New Money. Who dis? The Ultimate Beginner’s Guide to Investing Your Money Wisely

Many of us aren’t lucky enough to come into money from a sudden inheritance or some other random windfall that I swear only happens on TV.  So, investing your hard earned money can seem daunting. 

But there comes a time in your life when you'll want to step out onto the edge, stop playing in the sandbox, and start playing with the big kids.

There comes a time when you'll want to make your money grow and to do that you need to learn how to invest.  And with so many different ways out there to invest your money, it can be difficult for a newbie to figure out where to start.  

There are 4 main asset classes when it comes to investing: Commodities, Businesses, Real Estate, and Stocks/Bonds.  (Actually, make that 5.  We can't forget about crypto!)

In this post, we are going to cover the basics of investing in stocks and bonds.

Quick Tip: What should you invest in as a beginner investor?

As a beginner, you should invest in index funds.  It is the quickest and easiest way to get started investing your money with little time and effort on your part. 

To get started, simply choose a reputable brokerage, open an account, transfer money into that account, and select a Total Stock Market index fund and a Total Bond Market index fund.  Then set your desired allocation as appropriate for your risk tolerance.

Easy? Right?

Well, it is probably easier said than done eh?  And I’m sure you still have lots of questions.  Luckily, I’m here to give you some answers.  After reading this, I want you to fill confident enough to get started investing immediately.  

So, here it is: The Ultimate Beginner’s Guide to Investing in the Stock Market.  

What are stocks?

Stocks are a kind of “paper” investment where you are purchasing a part, or a share, of a company.  Back in the day, when you purchased stocks, a record was kept on a sheet of paper that would be sent out to you stating how much stock you owned in that company.

Now, everything can pretty much be done online.

Companies issue stocks in order to raise money they can then use to invest and grow their business.  Buying stocks gives you rights to share in the company’s growth and earnings.

As a shareholder, you benefit through the increased valuation of your stock, through a dividend that the company pays out, or both. There are two kinds of stock, common stock and preferred stock.

Common vs. Preferred Stock

Common stocks give you voting rights in a company but you may not necessarily receive dividends.  On the other hand, preferred stocks come with dividends but no voting rights.

In the event that a company goes bankrupt, a preferred shareholder will be paid before a common shareholder if there is any money available after liquidation of the company’s assets.

Stocks are generally sold on a stock exchange, such as the New York Stock Exchange, though there are private “over the counter” sales as well.  

Buying stocks can help you grow your money.  You are putting your money to work for you and, if investing for the long haul, your money will compound and grow, greatly outpacing inflation.

The key thing to remember when purchasing stocks is that you are purchasing a company.  So make sure that company has sound financials, good leadership, and is poised for growth.

What are bonds?

Bonds are different from stocks in that instead of buying a part of the company’s equity you are buying a part of their debt.  In a sense, you are loaning money to the company or government, which promises to pay you back with interest.

This interest is determined by the coupon rate and comes in the form of annual or semiannual dividend payments.  Similar to stocks, companies issue bonds to finance projects and grow their business. 

Government Bonds

Bonds can be issued by governments and municipalities.  Governments will use these funds to build up infrastructure, fund welfare programs, and otherwise keep the government running.

These are called Treasury Bonds in the US as these bonds are issued by the Department of Treasury. 

Bonds issued by the government are considered one of the safest investments you can make.  After all, the government can always raise taxes or just print more money to pay you back.

Depending on the length of the bond, there are different names for each. Bonds with a time frame (or maturity date) of a year or less are called bills.  

Treasury notes have a maturity date from 2 to 10 years and treasury bonds have maturity dates of 10 years or more with the longest being 30 years.

Corporate Bonds

Governments are not the only entities that can issue bonds.  Corporations can as well.  But you have to be more careful when investing in corporate bonds.

Because not all bonds are as safe as a federal government bond, there are agencies that rate bonds in order to help the investor assess that particular bonds risk of default (ie, the possibility of you not getting your money back).

The three rating agencies are Fitch, Moody’s, and Standard and Poor’s.  They all have different rating systems.  But, naturally, bonds that are triple A, AAA, are much better than bonds that are triple C, CCC.

Bonds, Interest Rates, and Inflation

One thing to remember about bonds is that they are very much influenced by interest rates.  If interest rates go up, bond prices go down and if interest rates go down, bond prices go up.  

