The investing world is full of sensational headlines like “If you had invested $1,000 during Amazon’s IPO, your investment would now be worth over $1 million.”
For new investors, this may lead to feelings of guilt or disbelief. Hindsight is 20/20 and numbers can be twisted to make anyone feel a sense of FOMO.
But claims like that are powerful because they’re…not entirely false. Investing can make you money. For me, investing was the key to becoming financially free before 30.
The best time to plant a tree was 20 years ago. The second best time is now.”Chinese Proverb
This guide is designed to be a non-judgy, easy orientation into the world of investing. Read on if…
- You’re not sure about what to do with extra cash
- You’re not comfortable with investing yet
- You’re afraid of losing money in the stock market
By the end of this guide, you’ll know the what, why, and how of investing and have a “set it and forget it” investing plan that you can implement in just about any free investment platform.
Skip this guide if you’re already regularly investing with low cost funds/ETFs. This is for beginners looking to get comfortable with investing their first dollars. Better yet, share this guide with a friend who a new investor.
⟁ The what and why of investing
Simply put, investing is the act of growing your money.
But how you choose to grow that money will make all the difference.
- Investing: put money into productive assets, or stuff that creates more value, and thus more money
- Speculation: betting on things purely based on price predictions
You want to be investing because it builds a long term habit of putting money in productive places. Speculating can make you money, but it’s easy to be reactive and lose focus. There’s a reason why gamblers and lottery players often lose more than just their money. This guide will concentrate on investing in the stock market – not trading stocks. You’ll learn why soon.
Why grow your money? Because inflation eats away at your money. Here’s what that looks like:
- Investors: Invests $1000, gets $1080 a year later.
- Un-invested: Holds $1000 in cash, gets deflated down to $950 because things get 5% more expensive
The difference between those two scenarios, stretched out over time, becomes enormous.
Investors can benefit from inflation because they convert their money into assets like stocks and real estate, which can go up in price. The uninvested who hold mostly cash get most of their wealth inflated away.
Basically, the purpose of investing is to grow your wealth and help you avoid losing money.
⚖️ “Should I even invest? And how much?”
Invest if you have extra cash. Don’t worry about investing if you don’t have at least 3 months of living expenses saved up.
Prioritize building a financial buffer first. Sometimes you have to play defense before you play offense, and that’s okay. Here’s an illustration of who should start vs hold off investing:
|Player A||Player B|
|Money coming in (monthly)||$2000||$1000|
|Money going out (monthly)||$1000||$1000|
|Should I invest?||Invest anything beyond $3000 savings||Build up emergency fund first|
Personally, I invest anything beyond 1 year of living expenses.
Need time to build up a financial buffer? Instead of feeling guilty about not investing, prioritize investing in yourself first. You can invest in yourself by finding other ways to make money. Increasing earning power = increased investing power. Investing in yourself also means saving money to create a financial line of defense for whatever life throws at you.
What if you have debt? There are two forces to consider: time and psychology. 1) Investing is a long term game of building wealth over time. 2) People generally want to avoid a loss than to receive a gain.
This means that there’s a bigger psychological benefit to paying off debt first. You can also calculate this by the cost of your debt (let’s say it’s 15% interest) and your expected performance in investments (let’s say it’s 10%). Then it’s a no brainer that paying off your debt is the better “investment.”
Generally, try to get rid of your costliest debt first. See if you can refinance it to make the debt lower.
🧺 What to invest in? Selecting investments and creating your portfolio
You can invest in almost anything these days, from stocks to beanie babies to crypto. These are all different types of assets AKA “asset classes.” Now…which assets to invest in?
We’ll stick with “traditional” asset classes in this portion, which have a long history of performance and stats to back them up. Don’t worry about newer asset classes like crypto or NFTs for now.
- Stocks: shares of companies
- Bonds: loans from companies or government that pay interest
- Real estate: land, property, commercial and housing developments
- Cash: money you keep on hand
Stocks tends to be higher risk and higher rewards, and are more volatile. Bonds are lower risk and lower rewards, and change less frequently.
There are a number of sample portfolios that work depending on your risk tolerance.
