Getting Started as an Investor

Embarking on your investment journey can be overwhelming. According to the 2022 Investopedia Financial Literacy Survey, 57% of U.S. adults are invested somehow. Yet, only one-third of them consider their investing knowledge to be advanced. This disparity highlights how challenging it can be to start investing, especially if you’re methodical and cautious about diving into such a crucial endeavor before acquiring sufficient knowledge, expertise, and confidence.

Creating a comprehensive list of essential advice for beginning investors is challenging because it may inadvertently omit critical points. Indeed, experienced investors have varied opinions on what should be included in a top ten list for new investors.

Nevertheless, we offer a checklist to assist you in starting your journey as a successful investor. This checklist emphasizes critical personal attitudes and strategic frameworks to help you become a more informed investor.

Key Takeaways

• Develop a financial plan, prioritize savings, and leverage the power of compounding.
• Understand the concepts of risk, diversification, and asset allocation.
• Aim to minimize investment costs.
• Familiarize yourself with classic investment strategies, remain disciplined, and think like an owner or lender.
• Avoid investing in assets or instruments you do not fully understand.

Have a Financial Plan

The initial step to becoming a successful investor is creating a comprehensive financial plan with specific goals and milestones. These goals involve saving for a home, funding your children’s education, establishing an emergency fund, supporting an entrepreneurial project, or ensuring a comfortable retirement.

While many focus on retirement savings, aiming for financial independence at an earlier age can be an even more appealing objective. The Financial Independence Retire Early (FIRE) movement advocates for accumulating wealth rapidly to provide more options earlier in life.

Although creating a solid financial plan can be done independently, if you’re new to this process, you may want to seek assistance from a professional, such as a Certified Financial Planner (CFP®). Ensure that your plan is a living document—regularly updated to reflect changes in your circumstances and goals.

The FIRE Movement

The FIRE (Financial Independence, Retire Early) movement encourages accumulating wealth well before the traditional retirement age to give you greater freedom and options earlier in life.

Make Saving a Priority

To become an investor, you first need to accumulate funds to invest. This typically involves setting aside a portion of each paycheck for savings. Suppose your employer offers a savings plan like a 401(k). In that case, it can be an effective way to automate your savings, mainly if there’s an employer match.

Consider other ways to make saving automatic in addition to employer-sponsored plans. Building wealth generally involves aggressive saving complemented by strategic investing to grow those savings.

A crucial aspect of aggressive saving is living frugally and being cautious with spending. Complement your financial plan with a budget, track your expenses closely, and regularly review your spending to ensure it aligns with your goals. Utilize budgeting apps and software or create your own spreadsheets to manage your finances effectively.

Understand the Power of Compounding

Consistently saving and investing from an early age allows you to harness the power of compounding, which can significantly increase your wealth over time. Although low interest rates have slightly diminished the effect of compounding, starting early is crucial as it will take longer for investments to double in value compared to previous periods with higher rates.

Understand Risk

Investment risk encompasses various aspects, including default risk (the possibility that a bond issuer might not meet its payment obligations) and stock volatility (which can cause sudden and significant value changes). Generally, there is a tradeoff between risk and return, meaning higher potential returns usually come with higher risk, including the possibility of losing part or all of your investment.

As part of your financial planning, assess your risk tolerance—determine how much loss you can handle and how much price volatility you can accept without undue stress. This evaluation will guide you in choosing investments that align with your risk profile.

Risk

Investment risk includes the potential for total loss, but it also involves other factors and measures of risk.

Understand Diversification and Asset Allocation

Diversification and asset allocation are critical for managing investment risk and optimizing returns. Diversification means spreading your investments across various assets to mitigate the risk that poor performance in some will be offset by better performance in others. Asset allocation involves distributing your portfolio across different asset categories like stocks, bonds, and cash.

Regularly review and adjust your diversification and asset allocation strategies as part of your ongoing financial planning.

Keep Costs Low

While you cannot predict future returns, you can control your investment costs. High costs, such as transaction fees and management fees, can significantly impact your investment performance. For instance, high-cost mutual funds do not guarantee better performance.

The Importance of Costs

Investment costs and fees can significantly influence your overall investment results.

Understand Classic Investment Strategies

As a beginning investor, it’s crucial to grasp classic investment strategies, including active versus passive investing, value versus growth investing, and income versus gains-oriented investing.

Active investing involves trying to outperform the market through stock selection and market timing. In contrast, passive investing seeks to match market performance through index funds. Value investors focus on stocks priced below their intrinsic value, expecting future appreciation. Growth investors, however, seek stocks with high growth potential, even if they are currently expensive.

Income-oriented investors seek steady dividends and interest, while gains-oriented investors prioritize capital appreciation over income. Understanding these strategies will help you choose the approach that fits your investment goals.

Read about Investopedia’s 10 Rules of Investing

Explore Investopedia’s special edition print issue for more insights into these investment strategies.

Be Disciplined

When investing long-term, adhere to your well-thought-out financial plan and avoid being swayed by short-term market fluctuations or sensational media coverage. Be skeptical of market predictions if they come from sources with proven, reliable track records.

Think Like an Owner or Lender

Stocks represent ownership in a company, and bonds are essentially loans to the issuer. To be a thoughtful long-term investor, evaluate whether you want to own a part of a business or lend money to an issuer. This perspective helps in making informed investment decisions.

If You Don’t Understand It, Don’t Invest in It

Given the complexity of modern investment products and business models, only invest that you fully understand, especially regarding their risks. Be cautious of investment trends and fads, which may not endure.

Avoid investments you don’t fully understand

Complex or trendy investments may carry hidden risks and potential pitfalls.

What Do I Need to Know Before Investing?

Before investing, you must understand your financial goals, whether saving for retirement, buying a home, or starting a business. Knowing your objectives will guide your investment choices. Also, familiarize yourself with basic investment principles—such as risks, fees, and strategies—and thoroughly understand any investment you’re considering.

What Are the 4 Main Types of Investments?

The four primary types of investments are:

• Stocks: Shares representing ownership in a company.
• Bonds: Loans made by an investor to an issuer who agrees to repay the principal and interest.
• Mutual Funds: Investment funds pooled from multiple investors to buy various securities.
• Exchange-Traded Funds (ETFs): Similar to mutual funds, they are traded on stock exchanges like individual stocks.

Is $100 Enough to Start Investing?

Many people think that substantial funds are required to start investing. However, numerous investment options have low minimum thresholds, allowing you to begin with $100 or less. For example, you can buy fractional shares of stock, use a robo-advisor, contribute to a retirement plan, or invest in mutual funds.

The Bottom Line

Starting as an investor can be intimidating, given the vast array of advice and investment options. Nevertheless, building your knowledge and understanding of investing and clear financial goals is crucial for making informed decisions that are likely to produce favorable results.

Addendum: A Classic Reading

For new investors, reading “Extraordinary Popular Delusions and the Madness of Crowds” by Charles Mackay is highly recommended. Written in 1841, this book offers an insightful study of crowd psychology. It examines historical financial bubbles, providing valuable lessons for contemporary investors.