So if you bought a bond a year ago, and now the interest rates are much higher, the value of your bond will drop.

Inflation can also greatly impact the returns for your bonds.  For example, if inflation is at 2% and you own a bond with a 5% coupon (which is the interest you are getting in addition to the original amount you paid), your net gain is only 3% on that investment.  

If inflation exceeds your coupon rate, you are now losing money.

To combat this, you have the option to buy Treasury Inflation-Protected Securities (TIPS) which will guarantee a fixed return greater than inflation.

Despite the risk of interest rate increases and inflation, it is good to keep bonds as part of your investment plan.  They not only give you some diversity but often times when the stock market goes down the bond market goes up.

So you can use bonds to mitigate the volatility of the stock market.

What are Mutual Funds?

A mutual fund is a fund in which many investors pool their money together to purchase stocks, bonds, and other securities.  It is a portfolio or a basket of securities that is professionally managed by a fund manager with the intention of trying to beat the market.

Previously, the ability to buy enough stocks to have a diversified portfolio was out of the reach of most every day investors as investing in so many companies was a bit too pricey.

Simply buying enough shares of a company to even make an investment worthwhile was pricey, so you can imagine trying to buy 10 more. Therefore, in order to make the stock market and a diversified portfolio more accessible to every day people, mutual funds were created.

There are many different kinds of mutual funds that fall into various categories based on their focus such as money market funds, equity funds (stocks), fixed-income funds (bonds), specialty funds, and more.  Unlike stocks, mutual funds do not give you any voting rights in a company.

With mutual funds, you also don’t have to research the companies as it is done for you. You just have to make sure you pick a good fund with an excellent fund manager. You are paid on your portion of the earnings of the fund as a whole.

Be aware though that the ease of investing in mutual funds comes at a price.  Fund managers will take a percentage of your investment amount each year in the form of fees.  

Many times, the fees are exorbitant and just not worth it when you could invest in index funds all by yourself.

What are Index Funds?

Index funds are a kind of mutual fund that are specifically put together to track a certain index, i.e. the Nasdaq or the S&P 500. 

The term, index fund, comes from Jack Bogle, who, with the creation of the first index fund in 1975, helped make investing more accessible to individual investors.

He wanted to help people invest wisely and not lose their money to fees and futile attempts at beating the market.  He is also the founder of Vanguard, a popular discount brokerage.  (Quietly, this is one of the reasons why I love Vanguard so much!)

How are Index Funds Different From Mutual Funds?

The main difference between a mutual fund and an index fund is that index funds are not actively managed like mutual funds. This saves you on fees and taxes, which means more money in your pocket.

In addition, index funds are not made to beat the market, as mutual funds attempt to do, but its purpose is to follow the specific market closely.  After all, beating the market consistently is virtually impossible.  

So, by keeping it simple and investing in index funds, you can ensure that, as an investor, you get a good return without all the added risk.

Most importantly, index funds tend to beat actively managed mutual funds most of the time.

According to an article published by CNBC, 92% of actively managed mutual funds, after a 15-year time period, continue to lag behind the S&P 500 market index.  And 80% overall underperform their benchmarks in the long run.

Choosing an Index Fund

In choosing an index fund you need to decide which index you would like to track.  There are many options to choose from: small-cap (relatively small companies), large cap (the biggest companies), growth stock, international, short-term bonds, long-term bonds, utilities, real estate, etc. 

But if you want to keep it simple, I suggest doing a total stock market and a total bond market index.  See my picks below!

The benefit of choosing an index fund, specifically a total market index fund, is the comfort in knowing that your choice will always perform close to the market and “the market always goes up” in the long run.

Furthermore, these funds are low-cost and very tax efficient as the turnover rates (rates of buying/selling) are very low.

What are Exchange Traded Funds (ETFs)?

Exchange traded funds are index funds but they can be traded throughout the day like individual stocks.  The keep the same low-cost, lower turnover philosophy of the index fund and mix it with traditional stock market investing.  

This means though that it is subject to the whims of the market unlike index founds which get their value from the assets in the portfolio.

As a Beginner, what should I invest in?

As a beginner, I would invest in low cost total stock market index funds. This is because, as a beginner, buying stocks individually is very risky. Unless you are good at reading financial statements and understanding their implications, I would leave that game to the big boys.  

