Investing 101: From Zero to Hero in an Hour
Investing is extremely complicated. There is so much information out there that it can quickly become confusing. In reality, as a beginner you only have three simple questions that you want answered: What should I invest in? When should I invest? How do I get started?
We know finding information that’s easy to understand can be surprisingly difficult. That’s why we’ve created this comprehensive guide that will teach you:
How to identify your needs as an investor
How to match those needs to an investment vehicle that could help you work towards your goals.
3 ways to begin investing in 2020
Please note: This article is for informational purposes only and should not be construed as investment advice.
Table of Contents
a. Identifying your needs - Why are you investing?
b. Types of investments - What to invest in?
● Stocks
● Bonds
● Mutual funds
● Exchange Traded Funds (ETFs)
c. How you can start investing
● Calculate your risk tolerance
● How you can invest
○ Solo investing
○ Robo advisors
○ Financial advisors
Identify Your Needs
Understanding why you are investing is extremely important. Clearly defining why you want to invest will help you assess your risk tolerance and choose an investment vehicle.
If you only chase the highest returns, you may find yourself in a troublesome position years down the line.
Dig a little deeper! How much risk are you comfortable with? Do you value diversification? Is cash flow important to you?
As you read through this guide, constantly ask yourself questions like these. There are many cases when investments that offer lower returns make sense!
Now that you understand that idea, let’s dive into the different types of investments so you can see what each one offers.
Types of Investments
Publicly Traded Stocks
Stock is a type of security that signifies the ownership of a portion of a company. Stock may be used as a synonym for equity. Investors that buy stocks are entitled to a portion of the company’s profits and gain voting rights within that company. The purchase and sale of stock is conducted through stockbrokers.
Stocks of public companies are traded on public exchanges or markets such as the New York Stock Exchange or NASDAQ.
These markets track the prices of stocks. Stock prices on the open exchange are determined primarily by supply and demand. This is why stocks can go up and down throughout the day in reaction to business forecasts, political news, and company announcements even if the valuation of the company stays the same.
Companies issue stock to investors to raise capital. These funds can be used for research and development, to grow and expand, or to increase liquidity.
As an investor, it is important to be able to recognize when a company’s stock is overvalued - when its stock price is higher than what it’s actually worth.
How Investors Make Money
Investors make money from stocks in two ways:
Buy low and sell high - by buying a stock at a certain price and then selling it when the price goes up, investors realize a profit.
Dividends - when stocks issue a dividend, investors receive a direct pay out for owning stock in the company. Dividend payments are often dependent on the type of stock that you own: common stock vs preferred stock. Dividends are not guaranteed and are subject to change.
Investing in stocks can take many forms. One example of this is the buy and hold strategy versus market timing strategies. Some have had success with market timing, but it is difficult to maintain return performance for years on end using this strategy. Forms of investing, such as day trading , involve buying and selling stocks throughout the day to take advantage of small changes in its price.
Risk vs. Reward
Moderate Risk
Investing in publicly traded stock is a balance of risk and reward, assuming you intend on using it as a long term investment strategy.
Investing in stocks may be an appropriate investment based on your risk tolerance and investment objectives.
Risks associated with stocks:
Market risk - the risk of your investment declining in value due to events in the market overall
Liquidity risk - you run the risk of selling your investments below a fair price if you need to get your money back when you want it.
Inflation risk - the risk of a decline in purchasing power if your investment does not keep up with inflation
Moderate Reward
Historically, stocks have provided a 10% average annual return on investment before inflation.
You may have heard that stocks average a return of 7%, which is after inflation of 2% to 3% is taken into account.
It’s important to remember that past performance does not guarantee future results, so be sure to create a strong investment plan alongside your financial advisor.
When to Invest
You’re young
It may make sense to invest in stocks when you're young for several reasons.
Compound interest is your friend… especially if you’re reading this in your 20s.
It may make sense to invest and reinvest in stocks when you're young to take full advantage of compounding interest.
