Investing for Beginners
Question: I know I need to be investing for my future, but it sounds really complicated and risky! How does it actually work, and where should I even start?
Answer: At first blush, investing may seem inaccessible and confusing — especially for beginners. But it’s a fairly simple concept. Here’s the gist: Investors (like you) buy a piece of a company or lend money to a company (or to the government) in the hopes of making more money. The amount of money you make depends a number of factors including on how well the company does.
There’s no reason you should avoid investing just because it might be a little intimidating at the outset, because all concepts and jargon can be easily demystified. Here’s a breakdown of some of the top investing questions.
What’s the Difference Between a Stock and a Share?
“Shares” are the ownership certificates of a specific company — so you might say you have 50 shares of Facebook, for example. To say that you own “stock” is just a more general term that means you own a number of shares in a company or multiple companies. For example, if you own shares of Facebook and Google, you own tech stock. Whether you call it a “share,” “equity,” or “stock,” it means the same thing: You have some ownership in a company’s assets and earnings.
What’s a Bond?
Bonds are debt, issued by companies, states and governments (in both the U.S. and abroad) to help finance various projects. For example, if an airline wants to buy a bunch of new planes, they might issue bonds to borrow money from investors in the market (like you). An investor who buys a bond loans money to the corporation or government for a set time at a fixed interest rate. This rate is determined by a number of factors, like what’s going on in the economy and how risky it is to be lending to that particular company or government.
In general, a bond is considered a less risky investment than a stock, because you know more out of the gate about the return — the interest rate — that you’re going to earn. The value of stocks is more likely to bounce up and down depending on the day.
What Does ‘Risk’ Mean?
It means taking a chance. When you invest in the stock market, you’re accepting some risk — some degree of uncertainty — because you never know exactly how well a company will perform. Maybe the companies you are investing in will outperform expectations and your shares will rise in price significantly. Then again, maybe they won’t have a particularly good year — or the stock market overall will trend down — and you’ll lose some of your investment.
An investment of any kind is all about balancing risk and reward. In general, riskier bets come with more potential for upside, but this also can mean things could go the other direction as well, resulting in a loss. On the flip side, a more conservative approach — like bonds — limits both the potential for upside and downside, and results in a much smoother ride. Deciding your risk tolerance is key to successful investing for beginners. The other thing to keep in mind is that stocks and bonds tend to do well at different times. For that reason, many if not most investors, have both in order to tame the amount of overall risk they’re taking.
What’s a Mutual Fund?
A mutual fund is a pool of investments created by a money manager, who places money in various stocks, bonds or (sometimes) other investments, like real estate or natural resources. This is really no different from a group of friends deciding to pool their money to buy something they couldn’t each afford on their own. Anyone can invest in a mutual fund. Rather than buying one share of Apple stock, you could invest in one share of a fund that invests in a much larger portfolio of U.S. companies, and still get a little piece of Apple. A benefit of mutual funds is instant diversification. By owning a pool of many different assets instead of a single one, you have the benefit of not depending on that one asset to do well. An index fund is a type of mutual fund that tracks a particular stock index like the S&P 500 or the Russell 2000.
What’s an ETF?
Exchange-traded funds, better known as ETFs, work similarly to mutual funds, but they trade like stocks. Mutual funds are only priced once a day. The prices of ETFs, like stocks, vary throughout the day. Many ETFs track an index, which is basically a well defined piece of the market like the S&P 500 (an index of 500 leading, large-company stocks), or the NASDAQ, (a tech-heavy index of the 100 largest non-financial stocks traded on the NASDAQ exchange) largest stocks). ETFs, like index funds, tend to have low fees and expenses because tracking an index instead of hand picking stocks to put in the fund is a lot less work.
Is There a Minimum Investment?
It depends. If you decide you want to start investing, you’ll need an investment account at a brokerage firm. (Some of these require a minimum balance to get started; others
don’t.) Online brokerage firms are usually a good place to start investing for beginners, since most are low-cost and offer education tools. Most of these don’t have minimum balance requirements. Some of the established brokers out there include Charles Schwab, E-Trade, Fidelity, Merrill Edge, and TD Ameritrade.
How Much Does It Cost to Buy Stock?
Once again, it depends. These days, many investment firms offer the ability to trade stocks, mutual funds or ETFs at zero costs. Others still charge a commission. So shop around. The fee for each can vary based on the firm where your account is held, how much of a particular investment you are buying and the size of your investment account. If you aren’t with a zero-commission firm, you will also likely pay a similar transaction fee if you decide to sell the investment.
Along with the one-time transaction costs, mutual funds and ETFs also have ongoing fees called expense ratios. These require you to pay an annual percentage of the share price as an ongoing fee. For example, if you want to invest $1,000 in a mutual fund that has a 0.5 percent expense ratio, you will pay $5 over the course of the year. Aim to keep expense ratios below 1 percent.
Do I Have to Pay Taxes on Money I Earn from Stocks?
There are a couple of different ways to make money from investing that can then be taxed. First, the value of your investment can increase over time, which is known as a capital gain. You won’t pay taxes on this until you sell the investment and the gain is “realized.” If you sell the investment before you’ve held it for a full year, you’ll pay taxes at your regular income tax rate. If you wait for the one-year mark, you will only pay at the capital gains rate of 15 percent.
Secondly, stocks can pay dividends, a form of profit sharing with investors. However, some companies choose not to pay dividends at all and reinvest those profits back into the company itself (which can pay off in terms of capital gains down the line). Bonds pay interest income, similar to how you would pay interest to the bank if you took out a loan. These payouts are taxed in the year you receive them at your normal income tax rate, with a few exceptions. (One exception is qualified dividends — an IRS designation for certain types of stocks. They’re taxed at a lower rate of 0 to 20 percent, depending on your income.)
Finally, it’s important to pay attention to where you keep those investments. If you have stocks in a tax-deferred retirement account like a traditional IRA or 401(k), you won’t pay taxes on any gains until you pull the money out of the account (hopefully at
retirement). If you have the investments in a Roth IRA, you never have to pay taxes on your gains. That’s a huge win. What Happens if I Want
My Money Back?
You can sell your investments at any time and withdraw the proceeds — but before you do, take a breath. Why do you want to sell? One of the most common investing mistakes is selling when the market dips. Remember: It’s time in the market, not timing the market, that leads to long-term growth. Short-term fluctuations are normal, and if you sell when your investments are temporarily down, you lock in those losses rather than giving your portfolio the chance to recover. And don’t forget — selling may also trigger taxes, depending on your gains. So before you say goodbye to an investment, ask yourself whether your money truly needs to come out right now.
