The oldest rule for thinking about how to start investing money is also the simplest: “Buy low, sell high.” While it seems blindingly obvious and begs the question of why anyone would want to do anything else when investing, you might be surprised how hard it is to put into practice.
Investing is a discipline which plays not only on astute analysis and remarkable luck but also on people’s behavioral responses. Holding onto your stocks during periods of intense stock market volatility takes a lot of courage and isn’t what the human brain is wired to withstand.
But how do you approach investing if you don’t have a background in it? Without much prior experience, it’s tough to say how to invest your money. There’s an ocean of information out there and sorting through it requires deliberate, thoughtful reflection when piecing together what you’ve read.
When it comes to growing your wealth and working toward financial independence, investing is an important tool.
Through investing, you can buy assets which, hopefully, grow in value, whether it is real estate like your home, a tax-advantaged investment (e.g., retirement account, health savings account), stocks, bonds or alternative investments.
All of these, when balanced appropriately and included in an investment portfolio, represent the best investments for young adults.
Let’s walk through some simple steps on how to begin to invest your money.
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First, Invest in Yourself
Recently, I attended a wedding with my wife and her family where my brother-in-law approached me with a conversation about how to invest money.
He wanted to know how he could replicate the performance seen by the world’s greatest investors and learn how to start investing with little money. Specifically, he yearned to turn a small sum of money into an account balance with two commas in quick fashion.
Boy, if only I knew the sure-fire way to make that path my own reality, we wouldn’t have driven to the wedding in a rented mid-tier subcompact.
I cautioned him that those investors are truly gifted and the exception to the norm. While it is important for him to know how to start investing young, I told him the common trait these legendary financiers share: following a systematic and disciplined approach to investing.
Further, they learned how to invest in yourself and gained a true appreciation for studying the stock market and the players working in it. These high income skills have yielded them significant returns over time.
I followed this with saying regardless of investing style, time frame, or philosophy, these great investors all have discipline, transact based on logical, informed thinking and do not let emotions drive their decision-making.
These are the most important elements required for investing success.
The investing styles are merely a means to an end and are developed later. Any investor starting out should focus on these core principles and learn to stick to them during times of good and bad.
How to Start Investing Your Money: Develop Your Investing Approach
As I explained this to my brother-in-law, I could see his disappointment in my not knowing any shortcuts to overnight investing success.
However, we launched into a discussion around how he could develop his own disciplined investing approach by first becoming a student of markets.
Knowing that this discussion could become overly cumbersome in just one conversation, I decided to share only introductory steps, which I outline below.
Investing isn’t easy but, at the same time, it shouldn’t be seen as a frightening endeavor. If done wisely and consistently, investing can separate you from retiring comfortably at a reasonable age and working into your golden years out of necessity.
We all want a comfortable retirement, so why shouldn’t we make smart decisions to get there?
With that thinking, I will do the same here. Short of a formal education in finance, my five high-level steps for gaining familiarity with investing in the stock market are as follows:
1. Read a Lot About the Stock Market
Sounds logical, right? You may be surprised by how many people I’ve heard say they got into a stock simply because so-and-so recommended it.
This person winds up not doing a lick of due diligence before investing and often doesn’t know what was happening in the stock market, nor anything about the company.
To counteract this, I suggest first beginning by reading reputable stock market investment websites that discuss markets (e.g., stock news publications).
As you read more, I really suggest approaching every article with a heavy dose of skepticism.
This will make you more likely to piece together content from multiple sources and form your own thinking about markets and the companies in them.
As an exercise, take a moment to read this 2018 U.S.-China trade war article about the earnings estimates for public companies. After you’ve read it, what were the main, salient points that stood out to you? I found the following to be most important:
- Many investors seem to think lackluster stock market movement during this quarter’s earnings announcements indicates peaking corporate profits. When companies announce record earnings and the stock market barely moves, it must mean expectations were high and future earnings don’t look to get any better.
- Analysts, or those people who follow stocks and publish opinions on them, seem to disagree and are increasing their profit projections at the largest rate in 6 years. This is where the skepticism should come into play. This conflict means someone is wrong, but who? Perhaps both are right and yet both are wrong. The truth likely lies somewhere in between.
