How to Invest: 2022 Beginner's Guide
Investing is different than trading. Investing is about the long-term view — that is, years or decades. Trading, on the other hand, is about the short term; think months, weeks, days, hours, or even minutes.
Personally, I've placed thousands of trades over my career. My day job is leading the charge at Reink Media Group, which owns and operates sites including investor.com, StockBrokers.com, and ForexBrokers.com. But I still invest (and trade) whenever time permits.
One last note before we get started. I've written this guide as a series of questions. That way, you can quickly scroll down and find what the answer that you seek.
OK. Let's dive in!
What is the stock market?
I like to think of the stock market as a marketplace. The products being sold are shares (ownership) of companies.
Some people are buyers, betting that the shares they buy today will be worth more in the future. Others are sellers, selling shares they own. Sellers believe the value of the company is going to go down in the future.
To buy and sell shares of stock, you use an online broker, which connects you to stock exchanges and other market centers. The two most notable stock exchanges here in the United States are the New York Stock Exchange (NYSE) and the NASDAQ. Combined, these two exchanges represent nearly $50 trillion in wealth.
For example, Apple, which trades under symbol AAPL, is listed on the NASDAQ stock exchange. Meanwhile Disney (DIS) is listed on the NYSE.
Ultimately, the goal as an investor is to buy shares of stock, then sell them later for a profit as the value of the company (stock price) appreciates (goes up).
What is the S&P 500?
The S&P 500 is the most widely followed index in the world. From Wikipedia,
The Standard and Poor's 500, or simply the S&P 500, is a stock market index tracking the performance of 500 large companies listed on stock exchanges in the United States. It is one of the most commonly followed equity indices. As of December 31, 2020, more than $5.4 trillion was invested in assets tied to the performance of the index.
If you want to invest in the United States as a whole, the easiest way to do it is to buy a fund that replicates the S&P 500.
In fact, both Warren Buffett and Jack Bogle (founder of indexing and Vanguard) believe the S&P 500 is all you need to have a worldwide exposure. This is because the S&P 500 generates just over 50% of its revenues domestically. The rest comes from overseas.
What is the Dow Jones Industrials Average (Dow)?
The Dow Jones Industrials Average, or Dow for short, is an index that tracks 30 large publicly traded companies. The index is named after Charles Dow, who established it in 1896. Like the S&P 500, the Dow is frequently referenced as a representation of the overall US stock market.
Fun fact: The Dow is frequently referenced on TV and media outlets simply because its price is higher than the S&P 500. All in all, it makes for better headlines, e.,g. "The Dow dropped 1,000 points!"
The reality, though, is that institutional investors and passive investors do not invest in the Dow. Overwhelmingly, they choose the S&P 500 because it is far more diversified.
What is passive investing?
As a new investor, it's important to understand the term "passive" in relation to investing. I'm sure you've seen the phrase "passive investing" mentioned before. If not, no sweat, I got you covered.
The primary objective of passive investing is to buy and hold shares over the long haul. Once shares are purchased, no matter what happens to the price, you do not sell.
In fact, passive investors consistently buy more shares, ideally each month. By holding over the long haul, the power of compounding takes over. There are also tax benefits to holding long term, but that's a topic for a different day.
While you can passively invest in any stock, the most common strategy is to invest in the overall stock market, e.g., the S&P 500. This way, you are diversified, which means owning shares of stocks in multiple industries or segments of the economy.
Historically speaking, over the past 90+ years, the S&P 500 has appreciated 9.6%, on average, each year. Certainly, some years are better than others (the S&P 500 fell 37% in 2008!) but over the long haul, the U.S. economy grows in size, and with that, stock prices appreciate in value.
What are the benefits of passive investing?
In summary, there are five key benefits of passively investing in the overall stock market:
- You can sleep well knowing you are diversified and own the entire stock market instead of just one single company.
- By buying and holding for decades, while reinvesting dividends, the power of compounded returns is realized.
- With passive investing in low cost index funds (ETFs or mutual funds), you are keeping fees as low as possible, which maximizes your returns.
