How to begin investing: The steps to take and terms to know

You’ve got big financial goals: a new home, sending your kids to college, and, eventually, retirement. There are a lot of ways to reach those goals, and investing your money is one method to help you get there.

But before you start buying up stocks like a stockbroker you saw in the movies, take a deep breath and make sure you’re ready. (And before you make any investing decisions, consult a financial advisor.) Investing is risky, so first you need a personal financial plan in place, and you should also have a firm understanding of how it all works. So, how do you begin investing?

Even if you’re wondering how to start investing with little money, it takes financial preparation, education, and clear goals to get started.

What are the financial benefits of investing?

Investing your money wisely can help you preserve and grow your money over time. “The key benefit of investing is that your money will grow without you having to do any work,” says Jim Wang, founder of a personal finance blog. “For decades, wealth has been created through the stock market because it can continue to grow without your direct intervention.”

Historically, investing has been a great way to keep ahead of inflation and its effect on your savings. Financial planning software will often factor in about 3%-4% annual inflation to align with historical averages, while the S&P 500’s annual return has been about 10% over time, according to Bankrate. Of course, past performance does not guarantee future gains.

It’s a good idea to know how to begin investing, because investing can also come with tax benefits—especially if you’re investing for retirement. If your retirement savings are invested within an IRA, there are tax advantages whether it’s a Traditional IRA or Roth IRA. A Traditional IRA allows you to deduct your IRA contributions from your current taxable income, and you pay taxes on any gains in retirement. A Roth IRA works the other way: You pay taxes on your contributions now, but you won’t be taxed on your gains in retirement.

When should I start investing?

Typically, the earlier you start investing, the more potential there is to grow your money, Wang says. For example, if you put away $100 a month and never invested it or earned interest on it, you’d have $12,000 after 10 years. But if you invested that same $100 a month and earned an 8% annual return, you’d end up with $18,000—or 50% more. Over decades, the difference can add up to tens or even hundreds of thousands of dollars. Be aware, however, that markets have their ups and downs, and there’s no guarantee of that kind of growth. (Always consult a financial professional before making investment decisions.)

While many people want to know how to start investing with little money, Wang advises not to rush into it. Before you start investing, he says to make sure you’ve already paid off your high-interest debt, are saving for retirement, and have an emergency fund to cover unexpected expenses that you wouldn’t be able to pay for with your regular income. If you’re looking for extra money to put toward your investment account, you might want to find a side hustle or look for easy ways to save money to boost your savings.

Looking for a place to put your emergency fund before you start investing? Consider a high-yield savings account. It’s safe and easy to access, and can earn a competitive rate to help your money grow.

What concepts and terms are important to know before investing?

Before you start investing, Wang says it’s important to understand some basic concepts and terms that can help you develop your long-term investment strategy and reach your financial goals. Because you should always consult a financial advisor before you begin investing, understanding these terms can help those conversations be more productive.

Diversified portfolio

As you learn how to begin investing, you’ll notice that a guiding principle is to minimize risk. To do that, Wang says it’s important to maintain a diversified portfolio of investments. “This is a portfolio of investments that includes a mix of stocks and bonds,” Wang says. “Within those two groups, you can be geographically diversified if you have both U.S. and international assets. You can also diversify across other asset classes, like real estate, so that your portfolio isn’t subject to the risk of any one asset class.” Wang recommends spreading your investments across different industry sectors, too—such as technology, health care, and finance.

When your portfolio is diversified, it isn’t overly exposed to the risk inherent in any one asset class or industry, Wang says. That means it’s less likely to experience big swings in value, which can help keep you on track toward your goals.

Investment automation

Eliciting feelings from fear to euphoria, investing money can be an emotional rollercoaster. These emotions can derail your investment strategy, Wang says, because they can lead to irrational buying and selling. Similar to savings automation, investment automation can remove emotions from the equation and keep your investing on track to reach your financial goals.

With your financial plan in mind, you can automate your investment contributions by establishing regular transfers into your investment account from your paycheck or a bank account. “Investment automation can also include using robo-advisors, which can help you invest in a balanced portfolio of funds that matches up with your goals, risk profile, and needs,” Wang says. The regularity of investment automation can also help you take advantage of “dollar cost averaging,” he says. “When you make investments at regular intervals, you smooth out the cost basis of your investments,” Wang says. “If you’re buying at both high and low prices, the cost of your investments will average out over time.”

Index funds

“Index funds are mutual funds or ETFs [exchange traded funds] that track a particular index, such as the S&P 500,” Wang says. You can buy shares of index fund ETFs just like a stock, but they move up and down based on the performance of many different underlying assets. For that reason, index funds offer investors a simple way to stay diversified.

For example, in addition to an index fund that tracks the performance of the S&P 500 (which is made up of 500 of the largest companies in the United States), Wang says you could also buy an ETF that tracks the price of gold or one that tracks the performance of European tech companies. He points out that while many actively managed mutual funds and ETFs charge fees for managing the underlying assets, index funds are typically cheaper, because they are passively managed. Just keep in mind that while index funds have certain benefits, they still carry risks. Always consult a financial advisor before making investment decisions.

How should I set my financial goals for my investments?

Wang stresses the importance of having a concrete plan to help keep you on track and increase your chances of reaching your financial goals. So before you can answer the question “When should I start investing?” you need to do these three things first.

Decide what you want to achieve with your investments

Are you looking to grow wealth? Or is your focus on preserving what you already have? These are great questions to ask yourself, Wang says, as you determine what you’re investing for. When starting investing, make sure your goals are specific, achievable, and measurable. That way, you can track your progress and you’ll know when you’ve reached your goal.

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Determine a time horizon for your investments

Investing for retirement is typically a long-term goal, perhaps decades in the future. But investing for college might be a mid-term goal of 10 or 15 years. Growing your money to afford a home renovation might be a short-term goal of one to three years. “A time horizon is extremely important because you need your investments to match your goals and your risk tolerance,” Wang says. “The longer your time horizon, the riskier you can be with your investments because you have time to outlast any market volatility.” (If safety and guaranteed returns are what you’re after, Discover® Certificates of Deposit (CDs) allow you to lock in an interest rate for a term that matches your time horizon.)

Consult a financial advisor before investing

Investing in your future can be overwhelming, but a financial advisor can help, Wang says. Financial advisors can determine which investments are the best fit for your time horizon and goals. They can also help you with tax strategy and other aspects of your financial journey.

How can you prepare to start investing?

In addition to growing your income, paying down debt, saving for retirement, and having an emergency fund, investing can be a fruitful component of your larger financial strategy as you move through life. Are you ready to start investing, or do you have some more work to do on your financial foundation first?

Many people still need to build up an emergency fund in case of any unexpected expenses like medical bills or home repairs. Sound familiar? Before you start investing, begin building an emergency fund today.

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