Investments are subject to risk, including the loss of principal. Because investment return and principal value fluctuate, shares may be worth more or less than their original value. Some investments are not suitable for all investors, and there is no guarantee that any investing goal will be met. Past performance is no guarantee of future results.
You have an emergency fund
As with every investment, you should have an emergency fund before you invest. You don’t want to have to pull money out of your portfolio to cover the costs of unemployment or even something as trivial as a tire replacement.
You don’t have a lot of high interest debt
A common question that many investors have is: should I invest in the stock market or pay off
debt first?
The answer to that question is: it depends.
If your debt carries an interest rate of anything over 7%, you should probably focus on decreasing debt. An example of this type of debt could be a high interest car loan.
If you have credit card debt then you should absolutely pay that off as soon as humanly possible. Credit card debt interest can negate any returns that you would expect to receive from the stock market.
You’re already taking full advantage of a retirement account
Retirement accounts often contain stocks, however they offer tax and potentially employer benefits that buying stocks directly from a stock exchange do not.
For example, your employer may offer a 401k plan. Consider investing in that before you buy stocks because your employer might match your contributions to the account. If you contribute $10,000 in a year, they may add $10,000 of their own money up to a specified limit. Essentially it's free money… what's not to love?
On top of an employer match, depending on the type of 401k plan, you will also be able to take advantage of tax deferment - you will be able to pay income tax when the money is withdrawn rather than when it is deposited. This can lower the amount of tax substantially if you are in a lower tax bracket once you retire depending on the type of retirement account. Generally the more you earn, the more you pay in taxes. You don’t want to pay tax on money you make when your earning potential is at its highest.
If you’re already reaching your annual contribution limits or the investment options provided by the retirement plan are unsatisfactory, talk to your financial advisor about other investment opportunities.
Bonds
Bonds are fixed income securities that are issued by governments and corporations.
Investors buy these securities with the expectation that they will receive regularly scheduled interest payments. When the bond reaches maturity, the principal investment is returned to the investor.
Think of this as giving a loan to a company or government. You give them cash and they agree to pay you a fixed amount of interest and to return all of your money at maturity although interest and return of principal cannot be guaranteed.
The purchase of bonds is subject to availability and market conditions. There is an inverse relationship between the price of bonds and the yield: when price goes up, yield goes down, and vice versa. Market risk is a consideration if sold or redeemed prior to maturity. Some bonds have call features that may affect income.
Risk vs. Reward
Low Risk
Bonds— government bonds in particular— are a low risk investment. Buying a bond allows you to know several pieces of information at the time of purchase:
When you can expect regular payments from the issuing body
When you expect to receive all of your money back
How much of a return on your initial investment you will receive
Risks associated with bonds:
Interest rate risk— interest rates and bond prices have an inverse (opposite) relationship. So when interest rates in the economy increase, bond prices fall. As rates raise, your bond will likely become worth less than when you purchased it, should you look to sell your bond on the market.
Reinvestment risk— this risk is associated with investors who want to buy new bonds in the future. bond interest rates in the future may be lower than the rates at which you purchase your bond today.
Callable bond risk—callable bonds include a provision which will allow the company that issued the bond (“the issuer”) to buy the bond that they sold an investor back earlier than originally expected.
Default risk—this is when the company or government entity that issued the bond cannot pay the interest or principal on time, or sometimes at all!
Inflation risk— inflation is the cost of goods and services increasing overtime. If the interest the bond is paying is lower than current inflation rates, your money pay loose some of its power to purchase goods and services in the future.
Low to Moderate Reward
Bonds can be a great option as a conservative investment. The return on investment might be low but the fact that they may issue payments directly to you over fixed intervals is a great benefit that may make it an attractive investment for people who would appreciate the extra cash flow.
When to Invest
You’re a conservative investor.
If risk isn’t your cup of tea, metaphorically speaking, you may want to explore bonds as an investment option. Bonds and the word conservative go hand in hand.
You’re looking for an investment option that may be safer ahead of a recession.