- You are maximizing tax efficiency by buying and holding for decades instead of days (traditional, taxable account, not a retirement account).
- You remove all the emotions of second-guessing yourself by keeping your investing approach simple.
How do you make $1 million investing in the stock market?
To illustrate just how powerful passive investing is, I built a basic spreadsheet that shows how putting $5,500 into an Individual Retirement Account (IRA) and investing the entire amount each year in Vanguard's S&P 500 ETF (symbol "VOO").
By investing $5,500 each year in a tax-deferred IRA and investing in the S&P 500, after 31 years you will have ~$1,000,000. *UPDATE 2020: Now you can contribute $6,000 each year into an IRA.
As noted earlier, historically speaking, the S&P 500 has returned 9.6%, on average, per year (source). Also, the Vanguard S&P 500 ETF (VOO) has an expense ratio of just .04% per year, which means the cost to hold the ETF fund would be only $40 for every $10,000 invested.
Remember, your $5,500 investment each year is pre-tax, which should make it even easier to save. In fact, I follow this exact strategy for my wife's Roth IRA (post-tax individual retirement account).
One final note here is that once you are age 50 or older, you can contribute an extra $1,000 per year (known as "catch-up" contributions), so $7,000 instead of $6,000.
What is the best online broker for passive investing?
Which online stock broker should you use to build your Warren Buffett portfolio? The answer is simple: it doesn't matter.
Today all large online brokers offer $0 stock and ETF trades, so as long as you buy the ETF version versus the mutual fund version, the cost is $0 per trade.
Whichever broker you choose, reinvesting the dividends through a DRIP (dividend reinvestment plan) is also a free option.
One final note. If you do want to use mutual funds instead of ETFs, then I recommend going straight to the fund source and using Vanguard. Buying and selling Vanguard mutual funds is free with Vanguard. Just know that the online brokerage is NOT user-friendly. (See a full review of Vanguard on sister site StockBrokers.com.)
Bottom line, it doesn't matter which brokerage you use to passively invest in the stock market. Just buy and hold until retirement.Sponsored
What is a robo-advisor?
Perhaps you want to follow passive investing principals of taking a long-term approach, keeping it simple, reducing fees, and investing in the stock market, but don't want to actually place the trades yourself.
If this is you, then you will want to consider using a robo-advisor instead of trading on your own. In short, a robo-advisor is essentially an automated passive investing service. The costs are higher than doing it yourself, but it is less work overall.
Lastly, if you want to work with a financial advisor, use the city search tool on investor.com to find a financial advisor in your city.
What are the benefits of investing when you are young?
One of the most important things that you can do as an investor is to get an early start on investing. Here are five crucial benefits:
- Time is on your side – The old saying “the early bird gets the worm” certainly applies to investing when you are young.
- Compounded returns – Compounded returns are extremely powerful over the long run. Even investing $10, $50, or $100 a month when you are in your 20s can be massive over decades of compounding.
- Improved spending habits – Investing early helps develop good money spending habits. Learning to think like an investor versus like a consumer is a powerful mentality shift.
- More flexibility later on – Your personal finances are bound to get tight at times throughout your life. By starting to invest at a young age, you will provide yourself options on how to navigate life's challenges.
- Quality of life – It goes without saying, the more money you have saved for retirement, the lower your stress and the better the "sleep factor."
All in all, don't wait to get started investing. Your future self will thank you!
How do I invest like Warren Buffett?
Warren Buffett is recognized as the greatest investor of all time because of his discipline and conservative approach to investing.
Warren Buffett's recommended passively invested stock portfolio is actually very simple. In fact, there are only two holdings: the S&P 500 and a short-term U.S. government bonds fund.
What are the symbols for these two Vanguard funds? You can buy an ETF version or a mutual fund version. I personally use the ETF version, but either one works.
- S&P 500 index fund - ETF symbol VOO (no minimum), Mutual Fund symbols VFIAX ($3,000 minimum)
- Short-term treasury bonds fund - ETF symbol VGSH, VFIRX ($50,000 minimum), VFISX ($3,000 minimum).
