If it is, take a few minutes to read our guide to asset allocation. It slows things down and answers questions like exactly what percentage of your money to put into stocks. Another important thing to do before you get started is to get a general sense of "who you are" as an investor. There are a few important questions to ask yourself, such as:. One of the important things to do before you get started is to understand why you're investing. This can play a major role in your investment style, risk tolerance, and more. For example, if you're saving for retirement, you should be less inclined to take risks that someone who has a substantial nest egg in a workplace retirement account but is simply investing to try to make some additional money.
The same can be said if you are investing for a specific goal, such as to pay for your kids' college education. Assessing your risk tolerance is more of a personality question.
Are you a risk-taker that is willing to ride out some turbulent moves in your stocks' prices in order to potentially achieve better long-term returns? Or, would large swings in the value of your portfolio make you nauseous? There's tremendous variety within the stock market when it comes to risk.
This is another question that can help you choose stock investments that are right for you. If your priority is to grow your money, for example, you don't need to focus on dividend-paying stocks. On the other hand, if you plan to rely on your stock investments for income, you may want to focus on higher-paying investments only. This is even true if you decide that you're best suited to invest in index funds. This is the main question that will tell you if you should buy individual stocks, or if you'd be better off focusing on ETFs and mutual funds.
To be sure, there's nothing wrong with the latter option. Index funds can ensure that you do as well as the overall market, which as we saw in the introduction is quite good over time. If you want to pick individual stocks, we absolutely encourage you to do so. However, there's a caveat. You need to commit enough time to thoroughly and effectively evaluate stocks before you buy them. At a minimum, I'd suggest only investing in individual stocks if you have at least a couple of hours each week to learn about investing and to evaluate potential investment opportunities.
A brokerage account is similar to a bank account, with the key difference of being able to buy stocks, bonds, mutual funds, and ETFs.
- More Financial Planning Advice?
- Trend Watch List Extended - Consolidation Versus Niche Marketing?
- With Investor Phil Town;
- Show Notes.
- Timing and why we’re all VCs.
- An Introduction to Fluid Mechanics and Transport Phenomena.
- The mathematics of market timing.
There are several great online-based brokerages with lots of features to help you analyze stocks, reasonable commission structures, and user-friendly trading platforms. When you open your brokerage account, you'll have to decide what type of account you want. Your broker likely has several options, but for first-time investors, there are generally two main ways to go -- standard or IRA. A standard brokerage account also referred to as a "taxable" account is your basic, everyday investment account.
An individual retirement account, or IRA, is designed for retirement savings and comes in two main varieties -- traditional or Roth. There's more to learn about IRA investing, but the first thing you should know about the differences between standard brokerage accounts and IRAs is that both have advantages and disadvantages.
A standard brokerage account lets your deposit as much money as you want and withdraw your funds whenever you need to. The downside is that you'll have to pay taxes on the dividends and interest income you receive each year, as well as capital gains tax whenever you sell an investment for a profit. On the other hand, IRAs are tax-advantaged accounts. With both types of IRA, you won't have to worry about dividend, interest, and capital gains taxes each year. Plus, there's a maximum amount of money you're allowed to contribute to IRAs each year. Another retirement consideration is whether you have a k or similar retirement plan at work , especially if your employer matches a certain amount of your contributions.
Let's be perfectly clear about this -- however you choose to invest in the stock market, it's almost always a smart idea to take full advantage of your employer's matching contributions before you invest any money elsewhere. Each of the accounts has slightly different contribution rules, but in general they allow for higher annual contributions than traditional and Roth IRAs, so they may be worth a look if you have any income from self-employment.
It's important to do some quick comparison shopping when it comes to brokers, as there are some significant differences. Some offer tons of educational features, as well as access to high-value research reports. Some even offer branch offices throughout the U. And others are light on features but offer some of the cheapest commissions in the industry.
Our sister website, The Ascent, has reviews and comparisons of several great brokers , so that's a smart place to start your search. Once you've decided which broker best fits your needs, opening a brokerage account is typically a quick and painless process.
Here's the key point. If you have the time, knowledge, and desire necessary to invest in individual stocks the right way, we absolutely encourage you to do it. If not, there's absolutely nothing wrong with building a portfolio of low-cost ETFs and mutual funds to take the stock-picking part out of the equation.
In fact, Warren Buffett has said that the best way for the majority of investors to get exposure to the stock market is through low-cost passive index funds. With that in mind, if you decide that you're better suited to invest in stocks through funds, here are a few things you need to know. A mutual fund is an investment vehicle that involves a bunch of investors pooling their money to invest for a common purpose. You can invest in a mutual fund through your broker, but you invest a set dollar amount, and mutual fund transactions only take place once per day.
Diversification | ASIC's MoneySmart
Exchange-traded funds, or ETFs, are similar in some ways. Specifically, they are a pool of investors' money for a common goal. However, they trade on major exchanges like stocks, so you would buy a certain number of shares, not a fixed dollar amount. And ETFs trade throughout the day, so if you place an order, it will be executed at the current market price. If you're planning to invest in funds, it's important to make the distinction between passively managed index funds and actively managed funds.
Does Buy-and-Hold Beat Market Timing?
Index funds simply are designed to track an index and replicate its long-term returns. Because they don't require any stock-picking expertise, these funds don't have to employ active managers. This keeps costs much lower, as I'll get into shortly. On the other hand, actively managed funds hire investment managers to construct a portfolio. The big difference from an investor's perspective is that index funds are designed to match the performance of a benchmark index. Actively managed funds are designed to hopefully beat a benchmark index.
The downside is that active management costs more. To be clear, this doesn't mean that if you invest in an actively managed mutual fund that you will beat the market. In fact, numerous studies have shown that the majority of actively managed funds underperform the stock market. Some actively managed funds can be worth the cost, but be sure the fund has a well-established history of beating its benchmark index.
As a final thought about funds, it's important to know how much you're paying. If you look at a quote of any mutual fund or ETF, you should see a number called the expense ratio , which tells you the fees you pay as a percentage of your investment each year. There's no set rule as to what's too expensive.
First off, this refers to the amount of your invested money. Obviously, things like your emergency fund shouldn't be in stocks. So, it's important to learn the basics of asset allocation. For beginners' purposes, we can narrow this down into two basic categories -- stocks equities and bonds fixed income. It's a smart idea for beginners to read through our guide to asset allocation , but for the time being there's one main idea you need to know. Stocks have higher long-term return potential , but also have more short-term volatility.
Bonds , on the other hand, tend to generate lower returns over long time periods, but also tend to be less volatile. Because of these traits, stocks are better-suited for younger investors while bonds are more in-line with what most older investors need.