Investing 101: Starting With The Basics

Investing can be a great way to grow your wealth, but it can be intimidating for beginners. Here are some tips to help you get started:

- Figure out what you're investing for: Are you investing for retirement, saving for a down payment on a house, or some other financial goal? Knowing your goal will help you choose the right investment strategy.

- Choose an account type: The most common types of investment accounts are brokerage accounts, 401(k)s, and Individual Retirement Accounts (IRAs). Each has its own pros and cons in terms of flexibility, tax implications, and rules and restrictions.

- Open the account and put money in it: Decide where to open your account and how much money you want to invest. There is no one-size-fits-all answer to how much you should invest, but it's generally recommended to aim for 10-15% of your income each year for retirement.

- Pick investments: You can buy individual stocks and bonds, invest in mutual funds or exchange-traded funds (ETFs), or hire a professional manager like a robo-advisor. Diversifying your portfolio by investing in a range of stocks and bonds is generally a good idea.

- Buy the investments: Look up the ticker symbol for the investment you want to buy and decide on the amount you want to invest.

- Relax and keep tabs on your investments: It's normal for investments to fluctuate in the short term, so try not to stress about short-term blips. However, remember to periodically check in on your investments to ensure they are still aligned with your goals and risk tolerance.

Assess your risk tolerance

When it comes to investing, it's important to assess your risk tolerance, or how much uncertainty and volatility you can handle without it affecting your life. This is a crucial step in deciding what types of investments to make and what your investment plan will look like.

Understanding Risk Tolerance

Risk tolerance is a measure of how much of a decline in your portfolio balance you can handle without becoming worried and selling out of fear. Those with a higher risk tolerance can generally withstand greater declines without panicking, and they tend to see market declines as normal fluctuations that will correct over time. On the other hand, those with a lower risk tolerance may view market downturns as permanent losses and be more inclined to sell their investments to prevent further losses.

Factors Affecting Risk Tolerance

Several factors can influence your risk tolerance:

• Financial goals: Understanding your financial goals is vital before considering risk. Common goals include saving for retirement, a child's education, or a down payment on a home. Each goal has a different timeframe and required amount, which will impact your risk tolerance.
• Time horizon: The time horizon refers to when you plan to use the money you've invested. Generally, a longer time horizon allows for more risk-taking, as there is more time for investments to recover from potential downturns. Conversely, a shorter time horizon may require a more conservative approach to ensure that short-term goals are met.
• Comfort with short-term losses: It's important to consider how comfortable you are with short-term losses. Investments can fluctuate, and stocks may decline in value. If you need your money in the near term, you may have to sell at a loss. A more diverse portfolio can help mitigate this risk.
• Savings: It is recommended to have savings set aside in liquid accounts for emergencies, regardless of your risk tolerance. However, if a large portion of your savings is in cash due to a reluctance to invest, this may indicate a lower risk tolerance.
• Tracking investments: Consider how often you plan to track your investments. If you intend to monitor them frequently, is it due to nervousness or excitement about new opportunities? If market downturns cause anxiety, focusing on long-term goals and diversifying your portfolio can help.

Tools for Assessing Risk Tolerance

Many investment websites offer free online questionnaires to help assess your risk tolerance and provide initial asset allocation suggestions. Additionally, financial advisors can assist in assessing your risk tolerance and developing a tailored investment plan. These professionals use carefully constructed questionnaires and their expertise to create a portfolio aligned with your risk tolerance.

Risk Tolerance Spectrum

Your risk tolerance falls somewhere on a spectrum, ranging from conservative to aggressive:

• Conservative: Prioritises safeguarding capital over potential investment gains.
• Moderately conservative: Willing to preserve capital while taking on a small amount of risk for potential gains.
• Moderate: Balances risk and reward.
• Moderately aggressive: Focuses on longer-term investment returns and accepts more risk to achieve this goal.
• Aggressive: Maximising investment returns is the primary objective, and significant volatility is tolerated.

Risk and Reward

It's important to remember that risk and reward are correlated. While lower-risk investments offer more predictable returns, they typically yield lower returns. In contrast, higher-risk investments, such as stocks, can provide the potential for higher returns but also carry a greater risk of loss.

By assessing your risk tolerance, you can make more informed investment decisions and create a portfolio that aligns with your comfort level and financial goals.

Consider a 401(k) or other employer retirement plan

A 401(k) is a retirement savings plan that provides tax advantages to savers. It is a company-sponsored retirement account, where employees can contribute a percentage of their income. There are two types of 401(k)s: traditional and Roth. With a traditional 401(k), contributions are made pre-tax, meaning they reduce taxable income, but withdrawals in retirement are taxed. On the other hand, Roth 401(k)s are made with after-tax income, so there is no tax deduction when contributing, but withdrawals during retirement are tax-free.

A 401(k) can be one of the simplest ways to begin investing, and it comes with some major incentives. Most employers offer to match a portion of what you agree to save for retirement out of your regular paycheck. If your employer offers a match and you don't participate in the plan, you are essentially turning down free money.

In a traditional 401(k), the contributions are made prior to being taxed and grow tax-free until retirement age. Some employers offer Roth 401(k)s, which allow contributions to be made after taxes. If you select this option, you won't pay taxes on withdrawals during retirement.

