Practical Investing Guide for Beginners
Posted by Lynnae on January 30, 2008
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I know virtually nothing about investing, so it’s good to have friends like Pinyo, who can explain it to me.
The following is a guest post by Pinyo of Moolanomy. He graciously agreed to fill in for me while I recover from a nasty cold. Since I never write about investing here, this will be a treat for those of you who want to know more about investing. If you are at all interested in investing, I encourage you to head over to Pinyo’s blog and consider subscribing to his feed. He’s very knowledgeable in the area of investing.
Neither one of my parents know how to invest in the stock market, nor was learning how to invest a part of my formal education, so I know how intimidating it is for people who are new to investing. Where do I start? What do I invest in? How am I doing? There are just so many questions. In this post, I am going to attempt to make it as easy as possible for someone brand new to investing to get started.
1. Money
Investing is unlike putting money into savings or CDs, there is risk involved. So you need money that you can afford to lose. This means that if you owe any money that you are paying interest on — i.e., credit card debts, student loans, car loans, etc. — you need to pay these off first. The only exception is your mortgage.
2. Brokerage Account
You can invest through three main types of financial institutions: a bank, a discount brokerage firm, or a full service brokerage firm. Out of the three, I recommend discount brokerage firm, because banks and full service firms generally overcharge their client and push products that are not always the best. Personally, I use TD Ameritrade, but you can also use Charles Schwab. I have used them both and I am comfortable recommending them.
3. Taxable Account versus Tax-Advantage Account
You will also have to decide if you want to start a normal taxable account where you can liquidate your investment and get your money back at any time, or start a tax-advantage account like Roth IRA or Traditional IRA where you are investing long-term for your retirement. You will not be able to access this money without penalty until you turn 59 and a half — you can invest the money however you like, you just can’t withdraw the money.
4. Invest
I have over 10 years of experience and I have made my fair share of mistakes, so believe me when I say don’t start with individual stocks. As a first time investor, I would recommend that you start with exchange traded funds, or mutual funds, instead. Let me briefly explains how each works:
- Stocks – Each share represents part ownership of a company. For example, if you buy 100 shares of AAPL, you’ll own a tiny part of Apple Inc. When you purchase shares, you have to pay the brokerage firm trade commissions which can be as low as $0 to somewhere around $6 to $30 for discount brokerage firms. Usually, you’ll have to pay more if you purchase through banks or full-service firms.
- Mutual Funds – Each mutual fund is a collection of many stocks. Throughout the year, the fund manager can buy and sell stocks inside the fund on your behalf. In essence, you buy the underlying stocks and pay for the fund manager’s services. When you buy shares of mutual funds, you could potentially pay 4 kinds of fees: (1) Trade commission, (2) Front-end load, (3) Back-end load (or redemption fee), and (4) Expense ratio. The ones that you should stick to is low expense ratio, no load, and no transaction fee mutual funds — meaning you are not paying anything but the expense ratio.
- ETFs – I believe this is by far the best investment vehicle. Similar to mutual funds, an ETF is a collection of many stocks; however, the stocks are more defined and they are rarely traded. Likewise, there is an expense ratio, but it’s generally lower than similar mutual funds. But like stocks, you have to pay trade commission each time you buy and sell shares.
The strategy that I believe is best for new investors is to build a globally diversified portfolio of low expense passively managed ETFs. For example, if you have $6,000, you could potentially split it up in $2,000 chunks and buy 3 ETFs: Large US Stocks ETF, Small US Stocks ETF, and International Stocks ETF. The subject of asset allocation — i.e., how you should divide your money across multiple types of investment is fairly complex, and I will not be explaining it here. If you are interested, you can take a look at my 401k asset allocation to get a better idea.
How to find the right ETFs?
