Rent, utility bills, student loan payments and the occasional trip might seem like all you can afford your first few years out of college. Once you’ve mastered budgeting for those monthly expenses (and set aside money in an emergency fund), it’s time to do something with extra cash. The tricky part is figuring out what to invest in — and how much.
As a newbie to the world of investing, you’ll have a lot of questions, not the least of which is: What’s the best investment strategy? Our guide will help you get started. Here’s what you’ll find below:
Why start investing now?
Investing when you’re young is one of the best ways to see solid returns on your money. You probably can’t count on Social Security to provide enough income for a comfortable retirement, so having your own long-term savings will be crucial. Even for shorter-term goals (like buying a home), investments that earn higher returns than a traditional savings account could be useful.
There will be ups and downs in the market, but investing young means you have decades to ride them out.
Investing in the stock market is a do-it-yourself way to plan for a comfortable old age. There will be ups and downs in the market, of course, but investing young means you have decades to ride them out. It’s also important because benefits from Social Security account for only around 38% of U.S. seniors’ income, according to the Social Security Administration. That figure may well decline in the coming decades because Social Security has been paying out more to retirees than it has been taking in from taxes paid by workers.
All of this means you’ll do yourself a big favor by learning how to invest in stocks to supplement Social Security. Investing in safe assets like bonds can help you bring in extra money in the short term. That might make a difference if you’re saving up to buy a house or another big purchase in a few years.
What can I invest in?
Whether you save for retirement with a 401(k) or similar employer-sponsored plan, in a traditional or Roth IRA, or as an individual investor with a brokerage account, you choose which investments to put your money in. It’s important to understand each instrument and how much risk it carries. Also, remember that you don’t need to have saved thousands to begin investing — even $500 can get you started.
There are many investment instruments for you to choose from. The most popular include:
- A stock is a share of ownership in a company. Stock prices move based on investors’ evaluation of the company’s performance, including leadership changes, new product releases or how it’s doing financially.
- Companies issue stock to the public to raise money to grow or pay off debt. Stocks are also known as equities.
- A bond is essentially a loan to a company or government entity, which agrees to pay you back in a certain number of years. In the meantime, you get interest.
- Bonds generally are less risky than stocks because you know exactly when you’ll be paid back and how much you’ll earn.
- A mutual fund is a mix of investments managed by an individual company. When you invest in a mutual fund, you don’t choose specific stocks or other securities; the fund does it for you. The inherent diversification of mutual funds makes them generally less risky than individual stocks, but there are mutual funds available at all risk levels
- Popular mutual funds include index funds, which follow the performance of a particular stock market index, and money market funds, which invest in short-term, low-risk assets.
Exchange-Traded Funds (ETFs)
- An ETF is a basket of securities — stocks, bonds, commodities or some combination of these — that you buy and sell through a broker. They combine the diversification benefits of mutual funds with the trading ease of stocks and are available at various risk levels.
- Index funds are also common among ETFs — and they generally carry lower associated management fees than mutual funds.
How do I pick an investing strategy?
Your strategy depends on your saving goals (and how much money you’ll allocate to each) and how many years you plan to let your money grow, says Mark Waldman, an investment advisor and former personal finance professor at American University in Washington, D.C. “The longer the time frame associated with your goal, the higher percentage you should have in stocks.”
If your savings goal is more than 20 years away (like retirement), almost all of your money can be in stocks, Waldman says. The stock market can be unpredictable, with huge ups and downs depending on how well the economy is doing, but you’re likely to make more money there than with less risky assets (like bonds, or keeping cash in a savings account). Over nearly the last century, the stock market’s average return is about 10% annually.
The data are very clear. They show that over any period of time longer than, say, 10 years, S&P 500 index funds outperform all other kinds of mutual funds.
Picking specific stocks can be complicated, so consider investing in an index fund, which mirrors the performance of an entire stock market index. An index fund is a good option for new investors because it provides diversification, or a way to reduce investing risk by owning a range of assets across a variety of industries, company sizes and geographic areas. Research has shown that index funds, which are “passively managed” funds, perform better than actively managed funds, which have a fund manager choosing specific stocks and bonds in an attempt to outperform the market.
“The data are very clear,” Waldman says. “They show that over any period of time longer than, say, 10 years, S&P 500 index funds outperform all other kinds of mutual funds.”
If you’re saving for a short-term goal, like a down payment for a house in the next five years, the risk associated with stocks makes it more likely you’ll lose money in that time frame. That means the percentage of your investments in stocks will decrease. If the time separating you from that goal is less than five years, invest in a money market fund or a bond fund. Both will bring you lower returns than stocks but are safer places to put money in the short term.
How much should I invest?
Knowing where you can put your money is a huge step, but you also need to figure out exactly how much to put there. If you don’t have a detailed budget, at least make a list of all your expenses: what you spend monthly on bills, loan payments, food and entertainment. Only invest once you know you can pay your monthly bills and you’ve saved at least three months’ worth of living expenses in an emergency fund.
A goal is to invest 10% to 15% of your earnings a year, but if that’s not realistic, at least start with the minimum initial investment. You can invest in the market with just a few hundred dollars at first.
NerdWallet’s picks of the best brokerages for beginners have associated account minimums ranging from $0 to $2,500. Many of these companies offer Roth IRAs with no minimum balance. Through your Roth IRA, you can invest a few hundred dollars in mutual funds or commission-free ETFs, or exchange-traded funds (ETFs), which reflect stock market indexes but often cost less than an index fund, without needing to save up thousands of dollars first.
You can also open a Roth IRA through a robo-advisor, an online investment account that lets you invest in low-cost ETFs with account minimums as low as $0.
These options can — and should — supplement your employer-sponsored retirement account. If your employer offers one, you’ll be able to contribute a percentage of your salary each pay period to your 401(k). In most cases, you choose the mix of assets you invest your 401(k) money in, depending on your tolerance for risk. Some employers will match your contributions with company funds — extra money you’ll usually have access to once you’ve stayed at the company for a certain amount of time.
Investing may seem scary, but it doesn’t have to be. Research your options carefully and consider starting off with a small initial investment in a passively managed fund. Especially if you’re working toward a long-term goal like retirement, it’s most important to stay confident, even during unprofitable years in the stock market, Waldman says.
“Leave it alone, don’t ever get out of the market no matter what, and just keep buying,” he says. “That’s the hard part.”