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Investing 101: A Guide to Investing Basics
A beginner's guides to the ins and outs of investing, and how to make your money grow.
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Dayana is a former NerdWallet authority on investing and retirement. She has written for The Associated Press, The Motley Fool, Woman’s Day, Real Simple, Newsweek, USA Today and more. She has written and contributed to several personal finance books and has been interviewed on the "Today" Show, "Good Morning America," NPR, CNN and other outlets.
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June Sham is a lead writer on NerdWallet’s investing and taxes team covering retirement and personal finance. She is a licensed insurance producer, and previously was an insurance writer for Bankrate specializing in home, auto and life insurance. She earned her Bachelor of Arts in creative writing at the University of California, Riverside.
Over time, inflation erodes the purchasing power of cash. At just 3% inflation, a $100 bill you stashed away last year will only get you $97 worth of groceries today. That's how it's possible to save money and lose money — that is, spending power — at the same time.
To combat inflation, many people turn to investing to help their money grow.
Investing 101: A summary of the basics
Before we dive into all the details of investing, here are a few basics for beginners:
How much money do I need to start investing? Not a lot. In fact, it’s mathematically proven that it’s better to start small than to wait until you have more to deploy — even if you try to play catch-up down the road. That little eye-opener is thanks to a magic formula called compound interest.
What should I invest in? It depends on your investment strategy. You can choose to invest in individual stocks or other investment vehicles, such as ETFs, that provide exposure to the stock market and diversification. One of the most common ways to start investing in stocks is to buy a mutual fund — a type of investment that pools money from many investors and invests it in a group of different stocks. You can consider it an “eggs in many baskets” approach.
How do I invest? If your goal is saving for retirement, an employer-sponsored plan, such as 401(k), is a great place to start. For those without access to savings vehicles at work, IRAs are another option for growing your nest egg. If you want to invest money you think you'll want to use sooner, opening and purchasing investments through a taxable brokerage account is your ticket to entry.
Is there a secret to making money in the stock market? Stay invested. Time (to let your investments ride out the market’s inevitable short-term rough patches) and temperament (the ability to keep cool while others are freaking out) are the keys to investment success. So says a guy you might have heard of named Warren Buffett.
If you own a mutual fund in your 401(k) — congratulations! — you've already started investing. Here are a few other entry points into investing in the stock market, from most risky to least risky:
1. Individual stocks
Buying individual stocks means you'll share in a company's successes as their stock price rises and receive dividends if offered. However, if a company's share price falls, your portfolio will also be affected, making it one of the riskiest investments on this list.
For that reason, stock investing requires a fair amount of research, ongoing diligence and a stomach for risk. Diversifying so that you're invested in different individual stocks and other types of investment vehicles could also help limit risk in your investment portfolio.
A mutual fund is a type of investment that pools together money from multiple investors and then invests that money in a collection of investments made up of stocks, bonds or other assets.
These investments all have something in common, be it companies that together make up a market index (such as index funds, detailed below), a particular asset class (bonds, international stocks) or a specific sector (companies in the energy industry, technology stocks). There are even mutual funds that invest solely in companies that adhere to certain ethical or environmental principles (aka socially responsible funds).
What’s nice about mutual funds is that in a single transaction, investors are able to purchase a neatly packaged collection of investments. It’s instant, easy diversification (exposure to many different companies) that lets you avoid buying stocks one by one, and are managed by a professional that selects each investment.
Index funds are a type of mutual fund. They are made up of company stocks within a stock market index, such as the S&P 500 or the Nasdaq Composite, and mirror the performance of that index.
In general, index funds may offer some of the best benefits for beginner investors and those wanting to balance their portfolio against risk. Index funds typically aren't actively managed compared to other mutual funds, resulting in lower fees (called expense ratios), which can boost overall returns.
Like index funds, ETFs contain a bundle of investments ranging from stocks to bonds to currencies and cash. The beauty of an ETF is that it trades like a stock, which means investors can purchase it for a share price that is often less than the $500-plus minimum investment many mutual funds require.
So, which of these should you use to build your retirement portfolio? The answer will be clearer after you learn how to choose investments.
Should you invest in the stock market?
If you start investing now, you can let your savings dollars hitch a ride in a vehicle you can hold on to for years and have it possibly become more valuable than when you started.
Historically, the rate of return in major asset classes shows that the stock market is going to give you the biggest bang for your buck. The stock market's average annual return is 10% before inflation, which other asset classes rarely come close to.
But many people say they think it’s too risky or they don’t know how to invest money. While this is a valid concern, and investing does carry the risk of loss, having a diverse portfolio can better equip you to weather market ups and downs and ultimately achieve your goals.
Practical matters
Sitting on cash that could be invested? Find out what it’s costing you.