Not to mention, individual stock picking is very time consuming. And let's be honest, people with full time jobs ain’t got time for that!

Also, keep in mind that when you hear about people losing their shirts investing, they are usually talking about the ones investing in individual stocks.  Not that picking individual stocks is bad.  It’s just that you really must know how to pick a good business with strong financials and growth prospects.  

Then you must stay on top of them to make sure nothing happens to make your once great company turn bad.

So, I say, stick to the index funds as this requires very little research, is as easy as clicking a button, and carries with it minimal risk.  Why?  Because, in the long run, the market always goes up.  

And if by chance the entire stock market does collapse, then I would say we all have much bigger problems to deal with because the world is clearly ending.

Lol.  I’m joking … kinda.

Another plus for index funds is that the fees associated with these funds are very minimal so you get to keep most of your investments and its earnings. 

I have seen some fees as low as 0.015%.  Hella-cheap!

My Two Cents

Here are my two cents on what should make up a basic beginners portfolio: a Total Stock Market Index Fund, Total Bond Market Index Fund, and a Total International Stock Market Index Fund.  

Really you will probably do just fine with only the stock and bond funds but it makes it more fun (and adds diversification) to throw in some international stock.

What Brokerage Should I Choose?

Now that you have an idea of what you are going to invest in, it’s time to choose with which brokerage you’ll invest.  I, quite frankly, think all of the top brokerages are pretty much the same.

Some have better apps, some have easier to use platforms, while others have the lowest expense ratios.  But they all tend to offer similar products.  Once you get down to the top 3, it is largely a matter of personal choice.  

The top 3 brokerages are Vanguard, Fidelity, and Schwab.  

I personally love Schwab and Vanguard but Fidelity has some of the lowest expense ratios around.  Here’s how they compare.

*requires a $3,000 minimum investment to get the lowest expense ratio

There are others as well with good reputations such as TD Ameritrade, E*trade, Ally Bank, and Robinhood.  Who you choose is totally up to you and whom you feel most comfortable with.

So head over to their websites now, check out their customer service, and choose the best fit for you.  Then open up an account.  Now!  Yes, now!  It’s time to take some action.

How Should I Allocate My Money?

Most people would say that this should be chosen based on your age using the rule of 100.  How this works is you would take your age and subtract that from 100 to figure out what percentage of your portfolio should be in stocks.  

For instance, if you are 20 years old, then 80% of your portfolio should be in stocks while 20% of your portfolio should be in bonds.

The 120 Rule

In recent years, however, in light of the fact that people are living longer and longer, some people are proponents of using the number 120 instead.

In that case, a person who is 30 years old should have 90% of their money in stocks and 10% in bonds.  This more aggressive approach will assure that you have a big enough nest egg for retirement.

An Example

Taking the 3 index funds we talked about earlier, you could put 65% in a total stock market index, 25% in a total international market index, and the remaining 10% in a total bond market index fund.

However, you'll also have to take into account your personality and your risk tolerance.  If you are the type of person to fret every time the stock market drops a tenth of a percentage point, you may want to increase your allocations to bonds. 

So your allocation may look something like 40% bonds, 40% total stock market, and 20% total international stock market.

~ A study conducted by professors at Trinity University suggests that allocating too much of your portfolio to bonds increases your risk of running out of money in retirement. This is especially true for people who want to retire early. ~

Other Considerations

While you can play around a bit and add fancier index funds such as the emerging markets fund or small cap growth funds, just be aware of their expense ratios and their turnover rate (especially if it is not held in a tax advantaged account). 

This is because the buying and selling of stocks may mean you'll have to pay taxes on it.

Furthermore, if you are considering an emerging market fund, they are uncertain and can be highly volatile.  So, I would probably make sure these funds don’t account for more than 5% or 10% of my portfolio.  

Dollar Cost Averaging

As a beginner, you should dollar cost average into the market every month.  What this means is simply determining how much you can invest each month and making those same payments into your accounts each and every month.  You can automate it.

By doing this, you ensure that you will be paying less on average.  This is because when the prices are high, you will buy less and when the prices are low, you will buy more.

Rebalancing Your Portfolio

The market is always moving up or down.  Over time you may notice that even though you started out with an allocation of 70% stocks and 30% bonds, it has now shifted to 90% stocks and 10% bonds.

