Investing is easy. Just watch “The Wolf of Wall Street.” All you do is get some buddies together, pool your money, buy low, sell high and then find a place big enough for your private jet and sports cars.
Investing doesn’t work like that in real life — and you probably won’t get super-rich in a short time. But by learning the basics of how to invest your money through a long-term approach, you can safely and securely grow your money over time.
1. Do I need a lot to start investing?
It is natural to think that investing is for people with throwaway money, but over time, pennies turn into dollars. “Being a financial advisor for over 25 years, it amazes me how some people are able to accumulate so much money even if they don’t have huge incomes,” said Michael Argiro, founder of Connecticut-based 4T Financial. “It is a systematic approach, and over time, by investing small amounts on a regular basis, people are able to accumulate large nest eggs.”
Why you care: Start now with whatever you have. Time is a greater asset than money.
2. What about risk?
The first rule of investing is that the potential for gain comes with the potential for loss. The higher the potential payout, the bigger the risk of losing money. Conservative investments like bonds are far less dangerous than highly risky investments such as penny stocks, but they don’t have nearly the potential for a big windfall. There is no such thing as a safe bet.
Why you care: If someone pitches an investment as “guaranteed,” “risk-free” or “can’t lose,” walk away. All investments come with risk — without exception.
3. What’s the value in diversification?
The old adage “don’t put all your eggs in one basket” was never more true than it is for investing. By spreading your money around different investments, you hedge your bets and protect yourself against a singular, catastrophic loss.
If you put all of your money in Acme Widgets, and Acme Widgets goes under, you go under with it. If Acme Widgets is just part of a larger blend of investments, you can absorb the loss and move on.
Why you care: It is important to create a portfolio with a wide variety of investments. Diversification is your greatest protection against risk.
4. Are a few stocks enough for diversification?
“Avoid individual stocks and invest in a low-cost, diversified stock market index fund over time,” said Bill Hammer Jr., a certified financial planner and president of Hammer Wealth Group. “Warren Buffett would tell you the same thing. If you’re a novice, this is just glorified gambling and likely to cost you a lot more than it will make you.”
Why you care: Beginner investors are often intimidated by the market and simply choose to buy stock in a company they like or that someone tipped them off about. Don’t pick individual stocks — that’s the opposite of diversification.
5. What is the stock market?
The stock market is a marketplace in which shares of publicly traded companies are issued and traded. This enables companies to raise vital capital, and it gives investors like you the chance to make money by buying into these companies — and to benefit from their financial achievement.
Why you care: The stock market is crucial to the national and global economy, and it is one of the best ways to invest money.
6. What are stock exchanges?
The stock market consists of individual stock exchanges, which exist to ensure fair and accurate trading. Stock exchanges exist all over the world. They are the physical marketplaces that make up the concept of the “stock market.” Among the most famous exchanges in the world are the New York Stock Exchange and Nasdaq.
Why you care: These marketplaces are where some of your most important investments will be bought and sold.
7. What are indexes?
Indexes are a crucial component of measuring the health of the stock market. Indexes are imaginary portfolios of securities, each of which uses its own method of calculation. The Dow Jones industrial average and the Standard & Poor’s 500 are among the most famous indexes. The S&P 500 is a “portfolio” of 500 large companies with common stock listed on the New York Stock Exchange or the Nasdaq, and is commonly used as a benchmark for the entire stock market.
Why you care: Indexes reflect the health of the overall market.
8. What are securities?
Security refer to financial instruments with some kind of financial value. Securities can be stocks, bonds or the rights to ownership, which are called options. Securities are generally either debt securities, which represent money owed, and equities, like stocks.
Why you care: If you decide to invest, you will almost certainly purchase securities
9. What are stocks?
Stocks, also called “equities,” are securities that represent partial ownership in a company. Companies sell stock to raise money or to pay off debt. People purchase them for capital appreciation, which means that when the value of a company grows, so does your stock price. Some stocks pay dividends
Why you care: Many funds available to you contain stocks purchased on the stock market.
10. What are bonds?
Bonds are debt securities, like IOUs. Governments and corporations issue bonds to raise money. Unlike stocks, in which the investor is buying into the company, a bond represent a loan that is to be repaid with interest. Bonds are safe and predictable and — if allowed to mature — preserve the initial capital. Bonds are often included in funds to mitigate riskier investments.
Why you care: Bonds are among the most common investments and will likely be a part of any fund you buy.
11. What is the difference between corporate and government bonds?
Bonds are issued by both private and public sector entities. Earnings on municipal bonds aren’t taxed, but the rates of return are lower. Corporate bonds pay higher returns, but the investor must pay taxes on earned interest.
Why you care: Your income tax rate will decide which kind of bond is right for you.
12. What are mutual funds?
Mutual funds pool money from many investors to be housed in one large portfolio. Mutual funds are diversified and may contain stocks, bonds or other securities. Investors like them because they are managed by professionals who do research and execute trades. Those managers take a fee, making mutual funds more costly than passively managed funds like index funds.
Why you care: Mutual funds are a common choice for beginning investors.
13. What are index funds?
Unlike mutual funds, which are actively managed, index funds are passively managed portfolios designed to mirror the performance of a specific index, like the Dow Jones or the S&P 500. Index funds are popular because they provide instant diversification.
Why you care: Unlike mutual funds, index funds are not actively managed because they simply mirror an index. Therefore, they have very low fees
14. What are exchange-traded funds?
Exchange-traded funds (ETFs) are like mutual funds in allowing investors to pool their money in a large fund. But they are bought and sold in shares during regular trading hours on stock exchanges, hence the name. ETFs are not mutual funds. They can only be bought and sold in market transactions and cannot be sold retail directly to investors. Many different kinds of funds, including index funds, can be bought as ETFs.