- 80/20 portfolio: 80% stocks, 20% bonds
- 60/40 portfolio: 60% stocks, 40% bonds
- 50% stocks, 30% bonds, 20% real estate
Generally, the younger you are, the more risk you can take on. Someone in their 20s can easily have a 100% stock portfolio and be fine. You have less money to lose and have time on your side for investments to compound and become significant.
Older people or those who’ve built up wealth are reasonably more conservative – you don’t want to lose what you have, especially if it’s time to use that money for retirement.
The general goal of creating a portfolio is i) to diversify and ii) invest in things that don’t always move in the same direction. If the stock market takes a dip, then real estate may hold up.
Start by investing in a basket of stocks, not single stocks.
It’s been proven that most people – not even hot shot finance managers – can beat “the market” by picking individual stocks. Picking stocks is more akin to speculation instead of investing. That doesn’t mean you can’t try to pick stocks, but it shouldn’t serve as your investing foundation.
If you bet on the basket rather than any individual eggs in that basket, you’re more likely to win long term. Just check out the long term historical trend of the S&P 500. It’s only gone up over time.
The stock “market” = all the publicly traded companies (there are over 4000) that offer shares you can buy.
For example, the S&P 500 is a basket of the 500 largest U.S. companies. Buying a fund that represents this basket, like the Vanguard S&P 500 ETF (symbol: VOO), means you’re “buying” the stock market.
Let’s say you only have $1000 and bought 1 share of Disney. Literally, all your eggs (money) are in one basket (Disney). If you spend that $1000 on 1 share of the S&P 500 index, then you’re holding a basket of the largest 500 stocks, which includes Disney.
A basket of stocks help you diversify and spread out risk so your money’s performance is not just tied to the outcome of 1 company.
🤔 Is putting your entire portfolio stocks risky?
You can do a lot worse than putting money in the S&P 500. Legendary investor Warren Buffet told his estate planners that when he passes away, “buy 90% in the S&P 500 index fund.”
Just make sure you’re mostly exposed to “the market,” meaning a portfolio that is at least 50% stocks. This is essentially a bet that America will keep growing and innovating. But like I mentioned earlier, your risk tolerance matters.
If you don’t want to construct your own portfolio, Target date retirement funds automate this decision for you. These are funds that automatically adjust from more risk (stocks) to less risk (bonds) as you get closer to retirement.
Let’s say you’ll be at or near retirement in 2045, you can look at the Vanguard Target Retirement 2045 Fund (VTIVX). As of this date, this fund is allocated to 87% Stocks and 10% bonds. The fund’s goal is to drift towards an allocation of 70% bonds and 30% stocks.
🧩 Buy index funds, avoid actively managed mutual funds
Now that you know to buy a basket of stocks, what basket should you buy? Cliff notes:
- Buy funds that have low “expense ratios.” This is the fee the fund charges you for using them.
- Buy index funds, which have lower expense ratios than actively managed funds
- Index funds are cheaper than actively managed funds, with an average expense ratio of 0.2%, while actively managed funds charge between 0.5% and 1.0%.
- Index funds historically beat mutual funds: that’s right, a fund that just “tracks” an index like the S&P 500 tends to outperform human managers that try to beat the market
- How to spot these funds: index funds will usually have the words “Index” in their names. If you’re looking at your 401k options and are not sure, the dead giveaway is in the expense ratios.
The purpose of an actively managed fund is to beat “the market” – or why even pay the extra cost? The hidden story here is that 95% of financial professionals can’t beat “the market.” Here’s an example:
|Index Fund||Actively Managed Fund|
|How it’s managed||Automatically tracks/mirrors a market, such as S&P 500 index||A team of investors tries to beat the market|
|Example fund||VFIAX: Vanguard S&P 500 Index||YAFFX|
|Example Expense||For every $1000 invested it’ll only cost you 40 cents. A $100K portfolio only costs $40.||For every $1000 invested it’ll cost $1.28 cents. A $100K portfolio will cost $1,280.|
In this example, the actively managed fund costs 32 times more than the index fund.
Here’s the rub—even if the actively managed fund matched the index fund in performance (in this example, it lags the index some), you’d be paying more in fees. Indexing wins.
