Investing for Beginners

Investing is a great first step toward building wealth for yourself and your family that can be used to reach your goals in the future.

An investment is any asset that you purchase with the intention of generating a return on your money, typically in the form of income, an increase in value, or both. But because there are so many options for how to invest—and your choices should be so tailored to your personal preferences—putting your money to work can be a little overwhelming.

We’ll give you the basics on how to start investing and show you why using a financial advisor for help is key.

How to start investing

As you’re just learning about how investing works, a common misconception you might encounter is that you need to have a lot of money in order to invest. But you can begin investing with any amount of money. In fact, many types of investments can start with relatively small amounts of money. Thanks to the concept of compound interest, even small amounts can grow over time. (Just be sure you keep an emergency fund for unexpected expenses.)

Typically, when people are looking to grow their money for future goals, they start with a plan offered by their employer, such as a 401(k). As time goes by, they might consider an individual retirement account and continue to look at more options. It’s important to understand the basic categories for new investors and how they are different from one another. Here’s a quick “Investing 101” to help you begin, starting with definitions.

1. Funds like mutual funds, which hold multiple stocks, bonds or other investments, allow you to make one investment and be instantly diversified, which makes funds generally less risky (compared to selecting individual stocks or bonds). Mutual funds tend to be actively managed, meaning their holdings are periodically adjusted depending on the fund’s goals and analysis of the market. IRAs, 401(k)s and 403(b)s are often invested in mutual funds.
2. Exchange-traded funds are collections of securities (stocks, bonds, commodities) that can be traded in a single transaction during market hours. They function similarly to mutual funds; however, they often have lower fees than mutual funds, and they can be traded throughout the day (like a stock).
3. Stocks are shares in a company. These tend to be riskier investments but also typically offer more potential for profit over time.
4. Bonds are shares of debt issued by a business or the government. These are safer investments, typically returning a lower profit than stocks over time.
5. Cash and cash equivalents are readily available cash and short-term investments like certificates of deposit (CDs). These are the safest investments but typically return little profit over time.

These are the most common categories of investments—often referred to as asset classes. There are also alternatives like commodities or real estate that require some more advanced knowledge.

If you’re just learning about how investing works, you might think that investing is only for “rich” people. In fact, many types of investments can start with relatively small amounts of money. Even small amounts can grow over time.

Likewise, there’s no particular best age to start investing. Some might start at 30, while others consider that too late to start.

Now that we’ve defined the main types of investments, let’s talk about what you’ll want to know as you start building a portfolio (the collection of investments you own).

Risk tolerance and time horizon

These important concepts will impact how you invest. There is no single best way to invest that will apply to each person and situation. Your ideal investment strategy should be based on your goals, time horizon and risk tolerance.

Risk tolerance is basically your emotional ability to deal with losing money. If you invested $1,000 today, could you deal with it being worth $500 for a period of time? That’s possible if you invest heavily in stocks, which tend to increase in value over time but can be volatile from one day to the next. If you answered yes to the previous question, then you have a high risk tolerance.

When it comes to investing, there are at least eight types of risk that you should keep in mind. The key to managing investments risks is to build a well-diversified financial plan that is tailored to you. A Northwestern Mutual financial advisor can show you how a range of financial options—including a mix of traditional and nontraditional investments—can help grow your wealth over time while also managing risks.

Your time horizon is the amount of time before you want to use your money. If you’re planning to use the money to make a down payment on a home within the next three years, you have a short time horizon and would likely have less risk tolerance. If you’re not planning to use the money until you retire in 30 years, then you have a long time horizon and can afford to take on more risk.

Asset allocation and diversification

Asset allocation and diversification are about putting yourself in a position to grow your money in a smart way.

Asset allocation is the percentage of stocks, bonds or cash you own. If you have a high risk tolerance and long time horizon, you’re likely to want a larger percentage of stocks because you’ll be able to weather ups and downs and make more money over the long term. On the other hand, if you have a low risk tolerance and short time horizon, you probably want more cash and bonds so that you don’t lose money right before you need it.

