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Investing Decisions Tree

How to Start Investing in Stocks for Beginners

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Investing in the stock market is one of the most accessible and reliable ways to build wealth and generate passive income. It is statistically possible, to invest $100 a month and become a millionaire by the time you turn 65. Regardless of when you start and how much money you can invest, there is something for everyone to gain by learning to invest in the stock market. In this article, I am going to make it as easy as possible for someone brand new to investing to get started. My goal is to answer common questions like where to start investing, what to invest in, etc.

investing in the stock market

#1 – Why Investing is Important

Investing is an essential ingredient if you want to achieve financial success. It is a proven way to grow your money and let compounding interest work for you.

The S&P 500 Index originally began in 1926 as the “Composite Index” comprised of only 90 stocks. According to historical records, the average annual return since its inception in 1926 through 2018 is approximately 10%. The average annual return since adopting 500 stocks into the index in 1957 through 2018 is roughly 8% (7.96%).  — Investopedia

Our study shows that the S&P 500 Historical Return, which is indicative of the Stock Market overall return, is about 9%.

Without investing, it would be nearly impossible for anyone to break through the $1 million milestones just by working hard and saving your money.

Investing and Risks

Investing is not risk-free. Unlike putting money into a savings account or a certificate of deposit, there are risks involved.

You should only invest money that you can afford to lose. For example, if you owe any money — e.g., credit card debts, student loans, car loans, etc. — you need to pay these debts off first. The only exception to this rule is your mortgage.

The good news is the risk of losing your money goes down substantially when you invest for a long time in the market, e.g., more than five years — so investing is an excellent financial move in the long-term.

#2 – Getting Started with Investing

Before you jump in, there are a few questions you need to answer to help you start at the right place so you can get to your destination.

how to decide if you should invest or not

1. Do You Need this Money in the Next 5 Years?

If you need the money you plan to invest within the next 5 years, investing in the stock market is not ideal.

If your time horizon is less than 5 years, you need to save your money and not invest. Your main goal should be to protect your capital against loss and minimize the impact of inflation.

This means you should be using high-yield savings, high-yield checking, or certificates of deposit for your short-term money. For instance, saving money for a down payment is a good example of saving for a short-term goal.

2. What is Your Goal? Long-Term Growth vs. Current Income

Do you mainly want your investment to grow in value or do you need monthly income from your investment?

Long-Term Growth

If your goal is to grow your money, then you should look at retirement accounts like 401(k) or IRA to enjoy some of the advantages. For example:

  • 401(k) – You don’t have to pay Federal and State Income Taxes on your deposits and your employer may contribute a matching fund, giving you an instant return on investment.
  • Traditional IRA – This account gives you income tax deductions similar to 401(k).
  • Roth IRA – You pay all the taxes on your deposits, however, your money grow completely tax-free. You do not have to pay any taxes on the withdrawal.

However, the main disadvantage with these accounts is that you cannot withdraw money until 59 1/2. If you withdraw before you turn 59 1/2, you’ll have to pay a 10% early withdrawal penalty. The one exception is you can withdraw the money you deposited into a Roth IRA any time, but not the gain.

For a more in-depth discussion, see the section below: Different Types of Investment Account.

Current Income

If your goal is for your investment to generate cash that you can use every month, then you have to invest your money in a taxable account so have access to the money as needed.

There is no withdrawal restriction with a taxable account; however, you’ll be paying short-term capital gains tax on the dividend and interest income at your marginal tax rate.

#3 – Portfolio Design

So far so good. Now you know where you want to invest the money, e.g., 401(k), IRA, or taxable account; and you know why you’re investing the money. The next step is to design your portfolio.

Long-Term Growth with an Aggressive Portfolio

For this objective, you want a portfolio that grows in value. This means focusing on asset classes like Stocks and Real Estate. For the actual investment itself, you will be using ETFs and REITs (see below).

An example of a well-diversified long-term aggressive portfolio might look something like this:

  • US Stocks 60%
  • International Stocks 30%
  • Real Estate 10%

You could use as little as one ETF for each of the slices, for example:

  • Schwab U.S. Broad Market ETF (SCHB) ETF for US Stocks
  • Vanguard Total International Stock (VXUS) ETF for International Stocks
  • Vanguard Real Estate ETF (VNQ) ETF for Real Estate

Based on M1 Finance research tool, this portfolio would have grown 31.88% in the past 5 years and paid 2.324% dividend per year.

M1 Finance historical performance and dividend yield for a growth portfolio

To make the portfolio a little more stable, you can add Vanguard Total Bond Market ETF (BND) and decrease your stocks percentages.

Current Income

For this objective, you want a portfolio that generates income consistently. This means focusing on asset classes like High-Dividend Stocks, Bonds, and Real Estate.

