A Simple Step-by-Step Guide to Investing

Investing doesn’t have to be complicated. If you follow a simple, proven process and stay consistent, you can build real wealth over time, without guessing or chasing trends. This step-by-step guide will show you exactly where to start and what to do next.

Table of Contents

How to Start Investing

Most of this guide focuses on investing in stocks. Although there are many different investment options available, investing in the stock market is an easy way to build a diversified portfolio and build real wealth over the long term.

1. Decide What to Invest In

The first step to start investing is deciding what you want to invest in. For stocks, you essentially have two options. You can invest in individual stocks, which is risky and stressful. Or, you can invest in index funds, which are a collection of stocks that are more passive and have a long-term track record.

Index Funds (The Ideal Path)

It’s an ideal option if you don’t have the time or desire to be an active investor.
Index funds are the best option for most people

In most of life, being lazy doesn’t produce good results. But that’s not the case with index funds. This investing approach is also known as “passive income” investing with index funds. You invest in a mutual fund or exchange-traded fund (ETF) that tracks one market index.

For instance, an S&P 500 index fund holds positions in the 500 largest U.S. publicly traded companies. Historically, this index has an average annual return of over 10%. S&P 500 index funds have a similar historical rate of return of about 10%, net of investment fees.

You will find index funds in your 401(k) plan or in your online brokerage. There are index funds for every major U.S. and international stock and bond index. You should start with an S&P 500 index fund, as it tracks some of the most stable companies in the U.S. The S&P 500 doesn’t have the highest earning potential, but it’s less volatile than smaller market sectors.

Already have an investment account?

The best way to see how you are currently invested is to use a free tool like Empower. It allows you to link all your investment accounts so you can see everything in one place. It will also provide recommendations to ensure your portfolio is balanced according to your goals.

2. Choose Your Investing Horizon

Before you invest, answer these two questions:

What do I want to invest in?
How soon do I need my money?

Besides deciding if you want to invest in index funds and other investments, you need to decide when you want to access your earnings.

The type of account you have determines how soon you can touch your money penalty-free. And how you pay taxes on your investment gains.

You might decide to invest in a tax-advantaged retirement account first because of the tax benefits of 401 (k) and Roth IRA accounts. But you can’t touch this money penalty-free until you turn 59 ½. If you’re 20 years old, that’s four decades before you can reap your investment returns.

So, you should also consider investing in a non-retirement account. Although your investment income in these accounts is taxable each year, you can always make penalty-free withdrawals.

However, investing is more volatile than keeping your money in a bank account. So, you should only consider keeping money in your investment account that you don’t plan on needing for at least three to five years.

3. Choose an Online Brokerage

Picking a broker can be as important as deciding what you’re going to invest in. A few investment platforms only let you invest in specific products, such as index funds. Others also let you invest in individual stocks and active funds.

You may choose an online brokerage that lets you invest passively and actively. Or, you may first choose a brokerage that only sells index funds.

Here are my top 3 favorite brokerages:

Charles Schwab
Fidelity
Vanguard

These three brokerages all offer commission-free index funds. There are slight differences in the portfolio allocation and fund fees. But the performance is nearly identical. Choose the brokerage you like best, and you’ll be happy with their index fund offerings.

4. Start Investing

After opening your retirement and non-retirement accounts, the next step is earning passive income. I recommend investing at least 10% of your income.

Reinvest Dividends?

Another decision you might have to make is whether to reinvest dividends.

At least once a year, most index funds and many stocks pay dividends. Most brokerages give you the option to reinvest the dividends to buy more shares of that stock. You can also invest in a different stock or transfer the dividends to your savings account.

To maximize your compound interest, you might decide to reinvest the dividends. This is a free way to buy partial shares of stock. These new shares will begin paying dividends themselves.

Schedule Monthly Investments

To keep the investment momentum going, schedule monthly contributions. With index mutual funds, you can have your brokerage invest all of your money into the fund each month.

If you prefer to invest in index ETFs (which usually have lower expense ratios than index mutual funds), Betterment and M1 Finance let you buy fractional shares so all of your money gets invested each month.

Remember, not every online broker lets you buy partial ETF shares.

For example, if you buy ETFs through an online broker such as Vanguard, you must buy full shares. If you invest $100 monthly and an ETF share costs $95, you get one share, and the remaining $5 doesn’t get invested.

It’s important to note that you don’t have to schedule automatic investments to invest monthly. But, if you’re likely to forget to manually invest your cash, it’s a good idea to schedule recurring investments.

Frequently Asked Questions

When you have minimal investing experience, the whole investing process can be confusing. While the best way to learn to invest is through experience, these questions can help you avoid common investing mistakes.

How Do Stocks Earn Passive Income?

