Investing can be one of the more complex concepts in personal finance. But it’s also one of the key cornerstones to financial independence and wealth building. While it might seem intimidating—from the alphabet soup of terms like IRAs and 401(k)s to keeping track of the latest market movements—understanding the basics can boost your confidence and help you feel comfortable getting started.
How to start investing
On a high level, investing is the process of determining where you want to go on your financial journey and matching those goals to the right investments to help you get there. This includes understanding your relationship with risk and managing it over time.
Once you understand what you want, you just have to jump in. You can decide to invest on your own or with the professional guidance of a financial planner. Below we discuss in detail each of the key step
s to help you get started with investing.1. Decide your investment goals
Before you decide to open an account and begin comparing your investment options, you should first consider your overarching goals. Are you looking to invest for the long term, or do you want your portfolio to generate income? Knowing this will narrow down the number of investment options available and simplify the investing process.
“Consider what your ultimate goal is for this money—is it for retirement, a down payment on a house in the next five years, or something else?” says Lauren Niestradt, CFP, CFA, and portfolio manager at Truepoint Wealth Counsel.
Understanding your goals and their timelines will help determine the amount of risk you can afford to take and which investing accounts should be prioritized.
For example, if your goal is to invest your money for retirement, you’ll want to choose a tax-advantaged vehicle like an individual retirement account (IRA) or a 401(k), if your employer offers one. But you may not want to put all your money earmarked for investing into a 401(k), because you can’t access that money until you turn 59 ½, or you will get hit with penalty fees (with a few exceptions).
You also don’t want to invest your emergency fund in a brokerage account because it’s not easy to access money if you need it quickly. Plus, if you need that cash when the market is facing a downturn, you might end up losing money when you’re forced to sell low.
2. Select investment vehicle(s)
After determining your goal(s), you need to decide which investment vehicles—sometimes referred to as investing accounts—to use. Keep in mind that multiple accounts can work together to accomplish a single objective.
If you’re looking to take a more hands-on approach in building your portfolio, a brokerage account is the place to start. Brokerage accounts give you the ability to buy and sell stocks, mutual funds, and ETFs. They offer a lot of flexibility, as there’s no income limit or cap on how much you can invest and no rules about when you can withdraw the funds. The drawback is that you do not have the same tax advantages as retirement accounts.
There are several financial firms that offer brokerage accounts like Charles Schwab, Fidelity, Vanguard, and TD Ameritrade. Working with a traditional brokerage usually comes with the benefits of having more account types to choose from, such as IRAs or custodial accounts for minors, and the option to speak with someone on the phone and, in some cases, in person if you have questions.
But there are disadvantages: Some traditional brokerages may be a bit slower to incorporate new features or niche investment options like cryptocurrencies. For example, fintech companies like Robinhood and M1 Finance offered fractional shares to investors years before traditional brokerages did.
Another brokerage account option is a robo-advisor, which is best for those who have clear, straightforward investing goals. The advantages of using robo-advisors include lower fees compared to a human financial advisor and automatic rebalancing to name a few.
If you have more complex financial goals and prefer more customized investing options, a robo-advisor may not be the best fit.
One important thing to note: Opening a brokerage account and depositing money is not investing. It is a common mistake for new investors to assume that opening the account and adding money is enough, however the final step is to make a purchase.
3. Calculate how much money you want to invest
As you decide which investment accounts you want to open, you should also consider the amount of money you’ll be investing in each account type.
How much you put into each account will be determined by your investment goal outlined in the first step—as well as the amount of time you have until you plan to reach that goal. This is known as the time horizon. There may also be limits on how much you can invest in certain accounts.
Decide on a percentage of your income that you can dedicate to building your portfolio. The general rule of thumb for retirement goals is to invest 15% of your income each year, but if you started investing later in your career or want to retire early you may want to consider investing a higher percentage. Keep in mind that 15% also accounts for any matches you receive from your employer. This means that you could contribute 10% of your W2 income with a 5% match from your employer to reach a total of 15% to hit this benchmark.
If you live paycheck to paycheck, 15% might seem like a crazy amount to invest. Don’t panic: It’s OK to start small, even just 1%. The important thing is to get started so your money will grow over time.
Plan how you’d like to invest your money. A common question that arises is whether you should invest your money all at once—or in equal amounts over time, more commonly known as dollar cost averaging (DCA). Both options have their advantages and disadvantages.
“For medium to long-term goals, dollar cost averaging is a valuable strategy to ensure that you’re investing consistently toward a goal and hopefully benefiting from purchases at both higher and lower trading prices. As they say, it’s not about timing the market, but time in the market,” says Tara Falcone, CFA, CFP, founder and CEO of Reason, goal-based investing app. Dollar cost averaging, even in small amounts, can be an effective investing tactic.
But DCA has its downsides: Because historically the market rises over time, you’re more likely to see a higher return if you had invested a lump sum at the beginning.
“The data show that investing the sum all at one time is better than dollar cost averaging. By investing the money all at once, you get to your target allocation immediately and, thus, have a higher expected return than if you kept a portion in cash,” says Lauren M. Niestradt, CFP, CFA, and senior portfolio manager at Truepoint Wealth Counsel. Your target allocation refers to the mix of stocks and bonds you should own based on your risk tolerance and how long you plan to invest.