You want to learn how to start investing. Congratulations! Taking this first step is one of the most important things you can do for yourself and, in many cases, your family.
Implemented wisely and with enough time to let compounding work its magic, investing can lead to a life of financial independence. Spend your time pursuing your passions, supported by passive income from things such as dividends, interest, and rents.
Here are some of the ways many new investors can begin their journey.
Decide Which Types of Assets You Want to Own
At its core, investing is about laying out money today expecting to get more money back in the future. Most of the time, this is best achieved by acquiring productive assets.
Productive assets are investments that throw off surplus money from some sort of activity. For example, if you buy a painting, it isn't a productive asset. In 100 years, you'll still only own the painting, which may or may not be worth more money. On the other hand, if you buy an apartment building, you'll not only have the building but all of the cash it produced from rent over that century.
Each type of productive asset has its own characteristics and pros and cons.
Here are a few potential investments to consider.
When you own equity in a business, you are entitled to a share of the profit or losses generated by that company's operating activity. Whether you decide to own that equity by acquiring a small business outright or buying shares of a publicly traded business through the purchase of stock, business equity has historically been the most rewarding asset class for investors. It has been wisely observed that a good business is a gift that keeps on giving.
Fixed Income Securities
When you buy fixed-income securities, you are really lending money to the bond issuer in exchange for interest income. There is a myriad of ways you can do it, from buying certificates of deposit and money markets to corporate bonds, tax-free municipal bonds, and a variety of U.S. savings bonds.
Perhaps the oldest and most easily understood asset class investors may consider is real estate. There are several ways to make money investing in real estate but it typically comes down to either developing a property and selling it for a profit or owning something and letting others use it in exchange for rent or lease payments.
Intangible Property and Rights
Intangible property includes everything from trademarks and patents to music royalties and copyrights. Over time, copyrights can generate a lot of money that can be used for other purposes, including redeploying the cash to buy stocks, taking vacations, or donating to a family's charitable foundation.
Farmland or Other Commodity-Producing Goods
Although it often involves real estate, investments in commodity-producing activities are fundamentally different in that you are either producing or extracting something from the ground or nature, often improving it, and selling it for what you hope is a profit. If recoverable oil is discovered on your land, you can extract it and take cash from the sales. If you grow corn, you can sell it, increasing your cash with every successful season.
The risks are significant—bad weather, disasters, and other challenges can and have caused folks to go bankrupt by investing in this asset class—but so, too, can be the rewards.
Decide How You Want to Own Those Assets
Once you've settled on the asset class you want to own, you need to decide how you are going to own it. To better understand this point, let's look at business equity. If you decide you want a stake in a publicly traded business, do you want the shares outright or through a pooled structure?
Outright vs. Pooled Ownership
If you opt for outright ownership, you are going to be buying shares of individual companies directly so that you see them somewhere on your balance sheet or the balance sheet of an entity you control. In this instance, you become an actual shareholder in a company and even have voting rights. Owning shares of a company may give you access to dividend income and your net worth can rise along with the company's value.
You mix your money with other people and buy ownership through a shared structure or entity. This is most commonly done through mutual funds. Some wealthy investors invest in hedge funds.
Decide Where You Want to Hold Those Assets
After you've decided the way you want to acquire your investment assets, you next have to decide how you want to hold those assets. Let's examine the options.
If you opt for taxable accounts, such as a brokerage account, you will pay taxes along the way but your money is not restricted. You can spend it on whatever you want, and however you want. You can cash it all in and buy a beach house. You can add as much as you want to it each year, without limit. It is the ultimate in flexibility but you have to give Uncle Sam his cut.
Some retirement plans and accounts have unlimited bankruptcy protection, meaning if you suffer a medical disaster or some other event that wipes out your personal balance sheet, you can walk away with your investment capital still compounding for you beyond the reach of creditors.
Some plans are tax-deferred, often meaning you get a tax deduction at the time you deposit the capital into the account to select investments and then pay taxes in the future, often decades later, allowing you year after year of tax-deferred growth. Others are tax-free, meaning you pay taxes on your money now but will never pay taxes on either the investment profits generated within the account nor on the funds once you withdraw the money later in life.
Good tax planning, especially early in your career, can mean a lot of extra wealth down the road as the benefits compound upon themselves.
Trusts or Other Asset Protection Mechanisms
Another way to hold your investments is through entities or structures such as trust funds. There are some major planning and asset protection benefits of using these special ownership methods, especially if you want to restrict how your capital is used in some way.
In addition, if you have a lot of operating assets or real estate investments, you may want to speak to your attorney about setting up a holding company.
How a Beginner Might Start Investing
With the framework out of the way, let's look at how a new investor might actually start investing.
Many employers offer matching money up to a certain limit. It makes sense to take advantage of this. For example, if your employer gives a 100% match on the first 3% of salary, and you earn $50,000 per year, that means on the first $1,500 you have withheld from your paycheck and put in your retirement account, your employer will gift you an additional $1,500 in tax-free money that is entirely yours. Even if all you do is park it in something like a stable value fund, it's the highest, safest, most immediate return you can earn anywhere in the stock market. To leave free matching money on the table is almost always an enormous mistake.
Next, an investor may want to fund a Roth IRA up to the maximum contribution limit. That is $6,000 for someone who is younger than 50 years old and $7,000 for someone who is older than 50 years old. If you are married, in most cases, you can each fund your own Roth IRA.
After this was done, a good investing program would probably involve building up a series of cash reserves including an emergency fund. Too many inexperienced investors have a lack of respect for cash. It's not meant to be an investment. That’s why it’s important that you work to have adequate savings on hand before you even consider adding additional investments.
Remember that cash is not only a strategic asset, but it can also dampen volatility and, during ordinary interest rate environments, provide decent yields, too.
Once this is completed, you may want to start working on paying off all of your debt. Pay off your credit card debt. Wipe out your student loan debt. If you want to, work to pay off your mortgage faster, too.
After that is done, you'd want to return to your 401(k) and fund the remainder beyond the matching limit you already funded and whatever overall limit you are allowed to take advantage of that year.
Finally, you would then begin to add taxable investments to your brokerage accounts, perhaps participate in direct stock purchase plans, acquire real estate, and fund other opportunities.
Done correctly over a long career, with the investments managed prudently, it would be almost a mathematical impossibility not to retire far more comfortably than the typical worker. It is simply the nature of compounding.
Consider Hiring a Financial Planner
If you need help, you may consider doing what many investors do and working with a registered investment advisor, financial planner, or other professional. Finding the best one for you can take a bit of trial and error, but it's an important relationship so you need to get it right. Some financial advisors charge a flat fee for consultation, while others charge a percentage of the assets they are helping to manage.