How to Start Investing
I’ve been asked by a reader how to get started, and noticed that I haven’t yet talked about this in a general way, because most of the posts here are about specific investment strategies. So here is a more general approach for those who are still looking at how to get started.
# Starting to invest
- Earn more money than you spend
- Save the difference so you have something to invest with
- Invest that money
This is the first, basic set of instructions on how to begin. Before moving on, make sure these three steps are checked off on your list. It’s no use to invest when you spend every dime you earn. Never invest borrowed money!
Once you have money to invest, the next step is to find investments that are worthwhile for you. What you would like to invest in depends on your preferences in terms of risk. The riskier something is, the higher the potential return (usually).
# Different levels of risk
- No risk = savings account in your local bank
- Little risk = bond portfolio (sovereign bonds are generally considered safer than corporate bonds, short-term bonds safer than long-term bonds)
- Moderate risk = stocks & bonds
- High risk = only stocks & peer-to-peer lending (via Bondora & Twino in Europe or Lending Club in the US)
If you don’t know which option to choose, go with the ‘little risk’ option, and when you feel comfortable with investing, add stocks to your portfolio. This will be a fine approach for the vast majority of people. I know some in the US, where retail investing in stocks is much more common than in Europe, will say that it is better to invest in stocks as soon as possible, and they’re right. It is potentially more profitable. But for people uncertain of how to invest and what to invest in, I think it is better to start with very little risk so you don’t get scared out of the market.
So you now know, based on how much risk you’re willing to accept, which of the options above you want to go with. So you want to buy stocks, or you want to be bonds, or you want to invest in peer-to-peer lending. How do you do this? Read on.
# ETFs – built-in Diversification
The simplest solution, and according to the Bogleheads the best one, is to invest with index ETFs. An index ETF is an exchange traded fund, i.e. a mutual fund you can buy and that buys assets so you don’t have to worry about which ones, how much, how often, etc. It’s essentially a managed portfolio that you can get into for a – in this case – very low fee.
Whether you want to invest in bonds or in stocks, or in a mixture of both, you can do so by simply buying a few ETFs. Vanguards ETFs are excellent for example, but many similar ones have popped up from other companies as well.
If you want to follow the classic 60/40 stock bond strategy, which is a very fine choice, you can do so with just two of the following funds:
- Vanguard Total Stock Market Index Fund
- Vanguard Total International Stock Index Fund
- Vanguard Total Bond Market II Index Fund
- Vanguard Total International Bond Index Fund
If you live in the US, choose the non-international versions. If you live in Europe, you might want to choose the international versions because they include more European assets and are therefore closer to home. But they’re all quoted in USD, so pay attention to the currency risk if the dollar exchange rate for the currency you live and save in varies wildly. I live in Luxembourg / the European Union, and the EUR / USD exchange rate is pretty stable so I do not worry a lot about this. I don’t think either the EU or US economy will disappear or crash anytime soon, so both assets in EUR and in USD seem safe to me personally.
# More complex investing – at your own risk
What I wrote above is enough to get you started, and it’s simple. And simple might actually be best. While I do enjoy thinking and reading about different stock investing strategies, like the Piotroski score and the Trending Value strategy, it is entirely possible that a simple portfolio based on 60% Vanguard Total Stock Market Index and 40% Vanguard Total Bond Market II Index will beat the performance of my own portfolio over long time periods.
Unfortunately for me, I like to take things into my own hands, and to play around with different strategies. That is not entirely rational, there’s also an emotional component to it. If you’re interested in different strategies, read up on them here on the blog and elsewhere. If you just want to start investing and take the simplest (and possibly best!) approach, stick to index ETFs, and read the Bogleheads guide. And do not worry about where the market stands currently. Just continue to invest gradually over time, and you have the best possible chance of getting wonderful results.
A note on peer-to-peer investing: Peer-to-peer sites like Bondora, Twino, Savingsstream and ABLrate offer wonderful returns, but if somebody tells you you get a return of 12%, this is not something risk-free. With returns that are similar to stock returns, the risk has to be close to that of stocks, too. So if you decide to venture into this territory, always remember that these forms of investing have not yet been around long enough to say much about their risks. As a consequence, I would recommend that you spread your P2P investments among several platforms (I now use Twino, Mintos, Savingsstream and Ablrate – Bondora was not a good choice for me personally) and that you don’t invest the majority of your savings into P2P sites. I think most of your savings should be in time-tested assets like stocks and bonds.
That should be quite enough to get you started.