Buffett, 91 years young, revealed his simple portfolio mentality in his 2013 annual letter to company shareholders (emphasis mine),
My advice to the trustee couldn't be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard's.) I believe the trust's long-term results from this policy will be superior to those attained by most investors — whether pension funds, institutions or individuals — who employ high-fee managers.
Buffett provided similar advice after Lebron James asked him what he should do with his own investments:
"Through the rest of his career and beyond, in terms of earning power, [he should] just make monthly investments in the low-cost index fund."
The reason Buffett recommends Vanguard funds over other providers is that the funds have the lowest costs respectively for the instruments they are designed to follow.
Here's one more Buffett quote on low costs and keeping investing simple,
Both individuals and institutions will constantly be urged to be active by those who profit from giving advice or effecting transactions. The resulting frictional costs can be huge and, for investors in aggregate, devoid of benefit. So ignore the chatter, keep your costs minimal, and invest in stocks as you would in a farm.
What is age-based asset allocation?
To build a portfolio that is properly diversified, you first want to look at your age and target retirement date. For this section I am referencing the largest asset manager in the world, Vanguard, which has a staggering $7 trillion under management.
When you're young, it is recommended to take more risk and invest more heavily in stocks vs. bonds to maximize returns. As you age, you want to increase your bond holdings while reducing your stock holdings to lower risk. After all, you are getting ready to retire.
Here's a good cheat sheet from Vanguard on the different allocations and historical returns.
To determine allocation based on age alone, Vanguard recommends starting with a 90/10 (stocks/bonds) mix and maintaining it until you are 20 - 25 years from your desired retirement age. From there, you slowly adjust your allocation every few years until you reach retirement in which you ideally would be allocated 40/60 (stocks/bonds).
For example, if your target retirement age is 65 and you are currently 30, then you would want a 90/10 mix. Once you turn 40, you could reduce to say 80/20, or wait a few years to start transitioning. At age 60, you'd want to be around 60/40 or 50/50.
While the above certainly keeps things simple as a framework, there are a variety of factors that come into play. Your current income, debt situation, current savings rate, target retirement age, and personal goals are all important.
Bottom line, your ideal asset allocation mix may not fit into a broad, simplistic mold, and that's ok.
I am not a professional advisor, nor do I have any interest in becoming one. That said, hopefully the above can at least help to provide a simple guide to use as a starting point.
What are target date funds?
If you want to passively invest in a traditionally diversified portfolio by age, the easiest solution is to buy a target date fund (TDF). Your money is invested over a set period of time, with the "target" being the year you expect to retire and start drawing on your capital.
With a target date fund (Vanguard calls them target retirement funds), you buy one low-cost mutual fund and everything portfolio-related is done for you automatically. Generally, the mix of investments becomes more conservative (less risky) the closer you get to retirement.
Vanguard has a fantastic free tool to determine what fund you need to buy based on your current age and desired retirement age.
Since I'm in my 30s, Vanguard's tool recommended I buy the Vanguard Target Retirement 2050 Fund (VFIFX) which charges an annual expense ratio of only 0.10%.
In fact, in my company's 401(k), this is the only fund that I hold. I automatically invest 5% of my paycheck each month (which our company matches 100%) and it automatically buys this fund.
All in all, target date funds are another great way to passively invest for retirement.
Investing is a lot easier than many people think because the best representation of the United States is simply buying and holding the S&P 500.
The goal of passive investing is to keep costs as low as possible, buying more as you go, then letting the power of compounded returns work for you as you hold for decades.
All in all, you can choose any online broker to build a Warren Buffett portfolio and follow the advice of greatest investor on earth. Awesome.
About the Author
Blain Reinkensmeyer As Head of Research, Blain Reinkensmeyer has 18 years of trading experience with over 1,000 trades placed during that time. Referenced as a leading expert on the US online brokerage industry, Blain has been quoted in The New York Times, Forbes, and the Chicago Tribune, among others.