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Do you feel overwhelmed with investing? And you do not know where to start with investing? Do you want a simple guide on how to get started with investing?
Then, this guide is exactly what you need! This is a step-by-step guide on how to start investing in the stock market.
I have written many articles about investing on this blog. But I have recently been reminded that I did not have an article on how to get started! I should have started with this article.
First, I am going to cover the things you should know before you start investing. And then, I am going to cover how you could get started with investing.
And what better time to start investing than with the start of a new year?
Know why you want to invest
First of all, you need to understand why you want to start investing. Your reasons to invest will matter a lot on how you are going to invest.
There are many reasons to invest in the stock market. But we can group them into two categories:
- Investing in the short-term to buy something. It could be to buy a new house, for instance.
- Investing in the long-term for your future. It could be to pay for your retirement. Or you could invest in the long-term for the education of your child.
Now, it is essential to know that investing is a long-term game. If you want to buy a house in the next year, it is probably not a good idea to invest now. Why is that? As we will see in the next section, the stock market is volatile. It will provide good returns, but only on average. If you invest now and the market goes down 20%, what are you going to do?
So, I would only recommend investing if you are investing for the medium or long-term. You need to answer a simple question: Can you wait until the market recovers if it goes down?
For instance, if the market went down 20% next year, will you be able to wait one year or more until it recovers?
If you cannot answer yes to this question, you are probably better off investing. If you sell because you are afraid of the losses, you will be in trouble. There will be some negative years in your investing journey. And you will need to wait until it recovers. Selling in a downturn is the worst thing you can do!
Know why you should invest
You already know why you want to invest. But do you know why you should invest? Could you not save money and let it rest in a savings account and achieve the same goals?
There is one big problem with cash: inflation! The value of your money will decrease over time. Inflation increases the prices of goods over time. On average, inflation goes up.
Inflation means that the money you acquired through hard work will have less value in the future. With the same amount of money, you will be able to afford fewer goods.
And the problem with bank accounts is that they do not follow inflation. By leaving money in your bank account, it is losing value over time.
On the other hand, investing in the stock market has higher historical returns than inflation. Investing means that you will generate more value from your money. And inflation will not eat up all your gains.
And since the returns will be higher, your money will grow without you having to do anything. You want your hard-earned money to work for you!
Know the stock market
Then, you also need to know the stock market. Do not worry. You do not need to know everything about it! You do not even need to know the details!
But there are several things you need to know before you even consider investing in the stock market.
First of all, there is no such thing as an investment without risk! All investments have some risks. It is up to you to decide on the level of risk you are willing to take.
Even low-risk investments will have negative returns some time! If you pick a low-risk instrument such as government bonds, you will still experience some downturns. There have been some years where bonds had performed very poorly. We are talking minus 20% in a single year!
You only lose money if you sell in a downturn. You should mix up paper losses and realized losses. If you check your account one day and see you are ten percent down, this is only a paper loss. If you sell, it will become a realized loss. It is essential to understand this.
Finally, you should not time the market. Timing the market means that you buy or sell at a particular time in the hope of making a profit. For many people, this means waiting to buy or selling early. But on average, you will lose this bet with the market. People are not able to beat or time the market.
Know the difference between stocks and bonds
In the stock market, there are two main instruments: bonds and stocks. There are others as well. But these two are more than enough to get started.
A bond is a debt that is issued by an entity. This entity could be a government, a municipality, or a corporation. To keep it simple, you should only focus on government bonds. They are the safest and most straightforward. A bond has a time to maturity and interest rate.
When it needs money, the government will issue bonds that people can buy. In return for their money, the buyer of the bond will receive interest payments regularly. Once the bond reached its maturity, the buyer will receive its money back.
The stock of a company is the set of all the shares of this company. You do not buy stocks directly, but you buy shares of stocks. By purchasing a share of a company’s stock, you will own a part of the company.
People investing in stocks are expecting the share price to grow. Generally, as the company grows, so does its share price. Another advantage of some shares is that the company pays a dividend to its shareowners.
Once a company has some money, it has several choices. It can invest it in itself to grow. Or the company can give the money back to the shareowners in the form of a dividend. This dividend will be given in cash to you into your broker account.
In practice, there is one significant difference between these two instruments: bonds have smaller risks and smaller returns, while stocks have higher risks and more profits.
In short, it means that stocks are great for the long term. And bonds are better for the shorter terms. But bonds will reduce the volatility of a portfolio. They are good for your risk tolerance.
Know what are index funds
Now that you know what stocks and bonds are, you may think that the next step is to choose companies to invest in (picking stocks). But this is not the case! Investing in individual stocks is not a good thing for most people.
Historically, picking stocks had lower returns than the average market itself. Picking stocks is called active investing because people actively choose which companies to invest in. On the other hand, with passive investing, you invest in a collection of stocks representing the market. These collections of stocks are called index.
