If you plan to make 2017 the year you start investing, congratulations! Smart investing is the most certain path to wealth, and your investment dollars will never have more long-term compounding power than they do right now. Before you dive in, here are some decisions you'll need to make, and some things you need to know.
You don't need a ton of money to get started
It's a common misconception that you need thousands of dollars to be able to start investing effectively. Nothing could be further from the truth. You can open accounts at many brokers, especially IRAs, with as little as one dollar.
Thanks to the emergence of commission-free ETFs and mutual funds with no-minimum automatic investment programs, you don't need much to get started, as long as you invest as soon as you can and continue to do so. Consider this: if you invest just $20 per week for 40 years, based on the stock market's average rate of return, you could end up with a $400,000 nest egg. Imagine if you could invest $50 or $100 per week.
IRA vs. regular (taxable) brokerage account
One decision you'll need to make is what type of account to open. You have two main choices. You can open a standard brokerage account, or you can open an individual retirement arrangement, or IRA.
Each option has its own pros and cons. A standard brokerage account is taxable, meaning that if your investments produce dividends or you sell investments at a profit, that income can be taxed. However, you are free to withdraw your money whenever you'd like, and you can also contribute as much as you like. You'll also be able to use margin privileges and invest in things like options (but I wouldn't recommend it for beginners) that are generally unavailable in IRAs.
IRAs have several advantages, particularly when it comes to taxes. There are two main types of IRAs -- traditional and Roth. Traditional IRA contributions may be deductible from your taxable income, but your withdrawals will be subject to tax. Roth IRAs don't qualify for a deduction, but your qualified withdrawals will be tax-free. Both accounts are tax-deferred, meaning that you won't pay dividend or capital gains taxes each year.
On the downside, IRA contributions are limited to $5,500 per year, with an additional $1,000 allowed if you're 50 or older. While Roth contributions (but not investment profits) can be withdrawn whenever you want, and there are a few other exceptions, generally speaking, you shouldn't invest in an IRA if you anticipate needing your money before you turn 59-1/2 years old.
You can learn more about IRAs and shop around for a brokerage in The Motley Fool's IRA Center.
Stocks, funds, or bonds?
Once you establish a brokerage account, the next step is to decide how to invest your money. For beginners, I highly recommend that most of your portfolio should be made up of index funds (both stock and bond), and you should add individual stocks gradually over time as you learn more about investing.
Asset allocation is an extremely important topic for new investors to be familiar with, and you can read a quick (but thorough) guide here. Essentially, when you're younger and have more risk tolerance, you want to keep most of your money in stocks or stock-based funds, and as you get older, you should gradually shift some of your money into more stable, income-generating assets like bonds.
Proper asset allocation also involves diversifying your portfolio, which basically means that you should invest in a bunch of different stocks and bonds. For example, even if you think a stock is going to double this year, it's a terrible idea to put 100% of your money into it. If you're investing in funds, spread your money out across large- and small-cap stocks, domestic and foreign stocks, as well as growth and value stocks. As an example, if the U.S. stock market crashes, and you have some foreign stocks in your portfolio, the impact on your account shouldn't be as bad as if you only buy domestic stocks.
Keep the long term in mind
What's the stock market going to do this week, this month, or this year? Nobody knows. There are simply too many variables that make up the stock market's performance for anyone to consistently predict with any level of accuracy.
It's important for beginners to be aware that market drops are a normal part of a healthy market. Recessions are natural, and will happen again, it's just a matter of when. The Dow Jones Industrial Average (currently just under 20,000) could finish 2017 at 23,000, or it could fall back to 17,000 or lower. Both scenarios are completely possible.
The point is that it's a losing battle trying to time the market, or any individual stock, but the market does have an upward bias over the long run. The smartest investors know that the most certain path to wealth is to invest in solid companies, and to hold onto them for years.
Take the next steps
The final, and perhaps most important, piece of advice I can give if you plan to start investing in 2017 is to learn as much as you can. I realize that not everyone has the time or desire to sit for hours at a time and read investment books and articles like this one, but if you can devote 10 or 15 minutes per day to boosting your investment knowledge, you may be surprised at how quickly you go from beginner to seasoned investor.
With that in mind, here are a few other articles that I feel are great starting points for new investors.
- 3 Investing Rules Beginners Need to Know
- 5 Investing Metrics You Have to Know
- 5 IRA Investing Tips That Could Earn You Thousands
- 5 Smart Stocks for The Beginning Investor
- 3 Valuable Lessons From Warren Buffett's Portfolio
It's also a good idea to check out The Motley Fool's Knowledge Center.
And again, congratulations on your decision to start investing! Learn as much as you can, keep your eye on the long term, and build a diverse portfolio of solid investments, and you'll find this to be one of the most rewarding decisions you've ever made.
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