There are several ways to do this. Brokerage firms like Charles Schwab and TD Ameritrade offer online tools where you can do your research. For example, you can use their online tools to find “low cost, Large US Stocks ETFs,” but it takes a bit of time to learn the web interface. The good news is that you can visit one of their branches and ask for help, or you can just ask one of the representatives to help you make the purchases. Remember, you are not looking for ETFs with the best performance (this is called chasing past performance), you are looking for ETFs that:
- Have a low expense ratio
- Represent the asset class well — i.e., small-cap, large-cap, international, etc.
How to buy the ETFs?
Once you identify which ETFs you will be buying, you will need their ticker symbols. For example:
- IVV is the ticker symbol for “iShares S&P 500 Index,” a Large US Stocks ETF
- VB is the ticker symbol for “Vanguard Small Cap ETF,” a Small US Stocks ETF
- VEU is the ticker symbol for “Vanguard FTSE All-World ex-US ETF,” an International Stocks ETF
At this point, you can enter a buy order through the online form, or ask the representative, to buy X shares of IVV, Y shares of VB, and Z shares of VEU. If you want to invest $2,000 in each, you just divide $2,000 by the latest ask price to get the number of shares.
What’s next?
Read as many books and web sites that you can to learn about investing. My caution is to avoid hot tips and hot stock picks. What you want to learn is how the market works, effect of expense on investment performance, asset allocation, risk management, investing for specific goals, etc. If you have any questions, please feel free to leave a comment and I will do the best I can to answer them. Please note that it’s also worthwhile to pay a fee-based financial advisor to help you through your first investing experience.
Photo by thelastminute.
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15 Responses to “Practical Investing Guide for Beginners”
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I am not a financial expert. I'm just a wife and mom doing the best I can to live a frugal life and get out of debt. Like any human, I make mistakes. I write this blog out of my own experiences, and nothing I write should be taken as expert advice. If you need financial advice, please consult a professional.
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Very nice, Pinyo. I think you’ve really covered the basics on this one.
Here’s a question, why should I buy ETFs if I could match the same with low-cost Vanguard indexes? The biggest advantage I see to ETFs is that they’re easier to trade…but I wouldn’t be trading them.
Good question Mrs. Micah.
1. Even the cheapest mutual fund is more expensive than comparable ETFs — VFINX (Vanguard Index Fund) expense ratio is 0.18% compare to IVV ER of 0.09%
2. Mutual fund is not as tax efficient if you invest it in taxable account; otherwise they are similar in tax-sheltered account. You can learn more about this concept by reading my posts: Would You Like to Pay My Taxes? and Mutual Fund Double Whammy
However, there is an instance where mutual fund is more practical. When you are buying an investment regularly — i.e., regular contribution of $50 per month — it’s cheaper to leverage no-transaction fee funds, because you will have to pay commission on each purchase for ETFs.
What a great outline. This is the kind of thing that needs to be taught in every high school in America. Why is it that personal money management, one of the most important parts of your life, is left out of the education system?
GREAT overview Pinyo. Great information for us investment n00bs
Thank you!
Lynnae, hope you are feeling better!
Thanks for the explanation, Pinyo. I’ll stick with mutual funds for my tax-advantaged accounts, since my plan on those is to buy monthly (once we can get up to that). But for normal ones I’ll look into ETFs. If/when we ever have one of those.
That’s too funny, I just used that picture on Monday! Great post as usual Lynnae.
OOps, just noticed Pinyo wrote it. Great post as usual, Pinyo!
With another set of rate cuts today it will be interesting to see if money flows back into the market.
@Mrs. Micah - That sounds like a good plan.
@Glblguy, Ron, and David - Thank you.
@RacerX - Fed action is interesting, but I would caution new investors to ignore noises like these. Instead, focus on learning the fundamental of investing and formula proper strategy for various goals. When you invest in the stock market, it could mean a decade or more, so small changes like this rarely matters.
Hi there,
Thanks for using my photo! If you could, please change link to my blog instead of my flickr account:
http://thelastminuteblog.com
as per:
http://www.flickr.com/people/thelastminute
Thanks!