First-time investor? Do your homework before investing your hard-earned cash. Unless you can predict the future, investing is a risky business. Know your goals, your needs and your tolerance for risk before you put your money at stake.
Step 1: Understand the risks of different types of investments
From safest to riskiest:
- Savings accounts, CDs, money market accounts
- Mutual funds with short- or intermediate-term bonds
- A blend of mutual funds with stocks and bonds
- Mutual funds with diversified stocks
- Individual stocks
Stocks and bonds are the two main vehicles that you are likely to invest in.
- A bond is a debt security—the issuer owes the holders a debt, and is obliged to repay the principal and interest
- More stable
- Lower potential gain
- Risk of issuer not paying you back
- Stock is capital raised by a corporation through the issuance and distribution of shares through financial markets
- Less stable
- Higher potential gain
- Risk of company failure
If trading individual stocks and bonds feels too risky to you, investing in mutual funds is another option to consider.
- A mutual fund is a collection of stocks or bonds
- Your money is pooled with the money of other investors into a fund that is invested in anywhere from a few dozen to hundreds of different securities
- Managed by an expert fund manager who reports to a board of directors
- Provides you with professional money management as well as instant diversification
Step 2: Establish your goal timeline
The time horizons of your goals will have an impact on where you put your money. With a shorter time span, a more conservative investment vehicle is typically in order. With a longer horizon, your investment has time to weather more risk.
- 3 years: New car fund – savings account or a mutual fund with short-term bonds
- 15 years: Kids college – balanced mutual funds
- 30 years: Retirement – stock-focused mutual funds
Step 3: Start early in life, start small and keep going
When you are starting to invest, it is best to start small and take risks only with money that you are prepared to lose—you’ll have two main choices for actually investing your money.
Utilizing the services of a financial advisor at your bank, credit union or specialized investment firm is the traditional way to invest in stocks, bonds and mutual funds
- Purchases and trades are facilitated through your advisor
- Broker commissions and maintenance fees can be expensive
- Educated professionals are guiding you
- Less time on your part
- Less stressful, as you are relying on a proven coach
- Even though you are relying on expert advice, there are no guarantees
Do it yourself
- Direct investing, do-it-yourself investing, self-directed investing—no matter how you describe it, investing on your own is a real option today, thanks to technology
- Trades are conducted by you through an online discount brokerage
- Typically lower fees and more transparency; you are closer to the process
- Learning and research are totally up to you
- Can be time-consuming
- Your emotions can get the best of you
- Your personal decisions and mistakes can be costly
Avoid these first-time investor mistakes
- Diving in head first.
The basics of investing are quite simple in theory—buy low and sell high. However, don’t be fooled by this overly simplistic view of the financial markets. It is important to study up before jumping in.
- Playing penny stocks.
At first glance, penny stocks seem like a great idea—with as little as $100, you can get a lot more shares in a penny stock than in a blue chip stock that might cost $50 a share. Unfortunately, what penny stocks offer in potential profitability has to be measured against the volatility that they face.
- Going all-in with one investment.
Investing 100% of your money in a specific market, whether it’s the stock market, commodity futures, foreign exchange or even bonds, is not a good move. It is better to diversify your risk by putting your dollars into a variety of investment vehicles.
- Investing all of your cash reserves.
Studies have shown that cash put into the market in bulk, rather than incrementally, has a better overall return; however, this doesn’t mean you should invest all of the money you have. You should always have cash available for emergencies and other opportunities.
- Chasing news.
Investing based on news is a terrible move for first-time investors. Trying to guess what will be the next revolutionary product or basing a decision on a rumor of earth-shattering earnings is not a recipe for success. Rather than following rumors, the ideal first investments are in companies you understand and have personal experience with.
Investing can be risky: Not all investments are guaranteed—some investments carry the risk of losing money, even when made through a financial advisor or financial institution.
Sources: AARP, The New York Times, Investopedia, Morningstar