How to start investing

Investing — it can be an intimidating topic.

You’ve probably heard people talk about how investing could grow your money. Who wouldn’t want that? But that first step into the unfamiliar can be filled with nerves and uncertainty.

What do I know about the stock market? How do I choose the right investments? What’s the difference between a stock and a bond anyway?

The fact is, if you’ve been contributing to a 401(k) or IRA, you already have been investing. Whether you are brand new to the topic or have already started with the basics, this guide will help you learn more about how investing works and what your options are.

Define your investment goals

The first step is outlining your goals for the money you're investing. Your goals could be buying a home, funding education, or saving for retirement. All the investment decisions you make should focus on your specific goals.

An important consideration is timing. When do you hope to achieve your goals? A few months? Five years? Ten years? Thirty? That timeline is known as your investment time horizon.

A portfolio designed to invest for the short term will look a lot different than one eyeing a long-term goal. Your investments should be aligned with the time horizon of your goals.

Understand your risk tolerance

Investing, by nature, involves risk. That means you could lose money on your investment. Often times, investments that have higher potential returns also have higher risks. That's why people opt to invest some of their money rather than stash it all in a savings account.

Not all investment portfolios are created equal; each has a unique amount of risk. Portfolios can be aggressive, moderate, or conservative.

For example, someone with a higher risk tolerance may steer toward an aggressive asset allocation. Their strategy attempts to maximize returns and take higher risk by investing primarily in stocks, as opposed to bonds or cash. Someone with a low appetite for risk would take a conservative route, with higher exposure to bonds. A moderate portfolio may consist of an almost 50:50 split between stocks and bonds.

Your individual risk tolerance could be impacted by:

• Personal preference: Are you the type of person who will pull out of your investment at the first sign of trouble? Or are you comfortable riding it out through market fluctuations?
• Investment time horizon: Time is always a factor with investing. For example, if your goals are 20 years away, then you can handle larger fluctuations in performance (since there's more time to recover from any losses). Following that same reasoning, goals that are only five years out tend to be exposed to less risk.
• Your wants vs. needs: Is your investment goal something you want or something you need? "Wants" can be postponed if the market experiences a fluctuation, while "needs" are more important to reach by a certain date. For example, buying a new boat or sports car would fall into the "want" category; funding your child's education would be a "need" for most.

Consider how your investments will be managed

Who will handle your investments — you or a financial advisor? The answer has a lot to do with your knowledge and comfort. Some investments require sophisticated knowledge and monitoring. Others are more set-and-forget.

People who successfully manage their own investments typically have advanced knowledge and experience in various investment vehicles and are willing to devote time to researching and monitoring the market. This method may involve fewer fees, but it's not for everyone. A good question to ask yourself would be: If a friend needed an advisor, would you recommend you?

Meanwhile, a financial advisor will use their expertise to build a customized portfolio and manage it for you. Advisors also help manage your emotions to help avoid common investing mistakes when making financial decisions. You'll periodically meet with your advisor to go over your portfolio and make the appropriate changes to your financial plan stay on target. In exchange, you'll either pay management fees (a certain percentage of all assets), commission, or a combination of the two. Many advisors may have minimum investment amounts too, so you may need to do some research to find one that is the right fit for you.

OK, now that you have the 101 information, let's answer some other questions you might have.

How can you make a return on your investments?

It all depends on the type of investment. In general, there are three types of returns:

1. Capital gains: For stocks, bonds, mutual funds, and ETFs, you earn a return when you sell shares for more than what you originally paid. If you sell the shares for less than what you paid, that's called a capital loss.
2. Dividends: Stocks can also yield a return via dividends - that's when the company shares a percentage of its profits with shareholders instead of putting the money back into the business. The amount of the dividend isn't guaranteed; it depends on how well the company did and the type of stock you own.
3. Interest: Bonds and other fixed-income investments earn returns in a slightly different way. These investment vehicles are essentially loans made to an organization. The organization must pay investors a pre-determined interest rate on a set payment period. Or, sometimes, at maturity. With these types of investments, you know exactly how much money you'll earn and when. Therefore, they're considered more conservative.

No matter your investment type, taxes are a factor, so consult with a financial advisor or tax professional to learn how to limit your tax bill.

What are the different types of investment accounts?

Accounts such as 401(k)s and IRAs are intended for the goal of saving for retirement. That’s because of their tax advantages and, in some cases, matching contributions from employers. However, there are two factors to consider:

1. Penalty-free withdrawals can't begin until age 59½.
2. 401(k)s and IRAs have annual contribution limits.

If you think you may need the money before age 59½ for your goals, an after-tax account may be a better option to avoid the 10% early withdrawal penalty from a 401(k) or IRA.

An after-tax account could also supplement your retirement savings if you want to contribute more than the annual limit.

Ready to start investing?

Investing doesn't mean that you need to constantly monitor the stock market. You can be as active or passive as you'd like, and you can choose a risk exposure you're comfortable with. In the end, it comes down to setting a goal, having a plan, and understanding your options to accomplish it. To continue learning about investing, retirement and more, explore our financial planning education and resources from Citizens Wealth Management.*