Bonds may be a safer investment option than stocks. If you are worried about your risk exposure during a recession, you will want to talk to your Advisor about investing in a more conservative product like bonds. Returns on bonds are not guaranteed but they typically come with less risk than many other types of investments.
Risk is relative to each and every investor, which is why it is important that your financial advisor complete a risk tolerance assessment to help you understand how much risk you’re really comfortable with taking on.
Cash flow is important to you
If you’re not interested in parking your money in a security and waiting for it to increase in value to realize your investment, bonds may be a good option for you.
Mutual Funds
A mutual fund is an investment vehicle that allows small individual investors to access diversified portfolios at a relatively low price.
Mutual funds are professionally managed. They are comprised of stocks, bonds, or other securities.
Investors buy into the fund and retain partial ownership of the entire fund. This means that investors buy the performance of the fund, rather than the individual assets that the fund has.
Investors share in the profit or loss of the fund proportionately to their level of investment. The more you invest, the more you stand to lose or gain.
Mutual funds can be a part of other investment vehicles. Employer-sponsored retirement plans, for example, are well known for investing in mutual funds.
Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the mutual fund, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.
How Investors Make Money With Mutual Funds
Mutual fund performance is determined by the aggregate performance of the investments that it holds, known as the fund’s market cap.
When you buy into a mutual fund, you invest in the fund’s performance. This is not the same as investing in an individual stock because you do not get voting rights and you are not buying equity in a company.
Instead, you are investing in the money manager’s ability to put together a portfolio of securities that are able to provide a net positive return.
The three ways to make money from mutual funds are:
Distributions - Certain stocks and bonds in the portfolio make payments directly to the investor in the form of a dividend.
Net Asset Value Increases - The Net Asset Value (NAV) is exactly what the name implies, the net value of the fund’s assets. As the NAV increases, so does the value of your shares in the fund. If investors can sell their shares in the fund for a higher price today than they paid for it yesterday, they’ve made money.
Capital Gains - When the fund owns a security that increases in value and it is sold, the resulting profit is known as a capital gain. Mutual funds distribute capital gains to investors. Capital gains are taxable based on how long you owned the asset before selling it. Assets held for one year or less are short-term capital gains which are taxed as regular income. Long-term capital gains on assets held for more than one year are subject to special tax rates that are typically lower than those on regular income. For additional information on capital gains rates, check out this handy guide by Investopedia .
Risk vs Reward
It is hard to generalize the risk and reward of mutual funds because it largely depends on what the mutual fund invests in and how it is managed. Overall you can expect to experience relatively low risk and moderate reward.
Low to Moderate Risk
The risk that you will take on when investing in mutual funds is related to the risk of the securities that the fund holds.
Mutual funds that invest in primarily stocks carry more risk than those that invest in bonds. To understand the relative risk of your mutual fund, you must first understand how it is managed.
What makes mutual funds popular recommendations for beginner investors and those that have employer-sponsored retirement plans is diversification at a relatively low cost.
Your risk is mitigated to a certain degree because you are buying proportional ownership of a fund that holds several securities. It is also professionally managed and thus is viewed as a “passive” investment.
You can expect to take on more risk than certificates of deposit but less risk than buying stocks on the open market.
Pro Tip: Research the fund manager, their investment strategy, and previous returns. Knowing what securities the fund owns is important but the proper management of those securities is much more important. Remember that you are not buying the securities, you are buying the right to share in the profit (and potential loss) of the fund - i.e. you’re paying for the manager’s ability to generate a return for you.
Risks associated with mutual funds :
Country risk
Credit risk
Currency risk
Interest rate risk
Liquidity risk
Market risk
Moderate Reward
The reward that you get from a mutual fund may depend on what type of securities it holds.
For example, if your mutual fund invests in bonds, you may expect to see a return of 4% to 5%. If your mutual fund invests in stocks, you may expect to see a return of 7% to 10%.
These returns are by no means guaranteed and are predicated on the historical performance of the market. Past returns should never be seen as a guarantee of returns in the future.
