This stuff can totally be learned — even if you don’t have a Masters degree in Finance. You just need a little bit of background, and some explanation using simple, everyday language.
So here we go.
Let’s get into the juicy details to get you started on your investing journey.
Understanding the Principles to Increase Your Savings
Personal finance principles are not complicated. No, seriously — it’s true.
However, executing them takes practice and discipline. Because if you want to build wealth, you’ll need to do these three things:
- Spend less than you make
- Save and invest the difference
- Reduce or eliminate debt
Admit it — you’ve more than likely heard all of these things before.
Sometimes they’re easier said than done, but they are definitely common sense things.
Living within our means, being disciplined about saving and investing, and minimizing debt will allow us to build wealth over time.
Unfortunately, there are no “get rich quick” schemes that work. There are no shortcuts.
But doing these three things over a long period of time will give you the best opportunity to build wealth.
So are you ready? Here’s where to start —
1. Work from a Budget
I know, I know. Talking about budgets is about as much fun as waiting in line at the DMV. On a Saturday. With your annoying neighbor who won’t stop talking. About her cats.
But if you don’t know where your money is going it’ll be difficult to consistently save and invest. So this is kind of a necessary evil.
Now I’m not suggesting you need to penny, nickel and dime every single item in your budget. Quite the contrary.
But you do need to know where your money is going every month, so you can analyze where you can potentially reduce expenses and increase the amount to save and invest.
Many people use spreadsheets to budget. However, if you’re not a spreadsheet person, you can also consider some of the budgeting apps available. Mint.com and You Need a Budget (YNAB) are two of the most popular programs out there, and they let you connect your bank account to pull expenses directly into the app. Once that’s done, it’s super-easy to assign categories to get a visual on where your cash is going.
Now, if you’ve already paid off a huge chunk of debt, it’s likely you have some experience with budgeting apps and tracking your expenses. But if not, these two apps are great ways to get started. I personally use Mint at the moment, and have been happy with what it provides.
Ready to move on to step two?
2. Determine How Much You Can Save
Your budget will tell you how much you can save and invest. That’s the foundation that must be in place to assure you can contribute a consistent amount to grow your wealth.
There are a bunch of different ways to do this. Starting with the below —
Okay, I’m pretty sure I know what you’re gonna say next — if it were as easy as “increasing income”, you wouldn’t be reading this post in the first place! I know, I get it. But just work with me here.
The sobering truth is, if you want to save and invest more money, increasing your income is the way to go. Because that means you’ll have more to save and invest.
So as an example, if you’re happily working in a corporate job, try to look for ways to get promoted. Learn the art of negotiation when asking for raises. Become more valuable by working harder and doing more than what’s asked of you. Show those bigwigs on a day-to-day basis how much they’d be utterly lost without you!
In addition (or as an alternative), look for ways to gain extra income outside of work. Find a side hustle or some part-time work that has flexible hours to bring in more money. Because the more money you bring in, the more you can save and invest.
If money for an emergency fund is not part of your budget, it definitely needs to be. What exactly is an emergency fund? It’s money you keep in a liquid (risk-free, penalty free) account that you can access at any time.
In other words, it’s totally, 100% accessible, whenever you need it, no matter what. The equivalent of cash money, dolla bills.
This is money you’ll have available “just in case”, to pay cash for unexpected expenses. Like if your car breaks down, or you have an unexpected vet bill. The main thing to avoid is putting these charges on a credit card.
Because once you have an emergency fund set up, you’ll no longer need to stress about those types of things — when there’s an emergency. See how that works?
Ideally, your emergency fund should have a minimum of three to six months of monthly expenses in it.
For example, in a perfect scenario: if your monthly expenses are $1,500, you would keep from $4,500 (3 months) to $9,000 (6 months) in the account. If expenses are $2,000, you’d keep $6,000 or $12,000 in it.
Now, I don’t want you to stress about those numbers. Because the most important part about an emergency fund is the very existence of it, in general.
Put what you can into it, and build it up from there. We don’t all live in a perfect world, so the formula above may not be attainable by everyone. But don’t worry, you’ll get there. The main thing is to get started.
Some people keep one or more years of expenses in their emergency fund. But whatever amount you do choose, be sure not to compromise that number. (Remember, it’s not a rainy day fund, or fashion emergency fund). And financing unexpected expenses on a credit card will put you right back into the hole you just dug yourself out of. (Preach!)
Once your emergency fund is in place, take a little gander at what’s left in your budget.
Ya know, that fun little activity from Step One.