So you need to take money from the stocks and move it into bonds to return your portfolio to its original allocation.  This is called rebalancing your portfolio.

Note: You can also rebalance your portfolio without selling anything.  Instead, just allocate more of your cash to buying bonds instead of stocks.

Why Should You Rebalance?

You should rebalance your portfolio to help control your risk and keep your portfolio aligned with your financial goals. You chose that allocation for a reason and unless that reason has changed you want to make sure you stay the course. 

Furthermore, as stocks are riskier than bonds, an increase in your stock position means an increase in your risk

It is tempting when you see one section of your portfolio outperforming the other, to want to invest more money in that section.  But this is exactly what you should NOT do.  

This would mean purchasing the stocks/bonds when they are high.  But remember you want to Buy Low, Sell High.  Rebalancing your portfolio assures that this is what you are ALWAYS doing.

How Do I Rebalance My Portfolio?

To rebalance, you simply have to sell the outperforming asset and buy more of the underperforming asset.

In the previous case, where the stocks grew to 90% of your portfolio, you would sell enough of the stocks to make it go back to 70% of your portfolio.  Then buy enough of the bonds to make that move up to 30% again.

From the table above, you can see that you would need to sell $4,000 worth of your stocks and buy $4,000 worth of your bonds to get back to the 70/30 split. But be aware that selling and buying stocks/bonds may generate fees and taxes.

As an alternative, if you are still adding to your portfolio monthly, you could simply buy more bonds and fewer stocks.  That way you can rebalance without buying or selling anything and avoid those fees and taxes.

When Should I Rebalance My portfolio?

It is necessary to rebalance your portfolio on a regular basis.  Experts say that rebalancing your portfolio once a year is sufficient although some like to rebalance monthly or bi-annually. 

You can choose a set time and date to rebalance every year or every month.  Some people set limits such as rebalancing their portfolio if it changes by more than 5%.

But be careful not to check on your portfolio too often because you don’t want to get caught up in the ups and downs of the market and start making emotional decisions that will affect your portfolio and your future. 

Rebalancing too often can cause increased fees and taxes.  To make life easier, you can set up automatic rebalancing.

When Should I Start Investing?

Right now! Or at least, as soon as possible.  As they say, time in the market is better than timing the market.  And you need to give your money time to compound and grow.  

Even if you can only spare a few dollars a month, I say do it now.  Maybe you have heard the story where someone is asked, “Would you rather have $1 million dollars now or a penny now that doubles everyday for the next 30 days?”  Which would you choose? 

Well as you might’ve guessed from my asking this question, the penny is the better bargain.  After the 30 days, this is how much you would have …

drum roll please …

a whopping $5,368,7009.12!

Sign me up!  How’s that for the magic of compound interest!  I really wish my money doubled like that! LOL

More realistically, if you invest just a dollar a day for the next ten years, you would earn over $1,500 in interest.

If you decided to go hard with $2 a day, you would get over $3,000 in interest with a grand total of $10,263.10 in your account.

I don't know about you but for me that’s a good chunk of change!

When You Shouldn't Be Investing

Okay, so ideally you would start investing now but there are some cases when you shouldn’t be investing quite yet.  That is when:

• You don’t have an emergency fund established
• You have credit card debt or loans with interest rates over 6%

If this applies to you, then if I were you, I would first set up an emergency fund and pay off that credit card debt before I invest.  However, if it's going to take you longer than a year to pay off, I'd start investing even if it's just a little.

Learn about how to invest in a bear market today!

The Rule of 72

Have you ever heard of this rule?  It’s used to determine about how long it will take the money you’ve invested to double.  To calculate this, you take 72 and divide that by the rate of return you expect to get from an investment. 

If you expect to earn 12%, then 72/12 is 6.  So your money will double in about 6 years.  And, as long as the rate of return stays the same, it will continue to double every 6 years after that.

Actions to take to start investing now...

*Just remember to rebalance your portfolio once a year!

Last But Not Least

Investing requires discipline and consistency.  You must invest a consistent amount regularly and no matter what, you cannot withdraw the money in your account for any reason.  

What about an emergency?  You say.  Well, that’s why you have an emergency fund!  Just be sure to replenish your emergency if you ever do need to use it.

I hope this wee beginner's guide to investing in the stock market has helped make investing easier for you!  If you have any questions or comments, drop me a line below!

Good Luck and Happy Investing!