An index fund is a fund that contains all the shares of the index. Instead of buying shares of the stocks, you purchase shares of the index. And by doing so, you do the equivalent of buying shares of every stock in the index. If the market does well, your shares will do well.
There are many advantages of passive investing:
- It outperforms active funds on average.
- It is simpler since you do not have to pick stocks.
- It is cheaper since fees on index funds are generally lower than on active funds.
- It has a greater diversification.
Therefore, I would recommend that if you are getting started, you start with passive investing!
Decide between mutual funds and ETFs
As we have just discussed, index funds are the best instruments to start investing. However, index funds come in two flavors:
- Mutual Funds. They are funds directly managed by a financial institution.
- Exchange-Traded Funds (ETFs). They are funds traded on the stock market.
Both of these alternatives are index funds. They both invest in a large number of shares and replicate the index itself. You will need to decide whether you want to invest in mutual funds or ETFs.
The only notable difference is how you invest in these instruments.
- To invest in a mutual fund, you will not need to access the stock market. You will be able to invest in mutual funds through a financial institution such as Vanguard or BlackRock. Your big national banks (UBS, for instance, in Switzerland) will also offer access to some mutual funds.
- On the contrary, to invest in an ETF, you will need access to the stock market. You will use a broker as the intermediary. And then, you will purchase shares of an ETF as it was a stock.
Mutual funds are simple to invest in. However, there is a big issue with them in many countries. Most of us do not have access to good mutual funds. For instance, one of the best mutual fund providers, Vanguard, does not offer its mutual funds in Europe. We have access to many funds from our banks. But these funds are significantly more expensive and smaller. So, they are inferior alternatives.
It is the reason why most people in Europe are investing (or should be investing) through Exchange Traded Funds (ETFs). If you are in Switzerland, like me, you have no choice but to invest in ETFs unless you want to waste your money on fees!
If you have access to good mutual funds, for instance, in the United States, you can start to invest directly with them.
If you do not have access to good mutual funds, you will invest in ETFs through a broker account (more on that later).
Choose your asset allocation
Whether you decide on mutual funds or ETFs, you will have to choose an asset allocation.
Asset allocation is a fancy term that simply means how much bonds, stocks, and cash you have in your investment portfolio. For most people, cash is not part of their portfolio. So you can focus solely on bonds and stocks. Your cash will stay separated from your investment portfolio.
Now, there are no good or bad asset allocations. You need to know the difference between different asset allocations and choose one that suits you personally!
We have already seen that stocks are more volatile and have higher returns. On the other hand, bonds are more stable but will bring lower returns.
Based on that, you should choose your asset allocation based on these factors:
- Your risk tolerance. How much risk are you capable of handling? If your portfolio is down 30%, what will you do?
- Your investing term. How long will you be investing before you will need this money?
Having a good risk tolerance means the ability to take on more stocks. And a long investing term also means you can have more stocks in your portfolio. But do not take these two factors independently. You need to consider them both.
For instance, if you need the money in 20 years (very long-term) but have a low risk tolerance, you should have a significant amount of stocks regardless.
You should not even consider having less than 40% of stocks. You need stocks to have good returns. Here are the most popular asset allocations:
- 100% of Stocks: Investing for the long-term and excellent risk tolerance.
- 80% of Stocks: Investing for the long-term and good risk tolerance.
- 60% of Stocks: Investing for the medium-term or average risk tolerance.
- 40% of Stocks: Investing for the medium-term or low risk tolerance.
These are only rules of thumbs, of course. Nothing prevents you from a 75/25 portfolio. It would be a perfectly fine portfolio.
And one last thing on asset allocation: It does not need to be set in stone. You should not change it often. But you can change it. First, as you age, your risk tolerance may change. And as you get closer to your term, you may want to increase the bonds to avoid a big surprise.
Choose a portfolio
Now, you know the allocation to stocks and bonds of your portfolio. It remains for you to decide on what indexes you are going to invest in. You do not have to pick stocks. But you still need to pick indexes.
Choosing a portfolio is an important step. You should not rush this decision. You must choose a portfolio that will suit your needs.
To simplify your search, you should avoid index funds that are too specific. For instance, you should not invest in sector index funds. These funds are investing in only one sector, such as Technology. They introduce a bias towards an industry. Keep it simple and invest in whole countries.
The same is true for funds that only invest in companies of some sizes. For instance, some funds are investing only in small companies. This is also a bet on which companies are doing to do best. And you should avoid bets! You need to bet on the entire market. It is the safest bet.
You will need to decide in which countries you want to invest. If you live in a vast country like the United States, you can invest only in your country. But if you live in a tiny country like Switzerland, it is best to diversify across many countries.
If you have bonds in your portfolio, I recommend that you only invest in bonds from your country in your currency. The idea of bonds is that they will reduce the volatility of your portfolio. If you had currency risks to that, you lose some of the advantages of bonds.