🧩 Gimme a sample portfolio to implement
You can get started by buying the cheapest stock market index fund. Or, use some of these other strategies:
|Young and/or risk averse||Balanced risk||Most Automated|
|100% in stock market index: VFIAX (Vanguard S&P 500 Index)||80% in stock market index: VFIAX |
20% in bond market index: VBTLX
|100% in target retirement fund VTIVX|
|The closest thing that tracks the S&P 500 Index.||If you want more predictable income from bonds||Choose based on when you’re going to be 55-65|
💪🏼 Maximize your retirement accounts: 401K and IRA
Now that you have a sample portfolio, where do you implement it? Start with retirement accounts.
Tax-advantaged accounts either allow you to pay less taxes now (401K and IRA), or pay taxes now and allow your investments to grow tax free (Roth IRA, Roth 401K). Let’s start with the Traditional 401K.
401K: the easiest place to start investing
Do you work for a company that offers a 401K? Make sure you’re enrolled in it. And once you’re enrolled, there’s still one more step. Make sure you’re contributing to it – which means you’ve selected investments, like one of the options I pointed out earlier like stock market index funds or target date funds.
The funds that are available to you in a 401K will vary depending on the company your employer uses, e.g. Fidelity, ADP, Charles Schwab. Here’s an example of selected investments in a 401K account:
If you don’t see money taken out of your paycheck for a 401K contribution, then you’re not contributing to it. Not sure? Talk to your company’s HR or benefits professionals.
There are some powerful advantages to the 401K:
- 401K Match: some companies offer to pay into your retirement up to a certain % of your pay. This is plain free money; your company is rewarding you for savings towards retirement. Also, any amount that your company matches does not count towards your annual contribution limit.
- Reduces taxes: the max contribution to your 401K is around $19,500/year and increasing. If you max out your $401K, you reduce the taxes you pay by that much—and it may even put you at a lower tax bracket
- Easy: You won’t miss the money as much when it’s directly taken out of your paycheck and invested on your behalf.
Note: 401K or Roth 401K? A Roth 401K takes after tax money and invests it, so it can grow and doesn’t get taxed when you’re at retirement age. All of this boils down to how high you think your effective tax rate will be at retirement.
For most people, choose the Traditional 401K. This option will give you more money left over because it reduces your income tax. If you make $59,500 and the annual limit is $19,500, then you’re effectively being taxed as if you made $40,000 instead. If you’re really worried about taxes going up in the future, you can do a 50% Traditional 50% Roth 401K strategy if your company has both options. Either way, you can’t really go wrong.
Self employed or don’t work for a company that offers 401K plans? Look into the Solo 401K plan.
IRA: Individual retirement accounts
Regardless of whether you have a 401K or not, anyone can contribute to an IRA. The annual contribution is about $6000, but the trend is that it’s been increasing every year.
- Traditional IRA: deduct contributions from taxes now, pay taxes when you withdraw later. No income limits for contribution to a normal IRA
- Roth IRA: contribute with after tax income, but don’t pay taxes when you withdraw later.
Unlike the company sponsored 401K plans, the IRAs you do on your own. Many financial institutions want your money and offer an IRA option, and are willing to offer you a sign up bonus. I’ll list 3 of my favorites:
- Vanguard: has the famous low-cost index funds
- M1 Finance: easily create your own investment “pies.” I wrote a guide about it here.
- eTrade: investing giant with access to both index and funds, ETFs and single stocks
🌊 Create your financial goals + flows
The 401K ($19,500) and IRA ($6000) contribution limits = $25,500 invested over the course of 1 year.
That comes out to be $2125/month, or $1062.50 per pay check if you’re paid every other week.
To simplify your investing, you can just work up the ladder:
- Max out your retirement accounts
- Additional money beyond your retirement accounts, emergency fund, and aspirational savings could be invested in accounts like M1 Finance
- Hold off on trading individual stocks or alternative investments (crypto) until you’ve established the foundation of passively investing into the stock market. Perhaps give yourself a season (let’s say at least 3 months) to try out this system.
Remember, you’re building a system to make yourself a long term investor (which pays), versus a reactive short term trader (most lose money).
☕️ Did all that that? Relax…or ask me for help
If you’ve set everything up by now and started investing in index funds, give yourself a pat on the back. You can relax now and feel like a boss.
This is the first draft of this beginner’s guide to investing.
If you anything is missing, doesn’t make sense, or you just want to chat 1:1 with me about getting started with investing, join my newsletter and respond to me by email. I’m happy to help out.