Whether you invest in individual stocks, index funds, or active ETFs, there are two ways you can make money.

One way is by asset appreciation. For instance, you buy 10 shares of stock at $50 and sell them for $60 each. You make $100 total, but don’t see this profit until you sell.

Another way to earn money from stocks is through dividends. Most companies and funds pay dividends quarterly or annually.

This is recurring income you earn as long as you own the stock. You can either reinvest the dividends or use the cash for other purchases.

What’s the Difference Between Stocks and Bonds?

Stocks and bonds are two different ways to invest in a company. Stocks are the most common way. Each share you own gives you an equity stake in the company and gives you one vote at annual shareholder meetings.

And, you can earn dividends on a quarterly or annual basis.

Regarding your shareholder voting rights, you can only vote if you own actual shares of the company. You don’t get to vote if you invest in index funds.

Bonds are considered less risky than stocks. This is because bondholders get paid first if a company goes bankrupt. You lend money to companies or the government. In exchange, you receive “coupon” payments (interest) from the borrower.

Bondholders can’t vote in shareholder meetings.

Stocks have greater earning potential but are riskier than bonds. As you near retirement, you should shift from owning more stocks to owning more bonds. For instance, you might own 90% of stocks as a 20-year-old investor. But you might own 60% of stocks when you retire.

What Are Full Shares and Partial Shares?

Another term that can be confusing for beginner investors is full shares of stock. Until very recently, the only way to trade individual stocks and ETFs was to buy or sell full shares.

With full shares, if a stock costs $50, you must have $50 cash to buy one share. You can’t get a partial share if you only have $40. You must wait until you have $50 to buy a full share.

In the past, only mutual funds offered partial shares. This is because they focus more on the amount of money you invest instead of the number of shares you want to buy. Some brokerages, including M1 Finance, let you buy partial shares of individual stocks and ETFs.

Partial shares make it easy because every single penny is invested. That way, you don’t have cash sitting idle until you have enough to buy full shares.

Index Funds vs. Target Date Funds

In your 401k or self-directed brokerage account, you might see index funds and target date funds.

An index fund is a fund that holds individual stock shares. Target date funds are “funds of funds” that invest in several stock and bond index funds. If you don’t want to rebalance your portfolio yourself, target date funds may be good because they rebalance your portfolio over time. They’re designed to become more risk-averse as you near retirement.

Target-date funds are similar to the automated investing approach Betterment pursues. But you need to compare target-date fund expenses with those of an automated investing app.

You should also compare them to investing in the same index funds yourself if you have the time to manage your own portfolio.

What’s the Difference Between a Mutual Fund and an ETF?

Mutual funds and ETFs both let you invest in a basket of stocks or bonds. But there are a few differences in how each product trades. Index funds and active funds come as both mutual funds and ETFs.

ETFs trade like stocks in real time, and their share prices fluctuate constantly. You invest in ETFs by the share, and most brokers don’t let you buy partial shares.

However, ETFs usually have lower fund expenses than their mutual fund counterparts. This means more of your money is invested rather than going toward paying investment fees.

The more money you invest, the more shares you earn, and the more you can earn in dividends. Mutual funds only trade once a day after the market closes. However, you must execute your trade during market hours. You can buy partial shares of mutual funds.

The downside of mutual funds is that you may have to make a large initial investment of $3,000 to open a position. Once you open a position, you may only have to invest $1 or $100 for future share purchases.

Because ETFs are cheaper to trade and usually have lower investment minimums, they can be a better option than mutual funds for your personal investing accounts. The largest exception is your 401k since most still don’t offer ETFs.

Dollar Cost Averaging vs. Lump Sum Investing

There are two investment frequencies you can pursue. For most investors, dollar-cost averaging is the better option because it doesn’t require trying to time the market. And you can invest small sums instead of large ones.

Dollar-cost averaging is where you invest the same amount of money each month. For example, every month, you invest $100 into an S&P 500 index fund. When shares are more expensive, you buy fewer of them.

When they’re lower, you buy more. That keeps you from overreacting to market swings. It helps keep your investment momentum going.

Lump-sum investing is making a large one-time investment. For instance, you invest a Christmas bonus or money you’ve saved up for several months. Investing a large lump sum may make sense when you have to meet a big investment minimum of $3,000 for a Vanguard mutual fund.

One risk of lump-sum investing is the temptation to time the market. You might wait for a stock or fund price to dip before you invest. Most investors can’t predict how the market will perform from one day to the next.

Before you know it, you never invest. Or, you invest at a market peak right before share prices drop sharply.

Summary

Investing for beginners doesn’t have to be difficult. The easiest and cheapest way to earn consistent positive returns is by investing in index funds. If you want to add more risk, you can consider investing in individual stocks. Now, it’s time to start investing.

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