Before you drop your life savings on the hottest stock your friend told you about, follow these 5 easy steps to become an investor.
All successful investors became wealthy through diligence and meaningful investing. It sure can be easy to make money when every asset class is increasing in value, but throwing your money at random investments without careful planning could end up poorly.
1. Define Your Investing Objectives & Strategy
Defining your investment objectives and strategy is the first step to becoming a successful investor. If you’re unsure where to start or overwhelmed by the process, it may be worth considering the wealth advisory services at Personal Capital. In return for a small fee, you can receive professional advice. For some people, that trade-off is worth it.
Ask yourself what your objectives as a soon-to-be investor are.
Common investing goals may include:
- Saving for retirement
- Life events (e.g., college, education, home)
- General Investing
- Lifestyle goals (buying a luxury watch, car)
Saving for retirement is usually the number one investing goal for most people, followed by investing for their children’s future, and lastly, if you’re wealthy enough, investing for lifestyle purchases.
WHAT NOT TO DO: If you are serious about becoming an investor, do not just open a brokerage account and put your cash into a random stock your friend told you about. More often than not, it won’t work out in your favor, especially in this market.
Types of Investors
There are 4 main types of investors. Each type of investor plays a specific role in the market:
|Type of Investor||Common Goals||Types of Investments|
|Growth Investors||Retirement Investing||Index Investing|
|Growth and Income Investors||Life events||Blended mix of stocks and bonds|
|Income Investors||Cash flow generation||Fixed Income (Bonds, REITs)|
|Trading and Speculative Investors||Lifestyle goals||Fintech, Start-ups|
2. Pick The Right Type Of Investment Account
The second step to becoming an investor is opening the correct investment account based on your investment objectives. Your investment goals should determine what type of account is right for your needs.
I’m a DIY investor, but if you are overwhelmed and don’t know where to start, using a robo-advisor or financial advisor could be helpful.
Below are a few of the most common investment accounts. When most people think about investing, a taxable brokerage comes to mind. This type of account allows for buying and selling most asset classes, including options trading.
|Investment Goal||Type of Investment Accounts||Contribution Limits?|
|General Investing||Taxable Brokerage||No limit|
|Retirement Investing||401K/403B/IRA||$20,500 for 401k & 403B, $6,000 for IRA|
|Education Accounts||529 Savings Plan||The lifetime cap depends on the state of residence|
|Accounts for children||UTMA/UGMA||Fund up $15,000 per year/ $30,000 per couple|
The most common investing accounts are retirement accounts opened through an employer and a taxable brokerage.
Depending on your goals,
In the long run, maxing out your tax-deferred retirement accounts, such as a 401K and 403B, will be the most advantageous for most people.
However, many soon-to-be investors become enthralled by the idea of quick profits and opening a taxable brokerage in search of easy money.
3. Choose Your Asset Allocation
Your objectives should define your investment strategy. According to Vanguard, 88% of your investing experience (the volatility you experience and your returns can be traced back to your asset allocation.
Most investors have a well-diversified portfolio of equities, bonds, alternatives, and cash; some even have crypto in a retirement account.
Depending on your investing timeline and goals, the general rule is to hold riskier assets like stocks & ETFs when younger and reduce your exposure to riskier assets near retirement age.
If your investment objective is income generation, you may want to focus on fixed-income investments.
Fixed-income securities fluctuate less in value but tend to have higher interest payments.
Alternatively, equities are a better option if you are looking for capital appreciation as they increase in value more than fixed-income investments.
There’s no correct answer. That’s why they call it personal finance.
Asset allocation is tricky if you don’t want to pay for expert advice. However, some people may want a hybrid approach. A lower-cost option is M1 Finance. The M1 platform offers a semi-guided approach to investing, including expertly selected portfolios. M1 also provides taxable brokerage accounts, IRA, and 401k accounts.
4. Educate Yourself About Investing
Continuous education is the key to becoming an investing guru.
Reading the Wall Street Journal is a great place to start if you want to learn about the stock market and investing. You won’t become an expert overnight, but your investing insight and understanding of investment jargon will develop over time. If there are any investing concepts you are not familiar with, your investment account will likely offer free training and research.