A good portfolio could be 80% of World Stocks and 20% of Swiss Stocks for Switzerland. If you want bonds, you could do 60% of World Stocks, 20% of Swiss Stocks, and 20% of Swiss Bonds.
For me, the best funds are the ones covering the entire world. For instance, Vanguard Total World (VT) is an excellent ETF. It is the one I am investing 80% of our portfolio with. But there are others. I would recommend you consider a world portfolio as your base index fund.
Once you have decided which countries you want to invest in, you can pick the best index fund for each of the countries. There are many tools to compare ETFs. My favorite tool for this is justETF.
If you want more information on this step, I have a complete guide on designing an ETF portfolio from scratch. This guide will help you choose an index, select a fund for this index and finally put your funds together to form your portfolio.
Decide how much you want to invest
Now, it is time to decide how much you are going to invest.
First, do you already have some money that you want to invest? If you already have a lot of cash, you can consider investing part of it.
Then, how much do you invest to invest regularly? It is a good idea to invest part of your salary every month in the stock market.
Of course, it is also a matter of how much you can invest. You need to remember that this money will not be available at all times. You need to invest money that you do not need right now. If the market is down a lot and you need the money, you will realize significant losses. So if you know you need the money, do not invest it!
You should also keep some money available in the form of an emergency fund. And you should not invest your emergency fund since you want it to be available.
An excellent way to get started is to start with lower amounts. You can decide you are going to invest 200 CHF each month. Or it could a 1000 CHF. It will depend on your budget and means.
It is much better to get started now with 100 CHF per month than never to invest. Starting with little money will help you break your investing paralysis.
As for the frequency, I recommend investing every month. But some people prefer to invest quarterly. I think it is good to invest as soon as you have money available for it.
Choose a broker
You know enough things and have decided on what to invest in. It is time to get started with the actual investing.
If you plan on using mutual funds instead of ETFs, you will not need a broker. You will just need to create an account with the fund provider you have chosen.
For investing in the stock market, you need to use a brokerage company (a broker for short). Your broker is the intermediary between you and the stock exchange. Against a small fee (more on that later), the broker will place orders for you on the stock exchange. Without a broker account, you will not be able to buy shares of your funds on the stock market.
Each country has many brokers. Most big banks will be brokers themselves. However, banks are not the best option for a brokerage account. They are way too expensive. We are talking about an order of magnitude more expensive.
As a small example, we would buy 2000 dollars of shares on the New York Stock Exchange (NYSE). In PostFinance, this would cost us 35 USD. With Interactive Brokers (IB), this would cost us 0.5 USD! PostFinance is 70 times more expensive than IB.
For Europe, there are two great brokers:
- Interactive Brokers. It is a U.S. broker with a U.K. branch for European people. They have very low prices and offer a wide range of investments.
- DEGIRO. It is a European broker from the Netherlands. They also offer a good range of investments at low prices.
I recommend IB over DEGIRO because they have lower prices and a better offer of investments. They are also more professional, and I trust them more than DEGIRO.
If you want to avoid foreign brokers, you can also opt for a Swiss Broker.
Make your first investment!
You have now taken all the necessary decisions. You can make your first investment in the stock market!
If you are using a mutual fund, transfer your funds to the mutual fund provider and invest the funds in your choice’s mutual fund.
If you are using an ETF, transfer money to your broker account and purchase shares of the ETF of your choice.
Congratulations, you are now invested in the stock market!
Keep it going
Getting started with investing is a great thing. But you need to keep it going. From now on, you should invest regularly.
I recommend investing every month. Even if it is small amounts, it will pile up quickly. It is how I am investing. Every month, after receiving my salary and paying all the bills, I transfer the remaining amount to my broker account. And from there, I buy the shares of my portfolio.
To limit your costs, I recommend that you only buy shares of one ETF each month. The best way to invest is to purchase shares of the ETF that is the most out of balance.
For instance, you want 60% of the VT ETF and 40% of the CHSPI ETF. If you only have 30% CHSPI, you buy shares of CHSPI this month. On the other hand, if you have 55% of VT, you buy VT this month. It is a great simple way to keep your portfolio balanced.
Following all these steps will help you get started with investing in the stock market. Investing is a great way to make your money work for you. And it will help you beat inflation.
I realize these are many steps. But these are all small steps. You do not have to rush through them. Even if this takes you one month to decide on everything, this is perfectly fine. You do not want to rush any decision.
Once you start developing a routine of investing, it will get simpler. And as soon as you begin to get the investing going, you will start to see the benefits of investing. It feels great when your portfolio grows without you doing anything.
I hope this will help you get started. If there is still something that is not clear, let me know in the comments below.
If you want more reading about the stock market, you can read about the myths surrounding the stock market.