- A growing economy and corporate tax reform have benefited companies but trade war activity makes for an uncertain outlook. To illustrate uncertainty, reporting companies have seen the most volatile trading in two years immediately after announcing earnings results. However, it appears this trading reaction could be the result of poor understanding of the effects of the recent tax reform legislation and clouds the visibility for accurately forecasting future earnings. So the volatility merely highlights poor forecasting abilities, not necessarily anything indicative of market direction.
- A lot of positive developments exist to push the stock market higher but looming risks serve to temper optimism usually present with such strong earnings growth.
- Bottom line: there doesn’t appear to be a strong case for a plummeting stock market but neither for a sustained rally.
As you read more pieces like this, reflect after each one and begin to piece together content from what you’ve read. Building this understanding won’t happen overnight.
2. Start Looking into Individual Companies
Naturally, you will come across individual companies. You should identify companies consistently performing well or making strides to improve.
I recommend starting by researching five companies you admire (preferably in different industries) and cultivating ideas about the strategies of each firm, their competitive advantages, and the core value they provide.
If you don’t believe any of these items to be durable over time, I would suggest moving on. You should recognize:
- what sets these companies apart from their peers,
- the prospects for the markets in which they operate (e.g., growing market vs. declining market), and
- how the stock market values them
The last item remains particularly important as the asset doesn’t so much matter but the price paid for it does. You can buy the most dogged companies for a fantastic price and earn a positive return while you can buy the most overpriced fantastic companies and lose money.
The point is you should pay considerable attention to the price companies trade for as this will be the greatest predictor of your potential returns: pay too much and risk losing money or pay too little and extract some value the stock market didn’t assign the stock.
As far as the underlying businesses themselves, you should cast aside companies if you uncover something you don’t like. Don’t let sunk costs guide your thinking.
Ultimately, a stock represents a piece of a company, so sustainable profitability is an important factor.
Companies who continually produce losses, by definition, cannot survive without endless investor appetite for losses (a rare occurrence as long-term investors are in the business of buying profitable companies).
You really want to assess how profitable these companies can be, because before you decide how much to pay for a stock, you need to understand how much money that company makes.
If the company makes a lot of money consistently, you will likely have to pay more to acquire the stock.
How to Find Individual Companies Worth Buying
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Related: Best Investment Accounts for Kids
3. Consider Investing in Index Funds and Mutual Funds
Investing is hard. It’s more art than exact science. By writing this investing step-by-step guide, my goal is not to simplify it.
In fact, what I want to convey as clearly as possible is just how difficult it is to invest in individual stocks.
Investing is so much more than following some rules of thumb. Getting an edge is difficult, so you shouldn’t develop irrational self-confidence and think you have an investing edge when you really don’t.
Usually, being humble and saying to yourself that you don’t really know can be great to steady your decision-making.
If you don’t have confidence in selecting individual companies to outperform the market, another strategy is to invest in index funds like exchange traded funds (ETFs), mutual funds or some combination of the best target date funds.
What is an Exchange-Traded Fund (ETF)?
An ETF is a marketable instrument that tracks an index or collection of assets. ETFs function like stocks, which you can buy and sell at any time on the market.
ETF prices fluctuate based on supply and demand, just like any security. ETFs are a type of investment that can be passive or active.
Passive ETF investments automatically go to work for you by purchasing a basket of underlying assets in an index as you invest your dollars, while active ETFs give investors options with custom management and even exposure to indexes as well.
ETFs don’t need to track stock market indices—they may also invest in specific industries or sectors.
Because of the various investment options available through passive and active ETFs, holders face varying charges for having their funds managed by ETF managers.
Management, administrative, and operational costs are common expenses for the fund.
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What is a Mutual Fund?
Mutual funds are a great way for investors to diversify their portfolio and receive the benefits of professional management. When many people put their money together and pool it, they can buy a common portfolio of assets to achieve the mutual fund’s objective.
A mutual fund is a collection of investments, typically stocks and bonds. Many investors come together by pooling their money to invest in this group instead of purchasing them separately or through an investment advisor, stock brokerage or other means of purchasing investments.
They can be managed by either a professional investing team or passively as an index fund. Active funds tend to have more input from the manager while passive ones have less reliance on managers’ decisions because the investments track an index.