Excellent sources for learning about investing include:
- The Wall Street Journal
- The Intelligent Investor by Benjamin Graham (Warren Buffet’s mentor)
- The Bogleheads’ Guide to the Three-Fund Portfolio by Taylor Larimore
5. Be Patient!
Becoming a successful investor is a long-term game. There will be periods of prosperity, volatility, market downturns, and the urge to panic and sell when the market is down. It’s critical to stick to your investment objectives and remember your goals.
Investing Habits To Avoid
Getting caught up in investing habits that can be detrimental to your portfolio and long-term investing goals is easy in search of quick riches. It’s easier to develop bad investing habits than good ones, especially when the stock market does not move in your favor.
Trying To Time The Market
Timing the market means buying low and selling high.
Sounds easy enough?
According to a study by Bank of America, if an investor missed the ten best market days since 1930 every decade, their total return would stand at 28%. If, on the other hand, the investor held steady through the ups and downs, the return would have been 17,715%.
Panic selling, also known as loss aversion, is the tendency to sell during a market downturn to avoid further losses. In 2020, at the onset of COVID, the S&P 500 dropped almost 25%, only to reach record highs months later.
And here we are in 2022. Due to accommodative federal reserve policies, the stock market is now in a bear market.
Business cycles come and go.
They always will.
In the long run, the patient investor usually comes out ahead.
Buying and selling securities on the same day to generate a small profit is a terrible idea if you are learning to become an invest r.
Not only is day trading incredibly risky, it usually doesn’t end well. The most significant number of millionaires are every day 401K investors. If you are starting to invest, day trading is not something you get involved in.
Trading Options As A Beginner
Options trading can get incredibly complex. While they can multiply gains, they can also multiply loss s. As a beginner, you should stay far, far away from options.
As you become a more advanced investor, options can play an essential role in your portfolio, from hedging to taking advantage of specific market conditions. But you must first understand how they work and their associated risks.
Investing Habits of Successful Investors
There are undoubtedly endless ways to get rich. However, most successful investors who have achieved financial independence all followed some essential investing tips on their way to financial freedom.
Regularly Contribute To Your Investment Account
When you start investing, making regular contributions to your investment account is critical, primarily when investing in a tax-advantaged account such as an IRA, 401K, or 403B. You start to feel the effects of compounding when you have $100,000 in an investment portfolio.
According to Vanguard’s 2022 How America Saves Report, individuals who contributed 6% vs. 3% to their investment account had a 70% larger balance after 10 years.
Diversify Your Portfolio
A critical part of investing is maintaining a diversified portfolio. A mix of stocks, bonds, alternatives, and cash works well for most people. However, it would be best if you were more inclined to invest in riskier assets such as equities the younger you are. A more balanced allocation of stocks and bonds makes sense as you near retirement age.
The easiest way to diversify is by buying an index ETF like VOO or SPY. These ETFs track the performance of the 500 largest companies by market cap. Also, index funds tend to have a much lower expense ratio – .03% and .09%, respectively. Compared to the average ETF fund, which has an average 0.53% fee, and mutual funds have a 1.42% fee.
There is no one size fits all approach. That’s why I like M1 Finance. They offer over 80 professionally picked portfolios comprised of stocks and ETFs that align with all types of investing objectives – from retirement portfolios to ESG portfolios.
Stick To Your Investment Objectives
Sure, your friend may tell you about the next high-flying stock that will be the next Apple or Google, but that doesn’t mean you s ould go all-in. No matter what, stick to your investment objectives even if the market is in a downturn. Market downturns happen quickly and can be painful, leading to panic selling.
Frequently Asked Questions
When Is The Best Time To Invest?
Now! If you think you can time the market, you are sorely mistaken.
After the pandemic started in March 2022, the S&P tanked and lost almost a quarter of its value. Two years later, the S&P 500 is up nearly 78%. Many people would have likely told you were crazy if you were going to start investing in March 2020.
However, the reality is that if you ignore the market volatility and maintain regular investment contributions, you will be ahead in the long term, and compounding is your friend when it comes to investing.
Can I Invest Without A lot Of Money?
Yes! M1 Finance is an investing app that allows you to invest in fractional shares of popular stocks like Tesla, and Google, among others.
Can I Invest Outside of The Stock Market?
Absolutely. Investing outside the stock market can be done through alternative investments like real estate, music royalties, and even investing in wine.
Alternative investments are becoming incredibly popular and more accessible for everyday investors. Having up to 10% of your portfolio in these asset classes can be helpful because of their uncorrelated returns to the stock market.