Updated December 28, 2017

How to Invest and Make Your Money Work for You

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So, you want to invest some of your money, but you have no idea how to start? No problem. This handy 10-step guide is loaded with useful resources to help you get started.

How to Invest Money
How to Invest Money © CreditDonkey

After all, if you want to build real wealth, you've got to make your money work for you.

Investing might sound complicated or even impossible to understand, but it doesn't have to be. Read this simple guide to learn how to cut through all the jargon, so you can start investing wisely and confidently.

Why Now is the Best Time to Start Investing

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The earlier you start investing, the more time your money has to grow. But not only that - the gains (AKA earnings) that you make early on start producing their own gains. This results in money that grows quickly. This is the magic of "compounding gains".

But it's not enough to simply understand why you should invest early in life. You have to understand the how as well.

But wait! Before you start investing: You should only invest if your personal finances are in good shape. This means:

  • Have an emergency fund: It's important to have funds set aside to cover emergencies - anything from a pricey car repair to sudden loss of work. Ideally it's best if you have enough to cover 3 to 6 months of living expenses, but be sure to save at least $500 before you begin investing additional money.

  • Pay off any credit card debt: If you have a balance, focus on paying off that credit card debt first. Any gains you make from investments could easily be swallowed up by the high interest charges. You get a much better return by using your money to pay off debt first.

Ultimate List of the Web's Best Advice for Beginners

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In this article, you'll learn about investing from the ground up. We've also compiled a list of the best resources to help you in this investment journey, which are presented as links at the end of each section. They are a great place to start if you are looking for more detail on certain topics.

Scroll down to continue reading or click a specific topic below to jump to that section.

  1. Budgeting for Investing
  2. Risks of Investing
  3. What to Invest In
  4. Investing vs Gambling
  5. Investing vs Saving
  6. Long-Term Investment Goals
  7. Where to Invest Money
  8. Understanding 401(k) Investing
  9. Understanding IRA Investing
  10. Understanding Other Types of Investment Accounts

Budgeting for Investing

When you're ready to start investing, first factor your investment goals into your existing budget so that investing can become a part of your life. Your investment budget should be part of your overall household budget, just like your bills, groceries, and car payments.

Don't have a budget, you say? Well let's change that! These articles will help you construct a budget so that you can begin "paying yourself first" with your investments:

Think there's no way you can invest on your tight budget? This article on how to invest in stocks with little money might help change your mind.

Risks of Investing

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We're not going to sugarcoat it: investments can of course be risky. You can lose some or even all the money you've put in.

Scary? Yes. But investing is the only way to build real wealth over time, and there are ways to limit your risks. We've all heard the phrase "don't put all your eggs in one basket." This is especially applicable to investing. For beginners, the best thing to do is to diversify your portfolio in two ways:

  1. Diversify your portfolio across different investments, so that you're not as exposed to the risk that any one investment goes bust. One way to do this cheaply is to hold ETFs or low-cost mutual funds, which hold a portfolio of individual investments themselves. We'll discuss this in more detail in the section below;

  2. Invest in a mix of different asset classes such as international stocks, domestic stocks, bonds, and money market accounts. Different asset classes have different levels of risk in different market environments. If you own 100 different stocks, you might think you're well-diversified. But if all of those stocks are issued by companies based in Japan and then Japan's economy experiences a sudden downturn, all of the investments in your "diversified" portfolio are likely to do the same thing at the same time: lose a lot of value.

Some investments are safer than others, and even the most diversified portfolio involves risk. Of course, the safer investments typically won't offer the same potential rate of return that a higher-risk investments do. This is the concept of "risk versus return," and it's important for you to think about how much comfort you have with your investments losing value. See the "Investment Risk Tolerance Quiz" below as a great starting point.

The links below are great resources for understanding risk as it applies to investing:

How can I invest a small amount of money?
You don't need thousands to invest. You can start investing no matter how much you have. A lot of brokers don't have a minimum requirement. Here are some ideas even if you have just $100.

  • Dedicate a small portion of your paycheck to your employer IRA: If your employer offers a company "match," as in many 401(k) plans, you should start here because they're literally matching your investments with dollars of their own - it's free money!
  • Invest in an ETF, which is a diversified collection of stocks
  • Sign up for a company like Acorns, which takes your credit card transactions and rounds them up to the nearest $1.00, then invests the extra change in partial shares of ETFs
  • Invest in a robo-advisor such as Betterment

Selecting Investments

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Before you make any investments, you need to get the terminology down.

  • A stock is a direct investment in a company. Also called equity, this type of investment takes more effort to research and analyze as stocks can go up and down quickly.

