Investing For Beginners Guide

By Pinyo, on May 1, 2008

Neither one of my parents know how to invest in the stock market, and it wasn’t a part of my formal education. I had to learn everything on my own, so I know how intimidating it is for people who are new to investing. Where do I start? What do I invest in? How am I doing? There are just so many questions.

Photo by thinkpanama via Flickr

In this post, I am going to try to make it as easy as possible for someone brand new to investing to get started.

1. Invest Money That You Can Afford To Lose

Investing is unlike putting money into a high yield savings account or a certificate of deposit, there are many risks involved. So you need money that you can afford to lose. This means that if you owe any money — i.e., credit card debt, student loan, car loan, etc. — you need to pay these off first. The only exception to this rule is your mortgage.

2. Brokerage Account

Next you need to find a place where you can trade your money for investment securities. You can invest through three main types of financial institutions:

• a bank,
• a discount brokerage firm, or
• a full service brokerage firm.

Out of the three, I recommend using a discount brokerage firm. Banks and full service firms generally charge too much and push products that are not always the best for you (because they are motivated by commissions and fees).

I currently using TD Ameritrade and TradeKing ($4.95 per trade — here’s an excellent TradeKing Discount Broker Review). But you could use any other discount brokerage firms, such as Zecco (free trades) and Charles Schwab (I’ve used them in the past).

Moreover, here are some tips on choosing an online brokerage account.

3. Taxable Account versus Tax-Advantaged Account

You will also have to decide if you want to start a normal taxable account or a tax-advantaged account.

• Taxable Account – You can liquidate your investment and get your money back at any time, but you have to pay taxes on capital gains yearly.
• Tax-Advantaged Account — Investment accounts like 401k, Traditional IRA, and Roth IRA where you can’t touch your money until you reach a certain age. The advantages of 401k and Traditional IRA include tax deduction on the amount you contributed and your investment grows tax free until you start to withdraw the money. For Roth IRA, there is no tax deduction, but your investment grows tax free and the withdrawal is also tax free.  On the other hand, there are limits to how much you can contribute each year to your tax-advantaged accounts and there is also a 10% early withdrawal penalty if you withdraw money before the full retirement age.

Which one you choose will depend largely on your personal situation.

4. Invest

I have over 10 years of experience and I have made my fair share of mistakes, so believe me when I say don’t start with individual stocks. As a first time investor, I would recommend that you start with exchange-traded funds (ETFs), or mutual funds, instead. Let me briefly explains how each works:

• Stocks – Each share represents a part ownership in a company. For example, if you buy 100 shares of AAPL, you’ll own a tiny part of Apple Inc. When you purchase shares, you have to pay the brokerage firm trade commissions which can be as low as $0 (i.e., via Zecco) to somewhere around $6 to $30 for discount brokerage firms. Usually, you’ll have to pay more if you purchase through a bank or a full-service brokerage firm.
• Mutual Funds – Each mutual fund is a collection of many stocks. Throughout the year, the fund manager can buy and sell stocks inside the fund on your behalf. In essence, you buy the underlying stocks and pay for the fund manager’s services. When you buy shares of a mutual fund, you could potentially pay up to 4 kinds of fee: (1) Trade commission, (2) Front-end load, (3) Back-end load (or redemption fee), and (4) Expense ratio. The ones that you should stick to are low expense ratio, no load, and no transaction fee mutual funds — meaning you are not paying anything but the expense ratio.
• ETFs – I believe this is by far the best investment vehicle. Similar to mutual funds, an ETF is a collection of many stocks; however, the stocks are more defined and they are rarely traded. Likewise, there is an expense ratio, but it’s generally lower than a similar mutual fund. But like stocks, you have to pay trade commission each time you buy and sell shares.

The strategy that I believe is best for new investors is to build a globally diversified portfolio of low expense passively managed ETFs. For example, if you have $6,000, you could potentially split it up in $2,000 chunks and buy 3 ETFs: Large US Stocks ETF, Small US Stocks ETF, and International Stocks ETF. Or you can make it even simpler by investing the entire amount in a Vanguard Target Retirement Fund.

The subject of asset allocation — i.e., how you should divide your money across multiple types of investment is fairly complex, and I will not be explaining it here. If you are interested, you can take a look at my 401k asset allocation and my Guide to Asset Allocation to get a better idea.

How to find the right ETFs?

There are several ways to do this. Brokerage firms like Charles Schwab and TD Ameritrade offer online tools where you can do your research. For example, you can use their online tools to find “low cost, Large US Stocks ETFs,” but it takes a bit of time to learn the web interface. The good news is that you can visit one of their branches and ask for help, or you can just ask one of the representatives to help you make the purchases. Remember, you are not looking for ETFs with the best performance (this is called chasing past performance), you are looking for ETFs that:

• Has low expense ratio
• Represent the asset class well — i.e., small-cap, large-cap, international, etc.

How to buy the ETFs?

Once you identify which ETFs you will be buying, you will need their ticker symbols. For example:

• IVV is the ticker symbol for “iShares S&P 500 Index,” a Large US Stocks ETF
• VB is the ticker symbol for “Vanguard Small Cap ETF,” a Small US Stocks ETF
• VEU is the ticker symbol for “Vanguard FTSE All-World ex-US ETF,” an International Stocks ETF

At this point, you can enter a buy order through the online system, or ask the representative, to buy X shares of IVV, Y shares of VB, and Z shares of VEU. If you want to invest $2,000 in each, you just divide $2,000 by the latest ask price to get the number of shares.

What’s next?

Read as many books and web sites that you can to learn about investing. My caution is to avoid hot tips and hot stock picks. What you want to learn is how the market works, effects of taxes and expenses on investment performance, asset allocation, risk management, investing for specific goals, etc.

If you have any question, please feel free to leave a comment and I will do the best I can to answer them. Please note that it’s also worthwhile to pay a fee-based financial advisor to help you through your first investing experience.

This was a guest post I wrote for Being Frugal on January 30, 2008, and it was featured in the Carnival of Personal Finance #151 hosted by Alpha Consumer.

Read more about

Get free updates

    via Twitter
    via Facebook
    via RSS or Email

Share this article

• 
• 
• 
• 
• Share

Pinyo is the brain behind Moolanomy personal finance blog and a few other web sites. If you like this article, please subscribe for free daily email updates.

All posts by Pinyo

Please share your comment:

Comment Rules: Constructive criticism is welcomed. Please use your PERSONAL name or initials and not your business name or URL, as the latter comes off like spam and I'll most likely delete your comment. Have fun and thanks for adding to the conversation! Here's our comment policy and guidelines.

11 blogs that link to this article:

If your trackback does not show in 24 hours, please resend to this trackback URI.

1. Weekly Roundup: April Review Edition | Frugal Dad
2. Weekly Roundup: April 2008 Review Edition | Frugal Dad
3. Sunday Money Roundup - Signing The New Lease Edition. | My Two Dollars
4. Weekly Round-Up Busy Week Edition
5. Weekly Round-Up Busy Week Edition
6. Roundup and Link Love - 4 Hour Work Week Edition | The Wisdom Journal
7. » Sunday Roundup - Patio Furniture Edition @ fivecentnickel.com
8. Less is More Edition - Personal Finance Review » Money Smart Life
9. You can’t save your way to prosperity. You can’t?
10. Budgetary » Blog Archive » Welcome to Budgetary!
11. Learning About Investing | stretchyDollar