After you’ve paid all of your bills and established your emergency fund — the amount that’s left over will become the money you’ll be able to invest.
And if in the off chance that amount is zero, then it’s probably time to look at where you can cut some expenses. Assuming you don’t have any more debt, there should be a decent amount of money left over for investment.
3. Decide on the Right Type of Account to Invest Your Money
Most people thinking about how to invest their money will look at retirement accounts first. Remember, this is after you’ve set your budget, created your emergency fund and determined how much you can invest each month.
If you have a career, it’s pretty likely your company offers its employees a retirement plan. These can go under different names, such as 401(k) or 403(b). The plans offer a way for employees to contribute money with each paycheck to an investment account. The money invested then grows tax-free, as long as it remains in the plan.
Who Doesn’t Love Free Money?
In most cases, the employer also contributes money to your account, in the form of a matching contribution. They agree to match what you put into your account with their own money, up to a certain percentage.
Here’s a common example: Your company offers to match your contribution up to 50% of the first 6%. This means for every six dollars you invest, you’re getting three dollars more from the company. That’s an automatic 50% return on the first 6% you put into the plan. There is no other investment out there that offers a 50% guaranteed return.
Plus the money you contribute is tax-deductible, which means it reduces your taxable income by that amount. You won’t pay taxes on the money until you actually withdraw it at retirement.
So it’s free money and a tax deduction. What’s not to love? It’s truly the best investment you can make.
Note: For 2019, the IRS allows you to contribute up to $19,000 of your own money into employer-sponsored plans. That means you can put a chunk money toward saving for your retirement.
Another smart investment you should consider contributing to is a Roth IRA.
Unlike employer plans, Roth IRA contributions are not tax deductible. That’s because the money you contribute to this plan has already been taxed. You can contribute $6,000 to a Roth in 2019. Earnings on the money while it remains in the account grow tax-free.
You can withdraw contributions at any time without penalties or taxation. But earnings are a little different. If the Roth account is five years old, earnings can be taken out without paying any taxes. However, if you are under age 59 ½ at the time you withdraw, you will pay the IRS a 10% penalty. (So that is something you should definitely try to avoid!)
But the great thing about a Roth IRA is that money withdrawn after five years and when you’re over age 59 ½ is tax-free income. That’s a huge benefit when you’re calculating retirement income. Having tax efficient (or in this case, tax-free income) in retirement is a major advantage of the Roth IRA.
4. Find the Best Investment Options for You
If you’re investing in your employer’s retirement plan, the options you have are the ones available in the plan. In the vast majority of plans, these are mutual funds.
In their basic form, mutual funds are managed portfolios of stocks and bonds. So what does that mean?
They are professionally managed, offer some diversification, and a variety of choices in the types of stocks and bonds available.
Most plans have a lot of choices (sometimes too many) of funds. Your benefits department can provide information to help you decide which funds to select.
For any money you’re investing outside of the employer plan, mutual funds are also a very good option. You aren’t limited to a set of funds chosen by your employer. And in many cases, you can find lower cost funds offering better performance. There are other options to consider as well.
Individual Stocks and Bonds
In mutual funds, the fund managers decide which stocks and bonds to invest in, and often invest in hundreds of stocks. But you can also purchase individual stocks and bonds on your own.
When you’re just starting out investing and have smaller amounts of money, it’s hard to diversify a portfolio of individual stocks. It takes a significant dollar amount to buy enough stocks to diversify your portfolio.
Picking stocks and bonds on your own is also riskier. There are a variety of stock picking newsletters and services to help you make the choice. Many of these services tout their ability to beat the market and provide higher returns.
But if you’re just learning how to invest or just starting out, I would not recommend individual stocks and bonds. Once you’re up for taking on more investment risk, it may make sense for you. Individual stocks are a high-risk, high reward proposition.
Index funds are a specific type of mutual fund. As we described earlier, funds have professional managers who decide which stocks to buy and sell based on their research. Index funds do just the opposite.
Index funds invest in unmanaged indexes made up of hundreds of stocks. The index you’ve likely heard of and are familiar with is the S & P 500 index. The index is made up of the largest 500 publicly traded companies in the U.S. The size of the companies is based on the market value of their stock. The larger companies have a much greater impact on the return of the index.
An S & P 500 index fund invests in all 500 of these companies. Managers don’t decide on how much to put into each company. Rather, the amount they put in each aligns proportionately with the size of each company in relation to the total index. There are dozens of stock and bond indexes available for investment.
