Our first lessons in money tend to cover how to get it (doing chores, finding a job) and how to keep it safe (opening a bank account). But these take you only so far. You need to know how to make it grow — so you can buy a house, put your kid through college, prepare for retirement, or just live a bit more comfortably — and that means learning how to invest money.
Learning how to invest can be the single best thing you can ever do for your financial well-being. It can feel daunting to begin investing your money, but it doesn’t have to be. Before you start, you have to figure out what you want from investing — what your goals are — and then you can determine how you’re going to get there. This article explains how to invest your money, even if you’ve never done it before.
Decide whether to be active or passive
First things first: Do you want to get your money invested, or do you want to learn how to invest?
Seems like a small difference, but it’s actually a big one: If you’re here to learn how to invest — or deepen your knowledge, if you already have a baseline understanding — you should read on for the how and wheres of doing that.
If you’re here because you have a bit of money and know you should invest it, but you’d really rather someone else do the work for you, you might be interested in a robo-advisor. This is a company that manages your investments for you. Here’s more about robo-advisors and what they do, along with our picks for the best companies in this space.
Identify your goals for investing
Figuring out how to invest money starts with determining your investing goals and when you want to achieve them.
- Long-term goals: The universal goal is often retirement, but you may have others as well: Do you want a down payment on a house or college tuition? To purchase your dream vacation home or go on an anniversary trip in 10 years?
- Short-term goals: This is next year’s vacation, a house you want to buy next year, an emergency fund or your Christmas piggy bank.
In this post, we’re largely focusing on long-term goals. We’ll also touch on investing with no specific goal in mind — the aim to grow your money is a fine goal by itself. Money for short-term goals generally shouldn’t be invested at all. If you need the money you’re saving in under five years, check out our recommendations for short-term goals.
Choose the right type of account
Just as there are a number of bank accounts for different purposes — checking, savings, money market, certificates of deposit — there are a handful of investment accounts to know about.
It’s important to invest within the right account — some accounts offer tax advantages if you’re investing for a specific purpose, like retirement. Keep in mind that you may be taxed or penalized if you pull your money out early, or for a reason not considered qualified by the plan rules.
Other accounts are general purpose and should be used for goals not related to retirement — that dream vacation home, the boat to go with it or a home renovation down the line.
Here’s a list of some of the most popular investing accounts:
If you’re investing for retirement:
- 401(k): You might already have a 401(k), which is offered by many employers and takes contributions right from your paycheck. Many companies will match your contributions, up to a limit — if yours does, you should contribute at least enough to earn that match before investing elsewhere.
- Traditional or Roth IRA: If you’re already contributing to a 401(k) or don’t have one, you can open an individual retirement account. In a traditional IRA, your contributions are tax-deductible but distributions in retirement are taxed as ordinary income. A Roth IRA is a cousin of the traditional version, with the opposite tax treatment: Contributions are made after-tax, but money grows tax-free and distributions in retirement are not taxed. There are also retirement accounts specifically designed for self-employed people.
If you’re investing for another goal:
- Taxable account. Sometimes called nonretirement accounts, these are flexible investment accounts not earmarked for any specific purpose. Unlike retirement accounts, there are no rules on contribution amounts, and you can take money out at any time. These accounts don’t have specific tax advantages. If you’re saving for retirement and you’ve maxed out the above options, you can continue saving in a taxable account.
- College savings accounts. Like retirement accounts, these offer tax perks for saving for college. A 529 account and a Coverdell education savings account are commonly used for college savings.
With the exception of a 401(k) — which is offered through your employer — you can open these accounts at any online broker.
Don’t worry if you’re just getting started. Often you can open an account with no initial deposit. Of course, you’re not investing until you actually add money to the account, something you’ll want to do regularly for the best results. You can set up automatic transfers from your checking account to your investment account, or even directly from your paycheck if your employer allows that.
Research what to invest in
Let’s be clear: An investment account is not an investment. Once you’ve chosen and opened an account, you need to actually select investments within that account. Common investments include:
- Stocks: Individual shares of companies you believe will increase in value.
- Bonds: Bonds allow a company or government to borrow your money to fund a project or refinance other debt. Bonds are considered fixed-income investments and typically make regular interest payments to investors. The principal is then returned on a set maturity date.
- Funds: Funds, like mutual funds, index funds or exchange-traded funds, can be used to purchase many stocks, bonds or other investments at once. They pool investor money and use it to buy a basket of investments that align with the fund’s stated goal. Funds may be actively managed, with a professional manager selecting the investments used, or they may track an index. A Standard & Poor’s 500 index fund, for example, will hold 500 of the largest companies in the United States.
- Real estate: Real estate is a way to diversify your investment portfolio outside of the traditional mix of stocks and bonds. It doesn’t necessarily mean buying a home or becoming a landlord — you can invest in REITs, which are like mutual funds for real estate, or through online real estate investing platforms like Fundrise, which pool investor money.
The investments you select should depend on your risk tolerance and goals. If you have a high risk tolerance and can stomach volatility, you’ll want a portfolio that contains mostly stocks. If you have a low risk tolerance, you’ll want a portfolio that has more bonds, since these tend to be more stable and less volatile.Your goals are important in shaping your portfolio, too. For long-term goals, your portfolio can be more aggressive and take more risks — potentially leading to higher returns — so you’ll probably want to own more stocks than bonds.
Whichever route you choose, the best way to reach your long-term financial goals and minimize risk is to spread your money across a range of asset types. That’s called asset allocation. Then within each asset class, you’ll also want multiple investments — that’s called diversification.
- Asset allocation is important because different asset classes — stocks, bonds, ETFs, mutual funds, real estate — respond to the market differently. When one is up, another can be down. So deciding on the right mix will help your portfolio weather changing markets on the journey toward achieving your goals.
- Diversification means owning a range of assets across a variety of industries, company sizes and geographic areas. It’s like a subset of asset allocation.
Building a diversified portfolio of individual stocks and bonds takes time and expertise, so most investors benefit from fund investing. Index funds and ETFs are typically low-cost and easy to manage, as it may take only four or five funds to build adequate diversification.
Decide where to open your account
Now that you know how to invest your money, you need to choose an account provider. You can open a retirement account or taxable investment account at any online broker or robo-advisor.
- An online broker will allow you to self-manage your account, buying and selling a variety of investments, including stocks, bonds, funds and more complex instruments. An account at an online broker is a good choice for investors who want a large selection of investment options or who prefer to be hands-on with account management.
- A robo-advisor in an investment management company that uses computers to do much of the work for you, building and managing a portfolio based on your risk tolerance and goal. You’ll pay an annual management fee for the service, generally around 0.25% to 0.50%. Robo-advisors often use funds, so they’re generally not a good choice if you’re interested in individual stocks or bonds. But they can be ideal for investors who prefer to be hands off.
See our picks for investment account providers
We’ve spent hundreds of hours researching and reviewing the top online brokers and robo-advisors before selecting the best for our readers. To help you find the one that’s best for you, we’ve highlighted their pros, cons and current promotional offers. See our picks for:
Now you know the investing basics, and you have some money you want to invest. Feel like you need more information? The below posts dive deeper into some of what we discussed above.