An example of a well-diversified income portfolio might look something like this:

  • High-Dividend US Stocks 30%
  • High-Dividend International Stocks 20%
  • Real Estate 25%
  • Bonds 25%

You could use as little as one ETF for each of the slices, for example:

  • Vanguard High Dividend Yield Index Fund (VYM) ETF for High-Dividend US Stocks
  • Vanguard International High Dividend Yield Index Fund (VYMI) ETF for High-Dividend International Stocks
  • Vanguard Total Bond Market Index Fund (BND) ETF for Bonds
  • Vanguard Real Estate ETF (VNQ) ETF for Real Estate 

Based on M1 Finance research tool, this portfolio would have grown 15.72% in the past 5 years and paid 3.423% dividend per year.

M1 Finance historical performance and dividend yield for an income portfolio

#4 – How to Set Up an Investing Account

1. Your Employer’s 401(k) Plan

The first place to look is your company’s 401(k) plan, especially if they provide matching contributions. If they do, you need to invest here first and try to take all the matching you can get. If your company matches up to 6% of your salary, then contribute 6%.

For example, if you make $50,000 and your company matches up to 6%, that’s $3,000  in matching. In this case, you should plan to contribute at least $3,000 per year to your 401(k) plan.

You’re automatically starting with a 100% gain on your investment! Moreover, your contributions will be tax-deductible.

To get started:

  1. Ask your HR or Plan Administrator about starting up your 401(k). They will help you set up an automatic deduction from your paychecks, and most likely, you will have access to a web portal to manage your account.
  2. Inside the portal, choose how your money will be invested — if you don’t, your money will sit in a cash account not doing much of anything.  For now, invest everything into an S&P 500 Index Fund, a Target Date Fund, or a US Large Cap Fund. If you have multiple funds to choose from, pick the one with the lowest expense ratio and no other fees.
  3. That’s it…everything should be on autopilot at this point.

For more information, see What Is a 401(k) Plan and How Does It Work.

2. Roth IRA

Second, you want to start a Roth IRA account where you can contribute the next $6,000 per year. You contribute after-tax money into your Roth IRA, meaning, you pay taxes on your contributions first…but the significant advantage is that your money grows tax-free!

To get started:

  1. Find a stock brokerage firm. Personally, I use M1 Finance and TD Ameritrade.
  2. And ask them to help you set up a Roth IRA account.
  3. You can contribute up to $6,000 per year into the account. You can do this all at once, or set up an automatic investment to draw money from your bank account and invest automatically, e.g., $500 a month is a good amount.
  4. Again, I would start with a single S&P 500 Index Fund or ETF with the lowest expense ratio. A fund is usually better for an automatic investment plan where you can add more money regularly without incurring a trading fee, and an ETF is generally better if you contribute and trade only once a year.

3. Next Place to Invest

If you completed #1 and #2, and still have more money to invest, you can decide between these options:

  1. Max out your 401(k) – if you don’t have any short-term plan for your money, you can try to contribute the maximum $19,500 per year to your 401(k). If you’re in the position to max out both your 401(k) and Roth IRA, you may also want to consider starting a normal investment account and invest there as well.
  2. Save for a Down Payment – if you plan to buy a house within the next five years, you might want to consider saving the excess cash into a high yield savings account and let it accumulate toward your down payment.

4. Next Steps

Once you start to grow your investment accounts, you will want to learn more about investing. Here are some of the key concepts to learn next.

  1. How expenses and fees impact your investment growth
  2. Asset Allocation, Diversification, and Rebalancing
  3. Timing the Market
  4. Tax-Loss Harvesting

#5 – Different Types of Investment Account

As mentioned earlier, there are three different types of investment accounts.

1. Taxable Account

This is similar to a bank account where you can invest your money instead of just saving it. You can use your money to buy different investments, and you can sell them at any time. Here, you invest with your after-tax money (i.e., there is no tax benefits).

When you sell, your gain will be taxed at your ordinary tax rate, unless you held the investment for more than one year. If you sell at a loss, you can use your loss to offset your investment gains and up to $3,000 of your other income.

2. Tax-Deferred Account

Investment accounts like 401(k) and Traditional IRA are tax-deferred. Money that goes into the account is tax-deductible in the year the money is added to the account, and your investment grows tax-deferred. When you reach your eligible withdrawal age at 59½, you pay the Federal and State Income Taxes at your marginal tax rate when you withdraw the money.

3. Tax-Free Account (Roth)

Investment accounts like Roth 401(k) and Roth IRA are tax-free. You contribute after-tax money into the account (i.e., you are taxed on your contributions) BUT your investment grows tax-free. You do not have to pay taxes on your withdrawal once you reach your eligible withdrawal age.

For both the tax-deferred and tax-free accounts, there is a 10% early withdrawal penalty if you withdraw money before the full retirement age.

Which one you choose will depend mainly on your situation.

#6 – Different Types of Investments

There are three primary types of investments that will allow you to invest in the Stock Market. As a first time investor, I would recommend that you start with either Exchange-Traded Funds (ETFs) and/or Mutual Funds. For now, avoid investing in individual stocks.