Unlike ETFs, investors can select different mutual funds with unique features and operational fees.
Mutual funds also come in two varieties: closed-ended or open-ended.
- Closed-ended mutual funds: Closed-ended mutual funds work in a similar manner as ETFs by issuing a fixed number of shares through an initial public offering. From there, these closed-ended mutual fund shares trade openly on the market like stocks or ETFs.
- Open-ended mutual funds: Open-ended mutual funds differ by offering new shares to the investors who place money with the mutual fund or redeeming them from investors who sell their shares back to the mutual fund.
Are ETFs and Mutual Funds the Best Way to Invest Your Money?
My preferred investing strategy involves investing in low-cost index fund ETFs or mutual funds for the long-term through brokerages which don’t charge trading commissions.
Index funds are the best way to invest your money if you aren’t sure of how best to invest in stocks. They allow you to invest your money in the stock market without it being extremely hard.
So, if you have little experience or confidence in your own judgement, index funds through ETFs and mutual funds are great options.
Related: Best Investments for Kids
What is Diversification?
It’s also advisable to hold some of the best ETFs and mutual funds for diversification purposes.
Diversification is a way to invest your money in the stocks of multiple companies at once, reducing your direct risk or exposure to any one company’s actions or profit potential.
As an example of diversification and how it can reduce uncertainty and come in alignment with your risk tolerance, consider investing in stocks of multiple companies versus in just one.
You could invest your money among the top 100 best companies in the market or choose to invest in 5 companies grabbing headlines.
The former is what I recommend as it provides you exposure across many more industries and makes for a diversified portfolio.
By limiting your concentration in only a handful of stocks and opting for a broader portfolio, when one company underperforms, it has less drag on your returns. As a counterpoint, if one stock outperforms, your broadly-diversified portfolio will lag behind.
On the whole, this should converge to average annual expected market returns, minimizing the volatility and hopefully orienting toward a steadier return upward in the long-term.
While no returns are guaranteed and past performance isn’t a predictor of the future, with time, choosing to invest your money in stocks should perform well in a diversified portfolio.
How to Start Investing Money
Many options exist for starting to invest money—even with small amounts—thanks to many new brokerages on the market.
Several offer fractional shares to invest your money, meaning instead of forking over $150 for a single share of Google (GOOGL), you can purchase a smaller fraction in line with the amount of money you have to invest and your desired investment.
Additionally, the best brokers and robo-advisors also avoid charging trading commissions for your investments, meaning you can contribute in increments as small as you can afford.
This is of particular importance to Millennials and Gen-Zers who may not have significant sums of money to invest all at once, but rather have small amounts of cash which come available after accounting for all of the expenses in the monthly budget.
Have a look below for some of the most popular financial apps for young adults or anyone looking at starting to invest your money.
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4. Take Action
Once you’ve gotten a decent handle on the overall market’s activity and analyzed a set of attractively-valued companies you think stand out from the rest, it’s your time to pull the trigger.
Alternatively, as I mentioned in step 3, consider investing in low-cost index fund exchange traded funds through a robo-advisor.
5. Continue Following the Companies and the Stock Market
By doing your due diligence, you will be able to follow these companies and see if they continue to perform as you expect. If a company makes a decision you don’t agree with or think will adversely impact its value going forward, it might be a good idea to cut your losses short and move on.
Investing well can produce very rewarding experiences you share with those you love. For me, it allowed me to buy my first home and now to grow my assets enough to purchase my next one together with my wife to start our family.
In general, developing your own disciplined investing approach based on rational, informed decision-making can lead to financial peace of mind.
Learning how to invest wisely at a young age will have you maximize your youth by allowing compounding to work to your benefit and see how to build wealth.
Do yourself a favor and invest in stocks by following these 5 steps on how to start investing money.
Finishing the conversation with my brother-in-law, as I laid out this process to meet his interest in becoming a student of markets, I stressed how these are the first steps to developing a disciplined investing approach.
Taking the mindset that informed investing can lead to real gains, I saw he wanted to jump in and work toward developing his own investing approach and investment plan.
He may not become the next Warren Buffett but following through will allow him to have his (wedding) cake, and eat it too.