Why you care: ETFs are very popular because they allow average investors to purchase shares of funds in small amounts.
15. What are hedge funds?
Hedge funds are yet another way to for groups of people to pool their money to purchase a large portfolio. Hedge funds, however, are not regulated nearly as heavily as mutual funds, and they generally are open only to accredited investors. Accredited investors are generally wealthier with high incomes and significant capital and assets. If you are a beginning investor, you will probably not be investing in a hedge fund.
Why you care: Anyone asking a beginning investor with modest resources to invest in a hedge fund could be running a scam.
16. What are penny stocks?
Penny stocks are low-priced stocks, sometimes trading for just a few pennies a share, and never for more than $5. The lure of penny stocks is that many giant, global companies started out as penny stocks, and investors who bought thousands of shares in the beginning when the stock traded for just few cents made enormous returns. The downside is that most penny stock companies will never amount to anything.
Why you care: Penny stocks are incredibly risky. Many penny stock traders target novice investors. Avoid them until you are competent and confident that you can decipher the often-foggy reporting that comes with penny stock investing.
17. How do I buy securities?
Although some companies allow direct purchasing, the overwhelming majority of stocks have to be purchased through a licensed broker. You tell your stockbroker how much of a given stock (or ETF, mutual fund or whatever) you want to buy, and he or she executes the trade.
Why you care: You need a broker to invest in the stock market.
18. What is the difference between a discount broker and a full-service broker?
Full-service stockbrokers give advice and tips to their clients, but they take a hefty fee. Discount brokers operate online and only execute trades, for just a few dollars a trade.
Why you care: Some investors have long-term relationships with their brokers. Other people will never meet or even speak to the people who execute their trades. This depends on whether you employ a discount broker or a full-service broker.
19. If I’m just starting out, don’t I need advice from a full-service broker?
It may seem counterintuitive, but full-service brokers often handle more experienced clients with more complicated investment needs. Novice investors often invest in simpler vehicles, like index funds. In these scenarios, investors often choose to save money on trades by picking a fund they like and paying a discount broker as little as possible to make the trade.
Why you care: You need to decide if the advice from a full-service broker is worth paying for.
20. What is dollar-cost averaging?
Dollar-cost averaging is a strategy where investors contribute the same amount of money consistently over time. If you invest, say $50 a month, in an index fund without regard to the fluctuating price of the stock, you’ll wind up buying more of it when it is cheaper and less of it when it is more expensive.
Why you care: Emotions are important for long-term investing. “If the market rises after your initial investment, you can feel good about how your portfolio has performed and how smart you were for not delaying investing,” Larry Swedroe, director of research for The BAM Alliance, wrote in a post for CBS. “If, on the other hand, the market has fallen, you can feel good about the opportunity to now buy at lower prices and how smart you were for not putting all of your money in at one time. Either way, you win from a psychological perspective.”
21. Will I be paid dividends?
Dividends are a portion of company earnings paid back to investors, through a dollar amount or a percentage of market price, called “dividend yields.”
Why you care: Not all companies pay dividends.
22. Who regulates America’s investment world?
The Securities and Exchange Commission.
Why you care: This branch of the federal government exists to protect investors and maintain fair, orderly markets.
23. What do I do if I think I’ve been scammed?
Contact the enforcement department of the SEC right away if you think a person or company misrepresented a security or any other investment.
Why you care: Anytime money changes hands, unscrupulous people will try to take advantage for profit — especially when it comes to novices.
24. Should I consider day trading?
Day traders seek fast, short-term gains by buying and selling in high volume throughout the trading day.
Why you care: Often glamorized as a fast path to big money, day trading is actually quite risky. The SEC warns against the practice.
25. Is short selling right for beginners?
Short selling, which involves betting against a stock, involves the selling of a security the investor doesn’t own. A broker loans the investor shares of stock out of his or her own inventory. Eventually, you have to “close” the short by buying those shares back to return to the broker. If the stock loses value after you borrowed it, you can buy it back cheaper and keep the profits.
Why you care: Short selling is a popular form of investing you may want to try once you master the basics.
26. What is foreign exchange?
Foreign exchange involves investing in, buying, selling or trading different kinds of international currency.
Why you care: The global foreign exchange market is by far the largest market in the world.
27. What are commodities?
Commodities are physical goods that are basically the same no matter who produces them, such as oil or gold.
Why you care: Commodities markets are among the most lucrative and heavily traded in the world.
28. What is futures trading?
Futures are contracts that obligate an investor to purchase goods like commodities at a later date. This strategy is often used to hedge or speculate.
Why you care: Futures trading allows you to bid on a range of goods for both long and short investments.
29. What’s the difference between options and futures?
They are very similar, but options are contracts that give investors the opportunity to buy instead of obligating them.
Why you care: Managers often use options to hedge or to speculate, which could lower or increase the risk associated with your fund.
30. What options do I have for retirement if I don’t have an employer-based 401(k)?
Individual retirement accounts (IRAs) are similar to 401(k)s, but you set them up yourself. Like 401(k)s, money saved in these accounts are sheltered from some taxation, but they also come with rules regarding withdrawal and contribution amounts. (True, entrepreneurs, small business owners and contractors can set up individual 401(k)s.)
Why you care: If you don’t have a 401(k), an IRA or a Roth IRA may be your best retirement savings vehicle.
31. What is the difference between an IRA and a Roth IRA?
There are two big differences. You can withdraw money from Roth IRAs without penalty before you reach retirement age, and the money in Roth IRAs grows tax-free. Traditional IRAs come with penalties for early withdrawal, and savings are tax-deferred.
Why you care: IRAs and Roth IRAs are both popular. You need to decide which best fits your income and tax situation.