Let me briefly explains how each works:

1. Stocks

Each share represents part ownership in a company. For example, if you buy 100 shares of AAPL, you’ll own a tiny part of Apple Inc. (and I mean microscopically tiny). When you purchase shares, you have to pay the brokerage firm trade commissions (somewhere around $3 to $30 per trade). Usually, you’ll have to pay more if you purchase through a bank or a full-service brokerage firm.

2. Mutual Funds

Each mutual fund is a collection of many stocks. Throughout the year, the fund manager can buy and sell shares 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 fees: (1) Trade Commission, (2) Front-end load, (3) Back-end load (or redemption fee), and (4) Expense ratio.

The funds that you should invest in are low expense ratio, no load, and no transaction fee mutual funds — meaning you are not paying anything but the expense ratio.

3. ETFs

I believe this is by far, the best investment vehicle. Similar to mutual funds, an ETF is a collection of many stocks; however, they trade like a stock throughout the day. ETFs are generally more tax-efficient than mutual funds due to in-kind redemption mechanism. Likewise, there is an expense ratio, but it’s generally lower than a similar mutual fund. But like stocks, you have to pay a trade commission each time you buy and sell shares.

What’s Next?

Read as many books and web sites that you can to learn about investing for beginners. 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.

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Trent Hamm
12 years ago

If you’re buying ETFs, why not just directly buy index funds from Vanguard? That way, you avoid the brokerage fees.

B Smith
B Smith
12 years ago

Pinyo-Great (re)post! Your advice is dead on. I especially like your advice to stay away from stocks until you really understand the market. You can make money on them, but need to know what you are doing. If you don’t you will lose big time.

You also need time to follow your stocks. If you have less than 10 hours per week to dedicate to this, you need to avoid individual stocks. Even mutual fund investing takes time, but now you are watching the market as a whole and can get by with just a few hours a week.

Vered
12 years ago

Great advice – thanks. I did buy a few stocks when I still was very new to investing. In my experience, as long as you’re not trying to time the market, and as long as you stick with companies that you know well and believe in, you should do OK. (For example, I bought stocks of Whole Foods (WFMI) a few years ago and am very happy that I did).

Edward
Edward
12 years ago

I currently have some stocks in a full service brokerage account. Is it typically possible to move them into a discount brokerage account? Or would I need to sell them from the full service account and then buy them again in the discount account (which would incur taxes from capital gains, as well as losses from comissions and the ask/bid spread)?

If it is possible, are there typically any fees/comissions involved (from either the source brokerage or the destination brokerage)?

I did a few google searches to try to find the answer, but had no luck.

Jerry
12 years ago

That point about investments being ‘money you can afford to lose’ leads to a big barrier for many Americans. The rapidly rising cost of living (gas, food, health insurance) puts discretionary income out of the question in many, many families.
Jerry

Jonathan
Jonathan
12 years ago

What a brilliant article for beginner investots, there’s some great advice and information packed into here. Your explantion of stocks, mutual funds and ETF’s is excellent and I especially liked the advice at the start about money you can afford to lose, very responsible advice.

Dividends4Life
12 years ago

Great synopsis for the beginning investor!

Best Wishes,
D4L

TIP Guy
11 years ago

This is a good guide for investing beginners. May be you could add your veiwpoints about how to manage debt. should investors start with focusing on reducing debt then start investing or do it simultaneously?

Miriam Fifi
Miriam Fifi
10 years ago

Brilliant,thank you. This has been the most helpful read I have come across since I started my research 3 weeks ago.Hopefully,I can take it from here.

Crystal
Crystal
10 years ago

I am much like you in that no one that I know invests in stocks or knows anything about them. For this reason, I am starting young on learning about how to invest. To start out with I thought I would try penny stocks to allow me to get used to the stock market without completely exposing myself and losing a lot of money. I can invest as little as $10 a month, and while I know I won’t gain too much, but I am learning a lot from my experiences. I am getting a lot of good tips from… Read more »

kartikeya amin
kartikeya amin
9 years ago

Hello Pinyo ,

I was impressed to read your crisp & very direct analysis of the queries raised on investment situations. Ours is to: transfer rollover funds of three accounts: Where to? With Bank IRAs or discount brokerage firms like Vanguard? And, what sort of diversification-Mutual funds of what type/s or any mix portfolios. We are seeking a 5 years waiting period for effective usage/to draw funds. do you have any solution? Thanks. The funds can be abt.$2oo,000.

Amin

PETER LETIZIA
PETER LETIZIA
8 years ago

Can I purchase an annuity through my IRA without tax consequences other than the taxes I will have to pay as I collect the income.

Daily Invest News
Daily Invest News
1 year ago

Thanks for a detailed post. The only thing I would add is to watch closely to the stocks you invested in or are going to invest. Numerous factors influence stock – from political changes (Trump’s presidency) to technology factors (Facebook security scandal). No one can forecast everything, but one can do as much as he can to reduce possible losses.

How to Start Investing in Stocks for Beginners

by Pinyo Bhulipongsanon time to read: 9 min
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