Index funds are among the lowest cost funds you can own. The lower costs mean more of your money gets invested. (Note: You had me at “lowest cost”…!)
Expenses on professionally managed funds are much higher than index funds. Returns of index fund outperform professionally managed fund about 75% to 80% of the time.
For most people, index funds are a smart option.
Robo Advisors (Automated Investments)
Robo advisors are a fairly new entrant to the investment landscape. They’re called “robo advisors” because they use algorithms to build and manage portfolios. These technologies automate the investment process. The investment vehicle most use to create their portfolios is exchange-traded funds (ETFs).
Okay, let’s hit Pause for just a moment. That’s some intense phrasing thrown into a few sentences. So if you’re not totally sure what that all means, just keep reading —
ETFs are, in many ways, like mutual funds. They pool together investor money and purchase a diversified portfolio of stocks or bonds.
But unlike mutual funds, ETFs are bought and sold more like stocks. I won’t get into the details of how they work here. The main point is that ETFs can be bought and sold during the day. They provide more flexibility in buying and selling shares. Robo advisors like that feature of ETFs.
ETFs also give robos the ability to easily diversify their portfolios at a very low cost. Investing with one of the many robo advisors offers a ready-made, broadly diversified portfolio of stocks and bonds. Most of them require investors to complete a short risk questionnaire to determine which portfolio is a good fit.
5. Diversify Your Investments
In its simplest form, diversification means having your money invested across different types of asset classes (stocks, bonds, cash) to help lower the risk of owning individual securities.
With mutual funds, investors who own three or four different funds are often fooled into thinking they own a diversified portfolio. In reality, they may not. If the funds all invest in large, U.S. based companies, they have four funds with lots of companies all in the same asset class (large U.S. companies).
True diversification means having money spread across many different asset classes (large stocks, small stocks, growth stocks, value stocks, etc.). That diversification applies to bond investments as well (short term, medium term, government, corporate).
With regular monthly investments, it’s next to impossible to get proper diversification with individual stocks and bonds. And with mutual funds, you need to have a solid understanding of the asset classes and how they work together.
To that end, when you’re just learning how to invest or investing smaller amounts of money, your two best options are index funds or automated investment programs (robo advisors).
They allow you to invest smaller amounts of money in a broadly diversified portfolio. In the case of robo advisors, there is also some effort put into finding a portfolio that fits your tolerance for risk.
6. Monitoring and Rebalancing
Last, but certainly not least, comes the need to monitor and rebalance your investments.
Monitoring, as the name suggests, means watching the investments to make sure they’re doing what they said they were going to do. It’s making sure your diversification and mix of investments stay close to where you wanted it to be when you started. If it sways from that mix, you could be taking on more risk or compromising the performance you wanted when you started.
Rebalancing means if parts of your portfolio grow or fall in value beyond what the managers targeted, you should 1) sell the ones that have gone up, and 2) buy the ones that have dropped.
In other words, bring the portfolio back into the balance (mix of stocks, bonds, cash) you designed when you started. Rebalancing does not need to be done every month. In fact, once a year is probably enough. With markets going up and down as rapidly as they do these days, the market often rebalances the portfolio on its own with its up and down moves.
There — Now that one wasn’t too bad, was it?
These thoughts on investing are targeted to those who may be just learning how to invest. But they’re also applicable to those who may have some knowledge of investments, but not a lot of money to invest.
Many believe the smartest way to invest in today’s markets is to own the market. And the best way to do that is through index funds or robo advisors. These two options are low cost and offer an easy way to own pieces of the entire market. There are index funds available for any market, stock or bond, around the world.
Here are some quick takeaways from this Investing 101 discussion:
- Take advantage of employer plans and Roth IRAs to the extent they are available.
- Be consistent with your investing. Put money in regularly, both in good and bad markets.
- Keep costs low, owning a broadly diversified global portfolio.
- Stay invested in that portfolio, and periodically rebalance as needed — and this will bring you investment success.
But remember — There are no guarantees when investing. However, following this formula can offer you the best chance for investment success.
I hope this crash course has opened your eyes to the world of investing!
How to Invest Money – 6 Easy Steps for the New Investor
Fred is the Founder and President of Leamnson Capital Advisory, LLC. He helps people preparing for and in retirement with financial, retirement, Social Security, and estate planning. At Money with a Purpose, he focuses on three primary areas: Personal Finance, Overcoming Adversity, and Lifestyle. He has been quoted in Forbes, USA Today and appeared in Money Magazine and MarketWatch, and many other publications.