  • A bond is a type of debt issued by a company or even a municipality, such as a city government. Companies and municipalities need money to invest in new projects, so - much like you might do with your mortgage - they take out a particular amount of money, and agree to pay a particular interest rate on it for a period of time. When you buy a bond, you're buying an agreement that a company will pay you $X per year or month, at a certain interest rate.

    This is less risky than a stock because you know how much you will be paid and when you will be paid. The only time you won't get your money is if the company "defaults" on its debt.

    See "Difference Between Stocks and Bonds" for more detail.

  • A mutual fund is a collection of stocks or bonds. It diversifies your investment across several or even hundreds of companies, thereby reducing the risk that any one company experiences financial trouble.

  • An ETF (exchange-traded fund) is similar to a mutual fund in that it holds a collection of stocks or bonds. But, as the name indicates, it trades like an individual stock - on an "exchange" throughout the day. (Mutual funds have limitations on how and when they can be traded.)

  • An index fund is simply a mutual fund or ETF that tracks an index of investments. Indexes are big groups of either stocks or bonds that are intended to give people an understanding of overall market performance.

    For example, the NYSE Composite Index includes over 2,000 mostly U.S.-based stocks.

    How do I invest in an index fund?

    • First, keep in mind you're investing in a fund that follows a specific index; when the index buys or sells investments, the index fund has to match whatever the index does. Therefore, it makes sense to buy the cheapest index fund possible, because all funds that track the same index are essentially doing the same thing.

    • Next, open up your brokerage or retirement account - see immediately below, and the "Where to Invest Money" section if you don't have one yet - and see which index funds are available to you. Do you want an index fund to track a set of stocks or bonds? Choose your asset class.

    • Once you've got a list of index funds that track a particular asset class, pay attention to their expense ratios. This is how you determine how much you're paying in fees to the fund's management company. Remember, lower (cheaper) is better.

    • That's it! Pick a cheap index fund that tracks an asset class you want, and invest your money in it.

  • You also can invest in money market accounts, savings bonds, annuities, CDs, real estate, precious metals, and other vehicles within certain investment accounts.

If you're just starting out, we recommend investing in ETFs and indexes or mutual funds, or using robo-advisors.

How much money do you need to start investing in mutual funds, ETFs, or index funds? It's a myth that you need thousands of dollars to invest in mutual funds. While it's true that some mutual fund companies require a high account minimum, there are brokerages with very low minimum requirements. Here are some options:

  • Ally Invest: No account minimum
  • TD Ameritrade: No account minimum; over 4,000 no-transaction-fee mutual funds
  • ETRADE: $500 account minimum; over 2,000 no-transaction-fee mutual funds

Check out these links on selecting the right investment for you:

Investing Vs. Gambling

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Because there's inherent risk involved in investing, it may feel a little like gambling, especially if an investment takes a dip during a tough day for the markets.

But the difference is clear if you understand it correctly. Gambling is about making short-term choices, usually on games of chance, and "the house" typically keeps a significant percentage of your money whether you win or lose (and you'll often lose). Buying and selling stocks at random, quickly, without researching or understanding the trends, is also a poor choice; while "the house" doesn't take your money, every time you make a short-term trade you're incurring transactions costs that would be better used towards longer-term investments you actually understand. Picking stocks at random and hoping they go up is like gambling.

Investing is when you take the time to make smart selections based on your long-term needs and goals. You're not making choices on whims or guesses, and you can choose investments that don't carry a ton of risk. Plus, if something isn't going the way you want, you can always make adjustments.

How do I start investing in the stock market?
This is the most intimidating part for beginners. Here are simple steps to take:

  • Know your risk comfort level. Think about what risks you're comfortable taking. If you're young, you can afford to be more aggressive because you have decades ahead of you to recover from any losses (and to accumulate wealth over time!). If you have a job with a steady income, you can take more risks because you have paychecks to cover your day-to-day living expenses.

  • Choose a brokerage. A brokerage is a company that executes stock market trades for you. Compare each brokerage's account minimums and fees. Decide how much guidance you need. A full-service broker will help you select investments, but this will cost significantly more than a discount broker, and is generally not recommended for people without large sums of money to invest. A discount broker will be completely DIY. A popular choice now is robo-advisors, where a computer will select investments for you based on your goals; see section on where to invest money for more detail.

  • Research. Don't just pick stocks at random. Research the company's goals, cash flow, profits, and debts. If you're not sure, you could invest in mutual funds or ETFs. These are collections of stocks and/or bonds. Each mutual fund or ETF has its own investment strategy, so be sure to understand the asset class in which you're investing. However, because these funds invest in a variety of stocks and/or bonds, it's not necessary for you to understand each underlying company's businesses, the way you would if you were picking an individual stock to buy.

