Katherine Gustafson is an author and personal finance expert from Portland, Oregon. She writes about investing for Wealthsimple as well as having written for Forbes, Business Insider, TechCrunch, and LendingTree. Katherine is a past recipient of the Izzy Award for outstanding achievement in independent media. She has a BA from Amherst College and an MA from Boston University.
So you’ve got a few extra pennies—or dollars—and you’re interested in putting it to work to grow your nest egg. It’s time to learn about investing and position that extra cash to do you more good than it will if it’s tucked under your mattress.
The word “investing” can sound daunting. But it’s simply about using your money to make more money by loaning it to others through the market. While you don’t need to be a Wall Street insider to understand the basics, you do need a good grounding in some straightforward concepts to get started.
So read on for a newbie’s guide to investing. We’ll cover all the topics you need to know to start out. Follow the advice here and see your money grow over time.Grow wealth with humans + technology. Wealthsimple Invest is automated investing powered by real humans to give you advice. Get started now.
Decide if you should invest
The first step in investing is figuring out if it’s something you should—and want to—do in the first place. Deciding that requires having a clear idea of what investing is, and what it’s not.
Investing is about putting money into potentially risky but return-generating financial products in order to grow wealth over the long haul. This is very different than saving, which carries no or little risk but provides less potential for return.
If you’d decided that investing sounds like the right option for you, the next step is to assess your financial situation to make sure you’re in a good position to risk a bit of your money. Look at your credit card and other debt, the amount you have in an emergency fund, and what your financial goals are. If you are carrying a lot of debt or don’t yet have much of an emergency fund, it’s a better idea to take care of those issues before investing money.
If your financial goals include things that require liquidity, like putting a down payment on a house, then saving for those goals is probably a better idea than investing that money. It’s not a great idea to pull money out of investment vehicles shortly after you put it in. In some cases doing so will come with penalties. So keep enough cash on hand to meet your goals, and only invest using any money left over.
Another thing to consider at this stage is how comfortable you are with risk. If you are averse to risk, saving may be a better idea than investing. If you’re very comfortable with risk, you can invest aggressively. Many people are likely somewhere between those two extremes. That means that investing some money—once you have some extra to space—is probably a good idea.
Figure out how much money you want to start investing
Considering that investing is riskier than saving your money, it’s important for you to only invest an amount of money you can (potentially) afford to lose. It’s best to start investing with a small amount at first so you can slowly increase your comfort level with the process. As you begin to see the results of your investments, you will likely want to increase the amounts you’re investing. Just make sure to only use money you could actually live without, even if the loss would be painful. There are no guarantees in investing—that’s part of the excitement, but it can result in painful lessons.
Choose your investing strategy
There are various ways to go about investing your money, some of them more hands-on than others. The first choice you’ll have to make is passive versus active investing. This is the difference between putting your money in a mutual funds or exchange-traded funds (ETFs) that are tied to an index like the S&P 500 (passive) or having a fund manager actively invest your money with an eye toward outperforming the index (active).
There is great debate about which of these is a better choice, though there’s increasing support for the idea that passive investing can be just as lucrative—or more so—than active investing tends to be. That is partly because active investors tend to charge high fees that eat into potential profits from the investments they make. Do your own research to decide which of these strategies feels right to you.
There is another choice you need to make as well, which is whether to go DIY or use a robo advisor to do your investing. Going DIY means either investing yourself using an online tool or working through a brokerage or investment management to invest your money. A robo advisor like Wealthsimple uses specialized software that does functions as a kind of investment manager, but does it work automatically and with far lower fees. Which of these you choose depends largely on how involved you want to be and how comfortable you feel with using technology to help guide your hand.
Evaluate different types of accounts
Investing can be done in a variety of different ways using a combination of account types. You’re likely already familiar with one of the most common methods of investing: saving for retirement. But you can also buy mutual funds, open a brokerage account with which to buy stocks, or pursue other options such as peer-to-peer lending.
Mutual funds:**** A great option for building long-term savings, mutual funds put your money into a diversified portfolio without requiring an investor to manage that portfolio. Retirement funds almost always include some mutual funds.
Retirement accounts: Retirement savings accounts are excellent places to invest money that you don’t intend to use for many years. These accounts are usually tax-advantaged, which means that you don’t pay tax on the money until you pull it out of the account in retirement, when you are likely to be in a lower tax bracket.
Brokerage accounts: If you want to buy particular stocks and bonds, you’ll need to open a brokerage account to hold the money you want to use for that purpose. You can reduce the fees you pay and be more hands-on with the process if you use an online brokerage.
Open an account with an investment provider
Whatever kind of account you want to open, the next step is to select the right investment provider to work with. Look at the reputation, products, services, and fees of the advisor, institution, or website.
Be particularly alert to the fees, as they can prove a significant drag on your earnings. Paying fees of 1-2% could result in a loss of up to 40% of your expected investment over a long time horizon. That’s a potentially massive loss, so do your homework on this topic and be discerning in the fees you’ll agree to pay.
Opening an account—whether a retirement account, a mutual fund, or a brokerage account— will require providing some personal identifying and financial information. You’ll need to input contact information and verify your identity using a Social Security Number, tax ID number, or an official government ID. You’ll have to connect the account to a checking or savings account into which you can transfer funds, and then you’ll need to add money to your account, usually through direct deposit.
Learn as much as you can about investing
Become familiar with the idea of diversification of your investments. It’s a good idea to invest in a variety of different accounts and/or stocks so that your entire portfolio isn’t dependent on the performance of a single investment. This means investing in a range of geographies, industries, and asset classes, such as stocks, bonds, and real estate. These investments should be unassociated with each other.
And don’t overreact. Fluctuations are normal in the market, and the worst thing you can do for your investments is to react too often or too strongly to these typical ups and downs. Diversifying your portfolio will make it likely for your investments to see smaller fluctuations, but it will still happen. Learn to ride the waves and hang on to your investments for the long haul.
Get started investing
Now, go fund your account and start making your money grow. If you’re wondering how to find the cash to make investing a bigger part of your life, use one of these tips to save a little extra to add to your investment accounts.
Monthly set-aside. Have a small chunk of your monthly paycheck put into an account dedicated to investing; you won’t miss it in your checking account if you never see it. And before long you’ll have built a nice little investment nest egg.
Follow the 50/30/20 rule. The 50/30/20 rule is straightforward way to set up your budget to enable investing. The idea is that 50% of your income should go toward your immediate needs, 30% toward things you want like travel and luxuries, and 20% should be dedicated to your financial goals, such as debt reduction, savings, and investing.
Use spare change apps. Another way to collect more money to invest is to use apps that round your purchases up to the next dollar. That rounded-up money—or spare change—is put into a special account that you can add to your investments.
Once you’ve got a bit of money on-hand, enact the plan you’ve designed to explore the wild and wonderful world of investing. Plenty of people and sites, such as this one, are ready and waiting to help you along the way.Wealthsimple Invest is an automated way to grow your money like the worlds most sophisticated investors. Get started and we'll build you a personalized investment portfolio in a matter of minutes.