• Contact your employer: Ask if a 401(k) is available and whether there is a company match. If a 401(k) is offered, the company will provide instructions on how to sign up.
• Choose your investments: You will typically have a range of options, from conservative to aggressive. A popular option is a target-date account, which automatically adjusts the asset mix based on your preset retirement date, becoming more conservative as you near retirement.
• Understand the differences between traditional and Roth 401(k)s: Traditional 401(k)s offer an immediate tax break, as contributions are deducted from your gross income. With a Roth 401(k), contributions are made with after-tax income, so there is no tax deduction when contributing, but withdrawals in retirement are tax-free.
• Maximize your contributions: While it may not always be possible to contribute the maximum amount, try to contribute enough to take full advantage of your employer's match. This is essentially free money that can boost your retirement savings.
• Consider the long-term benefits: Compounding occurs when the returns generated by your savings are reinvested into your account, generating their own returns. Starting a 401(k) early in your career allows your money to grow over time through the power of compounding.

Robo-advisors

When choosing a robo-advisor, it's important to consider factors such as management fees, expense ratios, account types, investments, rebalancing, and access to human advisors. Management fees are usually shown as a percentage and are paid annually. Expense ratios are paid to the people and institutions that manage the funds you invest in, not the robo-advisor. Account types include retirement accounts like IRAs and 401(k)s, and taxable accounts with no specific tax advantages but no limits on contributions or distributions. Most robo-advisors use low-cost index funds and ETFs.

Some of the top-rated robo-advisors include:

• Wealthfront: Offers a range of investment and money management products with low fees and a low minimum investment of $500. It also has a high-yield cash account and debit card, and daily tax-loss harvesting.
• Betterment: Great for beginners with a $0 account minimum and $10 minimum to start investing. It offers multiple portfolio choices, including crypto, and low-fee financial advice packages.
• SoFi Automated Investing: Charges no investment management fee and has a $1 minimum investment. Offers access to financial advisors and a broad range of financial solutions.
• M1 Finance: Suitable for sophisticated investors who want access to customized portfolios and the ability to choose their own stocks and ETFs. It also offers high-yield cash accounts and low-interest rate borrowing.
• Acorns: Features a "round-up" feature that automatically invests your spare change, making it a good option for those who struggle to save.
• Ellevest: Designed for women investors, offering tailored investment portfolios and discounted financial advisor access.
• ETRADE Core Portfolios: Provides a solid robo-advisor platform with a user-friendly mobile app, and access to the broad Morgan Stanley lineup of investment and financial management services.

Index funds

• Open an investment account: Different types of investment accounts are suitable for different goals. For example, taxable brokerage accounts are good for building wealth, while retirement accounts like an IRA or 401(k) provide tax benefits for long-term investing.
• Decide on your index fund investment strategy: This will depend on your financial goals, risk tolerance, and timeline. Generally, it's recommended to keep more of your portfolio in stocks when you're further from your goal and gradually adjust to more bonds as you get closer.
• Research your index funds: Pick an index or multiple indexes to track. Common indexes include the S&P 500, Dow Jones Industrial Average, NASDAQ, and Russell 2000. Compare the expense ratios, fees, investment minimums, and long-run performance of different index funds before deciding.
• Buy the index funds: You can buy shares of the index funds you've chosen through your brokerage account. You'll need to buy enough to reach the fund's investment minimum, but after that, you can typically buy fractional shares.
• Set up your purchase plan: Investing is typically an ongoing practice, so consider setting up automatic investments at regular intervals. This is known as dollar-cost averaging and helps to reduce the emotional push to buy high and sell low.
• Decide on your exit strategy: While buying and holding is a solid investment strategy, you should also think about when and how you'll sell your shares, taking into account capital gains taxes and tax-loss harvesting.

Some popular index funds to consider include:

• Fidelity ZERO Large Cap Index
• Vanguard S&P 500 ETF
• SPDR S&P 500 ETF Trust
• IShares Core S&P 500 ETF
• Schwab S&P 500 Index Fund
• Shelton NASDAQ-100 Index Direct
• Invesco QQQ Trust ETF
• Vanguard Russell 2000 ETF
• Vanguard Total Stock Market ETF
• SPDR Dow Jones Industrial Average ETF Trust

Exchange-traded funds (ETFs)

ETFs are ideal for those who want to invest in many securities all at once without having to analyse companies and pick stocks. They are also a good option for those who want to buy and sell intraday, as ETFs can be bought and sold anytime during a trading session.

ETFs are known for their low fees. The expense ratios of most ETFs are lower than those of the average mutual fund. The average expense ratio for an index ETF was 0.16% in 2022, and as of 2024, the SPDR S&P 500 ETF (SPY) had an expense ratio of 0.09%.

ETFs are also tax-efficient. Because of their passive management, ETFs usually have fewer capital gains, which means investors may pay less in taxes. In addition, in-kind exchanges for an ETF's securities also result in fewer capital gains.

ETFs are available for various investment goals and strategies. Some common types of ETFs include:

• Bond ETFs: These provide regular income to investors and distribution depends on the performance of underlying bonds, which may include government, corporate, and municipal bonds.
• Stock ETFs: These are baskets of stocks that track a single industry or sector, providing diversified exposure to a single industry.
• Commodity ETFs: These invest in commodities like crude oil or gold, offering a hedge against inflation and an alternative to stocks and bonds.
• Currency ETFs: These track the performance of currency pairs, allowing investors to speculate on currency moves or hedge against currency risk.
• Bitcoin ETFs: These expose investors to bitcoin's price moves in their regular brokerage accounts.
• Inverse ETFs: These earn gains from stock declines by shorting stocks.
• Leveraged ETFs: These seek to return multiples on the return of the underlying investments.

When considering investing in an ETF, it is important to review its goals and strategy, underlying assets, expense ratio, liquidity, performance history, and how it fits within your overall portfolio.

Frequently asked questions