Read our complete guide on How to Invest in Stocks for Beginners.

Investing Vs. Saving

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A penny saved is a penny earned... Or is it?

You'll often see the terms "investing" and "saving" used interchangeably. But they are not the same thing.

When you invest money, that figurative penny saved could return earnings a lot bigger than if it's just sitting in your sock drawer.

Saving is the act of putting aside cash you have earned. You usually save for shorter-term goals, like vacations. You usually have quick and easy access to your funds (like a savings account).

When planning for long-term goals, however, investing your money goes a lot further. Investing is when you put your money into assets (whether that be stocks, mutual funds, metals, or a house) that will hopefully grow over time.

We recommend a balance of both saving and investing. Save to build up an emergency fund and for short-term goals, and invest for your long-term future.

For more about the difference between saving and investing, check out these articles that we found interesting:

Long-Term Investment Goals

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Your long-term investment strategy will be much different from your short-term savings strategy. Because you have more time, you can afford to take more risks. Ups and downs are bound to occur, but you'll have time to ride these out.

The downside to long-term investing is your money will be tied up. So it's important not to invest funds that you need for day-to-day expenses or funds that you may need in the next several years. Soon-to-be-homebuyers who will need cash for a down payment, take note!

Investing is best used when saving for things like your retirement, your child's college education, or a down payment on a vacation home that you want to purchase a decade from now.

In the links below, you'll get even more valuable information on long-term investments:

If you want to invest for the short term: Investing is generally best long-term (we're talking 10+, 20+ years), but you may have short-term goals as well. You may just need a place to put your money, while making it grow a little. Here are some options for short-term goals:

  • High-yield savings account: A savings account is best if you may need quick access to your money. Here are some of our top picks of online savings accounts with high interest rates.

  • A CD (Certificate of Deposit): This is a very secure way to store your money. A CD will have a fixed term, so you cannot withdraw the money before the term is up. But to reward you for the commitment, the interest rate will be higher than what you'd achieve with a savings account. Here are our picks for CDs with the highest interest rates.

Note that these investment options will not make you rich. But they are safe options for you to store your money, while earning a bit extra in interest.

Selecting a Brokerage

When you're ready to begin investing, you'll need a brokerage to set up and hold your investment account. Think of it like using a bank to hold your bank account.

If you're considering opening a brokerage account account, you must check out these promotions.

Some brokerages specialize in certain types of investment accounts. But most of them offer any kind of account or investment service you'll need.

  • If you want to manage your investments yourself, online brokerages give you nearly full reign.

  • If you need guidance, a full-service brokerage will offer advice and personalized service for a fee. Make sure you understand how much that fee is, and how that fee is paid: hourly or as a percentage of your assets.

  • If you want to be completely hands off, robo-advisors use computer algorithms that select and manage investments for you, based on your individual characteristics.

    Why consider a robo-advisor?

    Fees are typically very low because there's no human advisor.

    This can be an excellent way for a new investor to get started, since it doesn't require you to know everything about all of your investments. Also, it re-balances and manages your portfolio periodically for you.

    As you become more knowledgeable, you can always start taking a more hands-on approach. These days, most major brokerage companies offer robo-advisor options, so they're readily available.

  • With a 401(k) account, your company will have selected the brokerage for you, so all you need to do is talk to your Human Resources department about how to get yourself signed up for an account so that you can start taking advantage of a free company match, if there is one.

It's okay to just start investing with a small amount of money at first. Brokers such as Ally Invest and Ameritrade have $0 minimum deposit, so you can start with as little money as you'd like.

If you like the sound of a robo-advisor, Betterment also has no minimum required. See our comparison list for best robo-advisors.

For solid tips on how to find the right brokerage for you, check out what these experts think:

Tip: Use dollar cost averaging. Since you've already built investing into your regular monthly budget (haven't you?), you're already making this concept work for you. Dollar cost averaging is when you buy a fixed amount at specific intervals (e.g., once a month). The market naturally goes up and down, so you're not locking yourself in at one rate for one large, lump-sum investment.

For example, let's say you want to invest $6,000 into a particular company whose stock price is $50. You could buy 120 shares now (= $6,000/$50), or you could spread it out over a year. 12 investments of $500 each represents the same amount of total money invested, but this way, if the stock price tanks one month, you're able to buy yourself some extra shares. This reduces the impact of a volatile stock and levels out the risk. Just make sure that if you're buying one company's stock each month, you're not getting hit with large transactions costs every month.

