Have you begun investing for your future? If you haven’t, it’s time to start. Whether you want to save to buy a home, pay for your child’s education or retire early, investing is the best way to grow your money and achieve your most important financial goals.
At Addition Financial, we work with our members every day to help them make the most of their money. Since investing is a common topic of conversation, we’ve put together this Investing 101 guide with information about the seven best types of investments for beginners. Here’s what you need to know.
What are the best types of investments for beginners?
Let’s start with our list of the best investment ideas for beginner investors. We’ve included both investment plans and individual investments.
#1: Employer-sponsored retirement plans
The very first thing we recommend is taking advantage of any retirement savings plan offered by your employer. Many employers offer either a 401(k) plan, a 401(c)3 plan, depending on their business structure. Both plans offer the option to contribute earnings on a pre-tax basis, meaning that you’ll reduce your taxable income. Some employers may offer a Roth plan, which means you’ll make contributions after taxes but be able to make tax-free withdrawals when the time comes. Within your plan, you’ll be able to pick and choose specific investments.
If you can afford to do so, we recommend maxing out your contributions to build wealth quickly. At the very least make sure to take advantage of employer matching contributions if you can. Some employers will match contributions up to six percent of the employee’s salary. Best of all, employer contributions do not count toward your maximum annual contribution.
#2: Individual retirement plans
If you are self-employed and don’t have an employer-sponsored retirement investment fund, then you may want to consider opening an Individual Retirement Account (IRA) or an individual 401(k). IRAs come in two types. A traditional IRA allows you to make pre-tax contributions while a Roth IRA involves post-tax contributions and tax-free withdrawals.
You should keep in mind that the Internal Revenue Service places caps on IRA contributions based on your eligibility for an employer-sponsored plan and your income. You can get the full details on the IRS website, here.
#3: Index funds
Index funds have a lot in common with ETFs in that they are linked to a market index that represents a portion of the stock market. Investing in an index fund means taking a passive approach to investing in that you’re not selecting individual investments but rather, buying an array of stocks whose performance should mimic the index.
Because you don’t need to use a financial advisor or broker to invest in an index fund, the fees are low, and you may not need to pay a commission at all. Keep in mind, however, that some brokerage firms have a minimum investment requirement for investing in index funds.
#4: Exchange-traded funds
Exchange-traded funds or ETFs are a good investment choice for beginners because they offer a way to spread your investment risk across multiple stocks. Like index funds, the performance of an ETF is meant to mimic the performance of a stock index such as the S & P 500.
ETFs are traded like stocks and prices may fluctuate throughout the day. It used to be common for brokers to charge commission for buying and selling ETF shares, but many do so without charging a commission now. Choose a commission-free option to save money and maximize your investment.
#5: Mutual funds
As their name implies, mutual funds are another investment option to spread your investment across multiple stocks. You buy one or more shares in the fund and in return, you get a share of all the fund’s investments.
If you’re investing in a mutual fund for retirement, you may want to consider a target-date mutual fund. These funds allow investors to choose a year for retirement and then invest your money with your retirement year in mind. A mutual fund has a manager whose job it is to choose specific investments.
Most mutual funds contain a mix of stocks and bonds. As your retirement date nears, a good manager is likely to move more of your investments into bonds, which are less risky than stocks and can help keep your money safe as you prepare for retirement.
#6: Real estate investment trusts
Real estate investment trusts, or REITs, offer beginning investors an easy way to diversify their portfolios by adding real estate. As investments, REITs tend to outperform the market. The FTSE NAREIT Equity REIT Index is used to track the performance of the United States real estate market, and over the past 25 years, it has earned 9.05% in returns while the S&P 500 has earned 7.97%.
By law, REITs are required to pay out 90% of their taxable income to shareholders as dividends, which means you can use them to generate income. Income earned from an REIT may be reinvested or used when dividends are paid for other expenses.
#7: Certificates of deposit
Certificates of deposits or CDs are low-risk investments that are useful for balancing your portfolio. The downside of investing in CDs is that your money will be tied up for the duration of the certificate’s term, which may range from six months to five years.
You may want to consider high-yield certificates of deposit, which can yield nearly five percent in interest for a five-year term, which is more than five times the national average of 0.98% for traditional CDs. CDs are also good investments for people who are nearing retirement age because of the low risk involved.
What percentage of your portfolio should be safe investments?
Stock allocation is an essential element of building an investment portfolio. You want to keep some percentage of your investments in safer options that are unlikely to lose all their value, with that percentage increasing as you get closer to retirement age.
The old rule was to subtract your age from 100 to determine how much of your portfolio to keep in stocks, which carry more risk than other investments. So, a 30-year-old investor could have 70% of their investment in stocks with 30% being in bonds or other low-risk investments. However, with higher life expectancies, some experts suggest subtracting your age from 110 or even 120.
The key is to remember that as you approach retirement age, you want most of your money to be in safe, easily liquidated investments. That way, you can use your retirement funds to pay for your regular expenses, augmenting your Social Security income to have a comfortable life.
What are the worst investments for beginners?
We would be remiss if we didn’t talk about investments to avoid. While it’s certainly fine (and even recommended) to take some risks with your money, it’s not a good idea to put your income toward investments that have a high failure rate.
Some of the most dangerous investments are speculative investments. These may include the following:
- Penny stocks
- Day trading
- Speculative real estate (undeveloped land)
- Commodity futures
- Foreign currencies (Forex)
- Hedge funds
- Private equity funds
We should also mention binary options, where you can either win big or lose everything. It’s fine to dabble in risky investments but we recommend keeping them to five percent or less of your total portfolio.
Cryptocurrency carries a lot of risk as the events of 2022 and 2023 have proven. While there’s the potential for enormous growth, the decentralized nature of crypto increases the risks of buying it. When prices drop, they can drop dramatically. It remains to be seen how cryptocurrency will perform in the long run, so here again, we recommend investing a small amount to minimize your risk.
Tips for beginning investors
Let’s close with a few tips for beginning investors:
- Make sure to have an emergency fund with at least six months of expenses in it to protect you as you start investing.
- Diversify your portfolio by including different types of investments, including stocks, bonds, ETFs, CDs and so on.
- Take advantage of employer matching funds if your job provides you with a retirement account. Remember, this is basically free money!
- If you want to buy individual stocks, make sure to research their past performance and diversify by choosing micro, small, mid and large-cap stocks.
- Balance your risk with a combination of growth investments and value stocks.
- Review your asset allocation regularly. As a rule, you shouldn’t have more than 10% of your total portfolio in any single investment.
We understand that choosing investments may be stressful and feel overwhelming. If that’s the case, you may want to work with a financial professional to help you create a balanced portfolio that will work for your financial goals and needs. You may also want to consider using an investment app or robo advisor.
Build your portfolio with help from Addition Financial
Investing as a beginner means understanding some basics of investing and choosing investments that will allow you to earn a good return without being too risky. The seven investment types we’ve listed here can form the basis of your portfolio.
Do you need a hand creating a portfolio as you start investing? Addition Financial is here to help! Click here to read about our Financial Services and connect with one of our Financial Professionals today.
Posted on Jun 1, 2023
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