When to Invest
You’re interested in investments that generate cash flow
If you’re not prepared to wait years to see some cash in your pocket from an investment, mutual funds can be good investment options due to their potential to provide investor payouts. These payouts can come in the form of distributions.
You don’t have large amounts of investable cash
If you want to invest in popular stocks but lack the capital needed to buy them, mutual funds may be an appropriate investment vehicle. Buying partial ownership in a fund that invests in those securities can allow you to invest in several “blue chip” stocks without the enormous price tag although there are other costs associated with mutual funds.
You don’t want to actively manage your investments
Mutual funds could be professionally managed. If you are a hands-off investor, investing in an actively managed mutual fund is an advisable option.
ETFs
Exchange-traded funds are exactly what their name implies - funds that are traded on public exchanges. Shares in ETFs are traded throughout the day just like stocks.
ETFs are securitized groups of investments that come in many forms. ETFs can contain stocks, bonds, and commodities, and other underlying investments.
So what makes ETFs different from mutual funds? ETFs are traded constantly throughout the day while mutual funds are only traded once per day after the market closes. ETFs also are typically less expensive than mutual funds due to lower expense ratios.
Risk vs. Reward
Like mutual funds, the level of risk and reward associated with ETFs depend on the securities that the ETF invests in. Active vs passive management styles also impact the outcomes of these investments. Generally speaking, you can expect to see these levels of risk and reward:
Low to Moderate Risk
The fact that ETFs are diverse investments by nature means that they offer some inherent protection against risk for investors, but like any investment, there are risks involved.
They are also lower-cost alternatives to both mutual funds and stocks, thus lowering the barrier to entry for many smaller investors. Passively managed ETFs have lower expense ratios than mutual funds.
ETFs offer the ability to own several investments by investing in one fund as opposed to buying each security individually on the market which could lead to saving on broker’s fees.
While risk is managed well in ETFs, it is still up to the investor to exercise their best judgment when trading ETFs. ETF share prices are more volatile than mutual funds because they can be traded throughout the day. This means that actively trading ETFs can lead to losses if traded emotionally or based on speculation.
Overall, ETFs can be less risky than stocks but riskier than mutual funds. This depends largely on the risk of the underlying security. For example, a bond ETF will be generally less risky than a stock ETF.
If you’re unsure of how to understand the risk of ETFs that you are invested in, we recommend that you speak to a financial advisor who can accurately assess its risk to see if it is a good fit for you.
Market risk
“Judge A Book By Its Cover” risk
Exotic-exposure risk
Tax risk
Counterparty risk
Shutdown risk
More...
Low to Moderate Reward
The reward of investing in ETFs is highly subjective as it is based on both the average return of the underlying security and the management of the fund.
You can generally expect to see higher returns on ETFs that are actively managed, although you will be paying extra in fees for this. We recommend that you speak to a financial professional who can analyze your situation and recommend an appropriate ETF based on your risk tolerance.
Investors can expect to see a return that is relatively close to the average rate of return of the underlying security if they intend to buy and hold. Actual returns may vary.
When to Invest
Looking for diversification without paying a large amount of broker fees
Buying an ETF can save you money when it comes to broker fees. Buying each security individually will mean that you are charged a fee on each transaction. Buying an ETF will allow you to own multiple securities with one transaction.
Want to get started investing in a particular industry or vertical
If you want to invest in a specific industry, an ETF could be the way to go. Rather than putting all your eggs in one basket and hoping that your new investment strategy works, try an ETF first and see if the industry’s performance lives up to your expectations.
Interested in the benefits of mutual funds but looking for lower expense ratios
If mutual funds got your attention then ETFs can be considered as an alternative. While you give up the active management portion with most ETFs, you will be able to enjoy lower fees as a result. This is not true in all cases so consult with your financial advisor to find out what you should be paying for your desired investment.
How to start investing
Assessing your risk tolerance
Risk tolerance is the relative level of risk that an investor is comfortable with taking on in pursuance of a return on their investment.