Understanding 401(k) Investing

Many young adults are introduced to the world of investing with a 401(k) account at work. This type of account helps you save for retirement by automatically setting aside money from your paycheck into a retirement account.

This is a great way to invest for several reasons. For one, the money is not taxed until you take it out of the 401(k) account, which is usually when you are retired and in a lower tax bracket. (If you withdraw the funds earlier, you'll pay a hefty penalty and more in taxes, so this should be avoided if at all possible.)

Many companies will match a percentage of what you contribute as well. This is literally "free" money, so make sure to take advantage of it if your company does matching. Keep in mind that 401(k) accounts do have limitations on how you can access the money and how much you can contribute each year.

For more on 401(k)s, check these out:

Understanding IRA Investing

You can supplement your 401(k) earnings with an IRA (Individual Retirement Account).

Like a 401(k), IRA accounts come with tax benefits. You can hold an IRA at the same time you have a 401(k). But there's a limit on how much you can contribute each year.

Different types of IRAs have different benefits. Roth IRAs are contributed with money that has already been taxed. So you will not be taxed again when you withdraw, not even on your earnings. However, Roth IRAs are only available to people earning below a certain annual income or who take advantage of special conversions, so you should consult a tax professional. A traditional IRA, available to everyone, doesn't tax upfront, but taxes your earnings when you withdraw your funds. If you change jobs and must take your 401(k) account proceeds with you, you can use a rollover IRA to maintain the tax breaks of the 401(k). Alternatively, if you're moving to another company that offers a 401(k), you may be able to roll over your old 401(k) balance into the new account. Whatever you do when you change jobs, don't take the "cash out" option - while you'll have actual cash in your pocket, you'll pay a hefty penalty fee!

For some detail on Roth IRA providers, see "Best Roth IRA Providers for Beginners."

For more detail on IRAs and how they might work for you, check out what these experts have to say:

Understanding Other Types of Investment Accounts

Some people need investment accounts other than the popular 401(k) or IRA. If you're self-employed, you can use an SEP-IRA in lieu of a 401(k) to obtain tax breaks.

Those saving for their child's college will want to consider a 529 college savings plan. This account offers huge tax breaks, as all earnings are tax-free. You just have to make sure your contributions remain below the federal gift tax limits.

Or maybe you want to invest money for another goal or without limits. In this case, a general brokerage account is your best bet. Just be aware that you will have to pay taxes on any gains you realize every April 15.

For more on those other investment types, see these articles:

Now you have a basic understanding of investing and what kind of investments to make. But it's also equally important to know what kind of investments to avoid.

These types of "investments" will not only NOT make you money, but risk losing your hard-earned money.

  • Pyramid schemes: Pyramid schemes operate a model where you are paid when you recruit more members into the program. It's just impossible for everyone to keep on making money down the pyramid. So if you are asked to pay to join a company and to recruit more members, beware of a pyramid scheme. Sometimes these are disguised as "business opportunities" or "multi-level marketing companies," where you pay to join a company and then sell their goods to other people. While you may make a small amount of money on commission, you are often required to sell a certain amount every month, and you will not be able to earn high enough commissions until you recruit more members.

  • Get rich quick schemes: You know the ones. Often, these will promise you high returns for little risk, while you get to work from home. Nope, you just know it's too good to be true.

  • Anything you don't understand: Minimum rule of thumb, you should be able to answer basic questions about it, such as the company's historical return and future projections. Remember, it's gambling if you just pick a company without understanding it.

Bottom Line

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There's no pressure to start investing while you're getting up to speed on the terms and what they all mean. Take your time to truly understand what you're about to do. Hopefully, we've helped steer you in the right direction with this beginner's guide.

Of course, you're never too old to start investing. The sooner you start, the sooner your money can start working for you.

Disclaimer: Opinions expressed here are author's alone. Please support CreditDonkey on our mission to help you make savvy decisions. Our free online service is made possible through financial relationships with some of the products and services mentioned on this site. We may receive compensation if you shop through links in our content.

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Comments about How to Invest and Make Your Money Work for You

  • Lovely Sharice
    on November 7, 2016 5:52 AM said:

    I learned the hard way about investing vs gambling! Bought a stock that had bad returns but they had just made a good investment (or so I thought) so I bought more shares than I should have and lost half. Now I look for consistent returns.

  • Stephen from Alberta
    on January 28, 2017 9:30 AM said:

    I learned about investing by being stupid and just throwing money in the market. Early on I bought penny stocks hoping to make it rich and then 2008 happened and I started from scratch again. This time I spent a lot more time looking into long term investing. It's paid off HUGELY

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