So, you want to start investing. Where exactly does that journey begin? If we go way back, it starts with how you were raised to think about money, and how that influences your relationship to it in the present. But investing is only one piece of the financial puzzle. If you have yet to start investing, this article explains each step to take before you begin.

At AAII, we believe that long-term investing is the best option for individual investors. A long-term strategy means you have the power of compounding on your side. Compounding is interest earned on interest previously made. For your investing portfolio, the magic of positive returns will beget larger increases for your portfolio over time since each percentage return will be realized on a consistently increasing balance.

Before you even consider investing, you need to make sure your financials are set up for investing success. This means you need a budget. It doesn’t mean you have to run your money like a business, but you should at least know where your money is going and what it’s supposed to be doing there. Only then can you determine what you have available to invest.

Building a Simple Budget

There are many ways to build a budget, including hiding money in envelopes or under your mattress. But if you primarily manage your money online, you can utilize something called the percentage budget. The percentage budget designates 50% of your monthly aftertax income to fixed expenses, 20% for savings or financial goals and 30% for wants or flexible spending. Your monthly living costs like rent and utilities, insurance, subscriptions and other bills you have to pay should take up 50% or less of your income.

Start by calculating how much income you receive in one month. Then, add up your fixed living expenses. If your expenses are over 50% of your income, you’ll have less money to work with in the other areas of your budget. However, this isn’t the end of the world; it gives you a financial goal to work toward. If your expenses are under 50% of your income, you have a leg up and could designate a larger percentage of your monthly income to savings.

Once you have a budget that dictates how much of your income you’ll be saving, you can start building up your emergency savings fund.

Emergency Savings Fund

All of the financial advice about saving boils down to one sentence: Pay yourself first.

If you don’t put any of your hard-earned money into savings, you are essentially taking money away from your future self. Like coming home from a night out to a full water bottle on your nightstand ready to help you rehydrate, it’s important to save not only for your long-term future but also for the short-term roadblocks you might hit along the way.

In general, it’s best to have three to six months of your monthly income in savings. An emergency savings fund can be tapped when your car needs new tires or to pay your first and last month’s rent on a new apartment.

In “A Lifetime Investment Strategy,” AAII’s founder James Cloonan said, “Exactly when any individual has money that is free from short-term emergency demands depends on individual circumstances. A common rule of thumb is that a long-term investment program can begin when income exceeds expenditures.” Whenever your emergency savings fund has enough money for you to feel like you can handle anything—aside from the apocalypse—the money you continue to save can be allocated to another financial account.

Opening a Savings Account

If you don’t already have a savings account, you’ll need to open one. You can do so with your current bank, or you can shop around for a higher interest rate, which will earn more on your savings over time. A behavioral finance recommendation is to open your savings account with a different bank to make it more difficult to transfer savings back to your checking account, but this is up to you and your needs.

Before opening a savings account, there are some safety measures to follow. First, it’s imperative to confirm that the establishment you are opening the account with is insured by either the Federal Deposit Insurance Corp. (FDIC), the Securities Investor Protection Corp. (SIPC) or the National Credit Union Administration (NCUA). You can find this information on each entity’s website:

• The FDIC insures money held in bank accounts and other official bank products. You can verify that your bank is insured using its BankFind Suite tool (https://banks.data.fdic.gov/bankfind-suite/bankfind). The FDIC’s standard deposit insurance covers up to $250,000 per depositor, per bank. If you have multiple accounts with one bank, you could qualify for a higher limit on FDIC insurance depending on the ownership category of your accounts.
• The SIPC insures investors’ assets in brokerage accounts and has a list of members you can search (www.sipc.org/list-of-members). The SIPC’s limit on protected assets is $500,000, including a $250,000 limit on cash held in investment accounts.
• The NCUA covers deposits in credit unions, and you can use its research feature to find insured credit unions (https://mapping.ncua.gov/ResearchCreditUnion). A credit union is a not-for-profit entity, whereas a bank is a for-profit institution. The NCUA’s insurance covers up to $250,000 per insured credit union, per member.

In addition, you must know what you want to do with the money you put into each of your savings accounts. It’s best if each of your accounts has a goal. The savings account you open for emergency savings should only be used specifically for that purpose, while a savings account with a higher yield could be used for saving up to buy a house.

Investing in Your Retirement Account

Once you have an emergency savings fund in place, you can consider investing in your retirement account. Many investors start with an employer-sponsored account like a 401(k) plan. Employer-sponsored retirement accounts take a specified percentage out of your pretax income each paycheck and invest it in the mutual funds of your choosing from those your plan offers. When you contribute a percentage of your pretax income to your retirement account, your company may match that contribution up to a certain percentage.

A mutual fund is a managed portfolio run by an investment company that pools investors’ money to invest in a set of securities. Mutual funds only trade once per day when the market closes at 4:00 p.m. Eastern Time. Fees can differ among mutual funds, and many mutual funds have a required minimum investment.

Most 401(k) plans are tied to a specific fund company. For instance, Vanguard retirement accounts set up through Vanguard can only invest in Vanguard mutual funds. The default investment for your 401(k) will likely be a target-date fund. A target-date fund is a mutual fund that will change the mix of investments in the fund as you near the retirement year in the fund’s name.

You can also open a retirement account with a brokerage firm, like an individual retirement account (IRA). This gives you more flexibility in terms of investment options, including exchange-traded funds (ETFs). ETFs, like mutual funds, pool investor dollars together. ETFs tend to have lower fees and can be bought and sold during the trading day.

How Much Is Needed to Start Investing?

They say you should only invest money you are willing to lose, but as a long-term investor, you don’t have to worry about losses as much. As Cloonan said in his book “Investing at Level3” (AAII, 2016), risk doesn’t necessarily need to be measured, “we just have to avoid it as much as possible.”

With all your potential worries cast aside, you can determine how much money you want to start investing with. These days, you could start investing with only $5. However, if you want to jump right into investing in stocks, you might need a minimum of a few hundred dollars depending on how expensive your desired stocks are. Since many mutual funds have minimum investment requirements, you may need at least $1,000 to start investing in them (though some will let you start with less than the minimum if you agree to automatically invest more each month). Personally, I started my investing journey with a $2,000 investment in ETFs. You will have to discover for yourself which investments fit your individual strategy based on your goals.

Conclusion

The most important part of investing and getting your financial information in order is that you familiarize yourself with the purpose and rules of each account. Don’t put your money somewhere you don’t understand, especially if it’s unclear how you will liquidate the account once you need to access the money. For this reason, your comfort level and understanding might lead you to invest in mutual funds first instead of stocks or open a regular savings account with your current bank. The right choice is whatever you determine is best for you, your money and what you want to do with it.

Related

Beginning Investor

Setting Up and Managing Your 401(k)

Related

Beginning Investor

How Much Money Do You Need to Start Investing?

Related

Beginning Investor

Investment Vehicle Attributes