Diversification splits your investments among different groupings or asset classes in order to reduce risk. That includes your asset allocation. But it also includes where you invest within asset classes. For instance, you might diversify between stocks in companies located within the United States and stocks in companies located in Asia.

Different sectors of the economy do better at different times. It’s tough to predict which one will do well in any given year. So when you diversify and own stocks across different sectors, you are positioned to make money on whatever sector is performing well at the time.

Rebalancing

If you’ve done a good job with asset allocation and diversifying, you still have to check in on your portfolio, which may drift away from the original allocation when one asset class performs better than another. For instance, let’s say you wanted 10 percent of your stocks to be companies in Asia. If companies in Asia have a great year, those companies may now make up 15 percent of your stocks. In that case you’ll want to sell some of those stocks and use that money to buy more stocks (or even bonds) in parts of your portfolio that didn’t do as well.

You might also decide to rebalance your portfolio if your risk tolerance or investment timeline has changed—perhaps as you get closer and closer to retirement.

Either way, it’s a good idea to rebalance your portfolio at least once a year and possibly more often. Once you’re ready, there are several ways to invest and different types of accounts that get different tax treatment.

Where to invest

You could invest directly through your retirement plan if you have one at work and haven’t already taken advantage of it. Typically, work-sponsored retirement plans have limited options that usually consist of funds, which are collections of stocks or bonds. Some funds are professionally managed. Others are designed to mimic a particular index like the S&P 500. Target-date funds are also popular. Those funds automatically rebalance to a less risky allocation as you approach the end of the target date (which is typically close to the year you want your money—maybe the year you’re planning to retire).

You could also invest directly through a broker. That could mean opening an online trading account that you manage yourself or working with a financial planner or professional.

Types of investment accounts

Tax-qualified accounts get favorable tax treatment. These include retirement accounts like 401(k)s, 403(b)s, IRAs and Roth accounts. Because these accounts get special treatment, there are typically limits on who can use them and how much someone can contribute.

Non-qualified accounts don’t get special tax treatment. This means you’re free to invest as much as you would like in them.

Common investing mistakes for beginners to avoid

Successful investing requires patience and discipline. It’s more of a marathon than a sprint. New investors might get overly eager for quick results, but it’s important to maintain an unemotional mindset.

Here are some common mistakes beginning investors make that you may want to try to avoid:

Investing emotionally

It’s easy for non-professional investors, especially new investors, to react to their investment value rising and falling. Late-night checks of values can set your mind racing, and taking money out of the market too soon can result in lost growth potential. A financial professional can add perspective and help you stay calm and avoid the mistake of trying to time the market.

Trying to time the market

Every stock carries risk, and the markets can swing wildly. Smart investors stick with their strategy for the long term rather than waiting for a decline in the market to buy and an upswing to sell.

Investing in risky asset types (e.g., “meme stocks”) due to trends

These investments suddenly turn up everywhere you look online, with some people claiming to make huge profits quickly. You can stay aware of trends and even have some fun with extra cash, but avoid investing dollars tagged for retirement or other goals in these trendy investments.

Lack of diversification

Putting all your investment dollars into stocks or a single sector of the economy likely won’t yield the best results for your long-term financial health. Instead, it’s better to build a portfolio that includes a variety of asset classes and investment types. Diversify by having a balanced portfolio.

Finding the right investment strategy

Especially as you’re starting out, you don’t need to know everything about the market and how to invest. Instead, you can partner with a financial advisor who can provide sound advice as to what investment options are most appropriate for you and your goals.

A Northwestern Mutual financial advisor can take a look at your financial situation and help you establish an investment strategy that supports your comprehensive financial plan. An advisor also may be able to help manage your investments for you—leaving all the heavy lifting to the experts.

Even if you just start dipping your toes in, there’s no better time than right now to start investing. You’ll be that much closer to reaching the financial goals you set for your future.

No investment strategy can guarantee a profit or protect against loss. All investing carries some risk, including loss of principal invested.