This is calculated by taking several factors into account such as the time horizon of your investment, the future earning potential of an investor, historical returns of different asset classes, and several other criteria.
Why Risk Tolerance is Important
Your risk tolerance will give you a baseline for understanding which types of investments you should be seeking. Investing is all about matching your investments to your goals and your risk tolerance will allow you to do that.
It will help you avoid taking on unwanted risk. It also helps you to understand what level of return you can expect from your investments. Risk is correlated to reward, therefore your risk tolerance will tell you what level of risk you should be comfortable with.
How to Calculate It
Calculating risk tolerance is difficult to do because it is a subjective score that is dependent on several facets of both your life and of the market.
You will need to speak with a financial professional who can do a full analysis of your lifestyle, current investments, and future goals in order to receive a truly accurate understanding of what level of risk you are comfortable with.
In the meantime, use our risk tolerance calculator to get a good idea of what your risk tolerance is.
Investing on your own
In order to invest on your own, all you will need is a brokerage account and you can start buying your first investments within 24 hours. While this option might seem like a good idea, we recommend that you try investing fake money before you actually start with the real thing.
This is known as paper trading. There are plenty of paper trading platforms to choose from and this will get your feet wet before you put real money at risk.
One of the most important traits that investors should seek is consistency. Paper trading is good practice for when you are ready to trade in a real account although there is no guarantee that you experience the same results.
Pros & Cons
Pros
You have total control of your investment
Your investments are private - you are not required to divulge any sensitive information
Learn by gaining first-hand experience
Cons
You’re very likely to lose money in the beginning
Investing on your own can be very time consuming between researching, market watching, and trading
You’re likely to overpay on trading fees due to overtrading which will eat into your returns
Using a robo advisor
Robo advisors are financial advisors that manage your finances with little to no human interaction. They rely on mathematical functions and algorithms to provide you with financial advice. They offer an automated approach to financial planning, allowing you to completely take your hands off the wheel and let software invest for you.
Pros & Cons
Pros
Quick set up or onboarding process
No need to schedule in-person appointments
Provides a logic-based approach to investing by using mathematical models
Cons
Can severely limit your ability to choose your investments
Offers surface level investment advice and is unable to provide creative financial solutions to complex problems
Lacks a human component - some robo advisors have customer service teams but they are not financial advisors and are only able to handle technical issues
Investing with a financial advisor
Investing with a financial advisor is another option that we highly recommend that you take advantage of it! You’re able to sit down with them and provide a detailed explanation of your goals, your challenges, and your doubts.
This is a highly undervalued aspect of investing that is usually overlooked by new investors. Financial advisors are able to come up with creative financial solutions to the problems that plague you the most.
They do the grunt work for you while you focus on work, personal relationships, and enjoying life. If handling copious amounts of paperwork and financial records on a daily basis don’t interest you, getting a financial advisor can be an affordable way to avoid that.
Financial advisors are also excellent networking hubs. You can gain access to their highly recommended network of accountants, attorneys, real estate professionals, and even other investors. A good financial advisor will make these connections available to you upon request.
Choose your financial advisor carefully. They will be a long-term partner that you need to both trust and feel comfortable talking to. Review their designations and make sure that they are operating in your best interest. When our Financial Advisors are managing your assets as Investment Adviser Representatives, they are acting in a fiduciary capacity.
Pros & Cons
Pros
May increase the degree of flexibility in terms of what you can invest in and how you invest. This largely depends on the type of financial advisor that you choose to work with. Be sure to ask a financial advisor about which products they are able to offer before investing.
Leverage years of industry expertise to make the most of your financial decisions
Receive highly personalized investment advice and gain the ability to ask any financial question that you may have
Cons
Person to person communication is required to some degree, whether that be over the phone, through video conferencing, or in-person
Requires that you share your financials with another person, both the good and the bad
You don’t get the experience of manually trading yourself - if you want to learn to day trade, this is not an option for you