Good for you.
Asking “How to become an investor?” is an important first step in becoming an investor. You’re off to a great start!
Anyone can become an investor, and there are a lot of ways to invest. You’ve got the stock market, real estate, crypto assets, commodities like gold, and private businesses. I’m going to focus on stock market investing, and it’s my goal to give you some foundational knowledge.
Briefly, I’ve been an investor and financial advisor for 20+ years. I’m honored to be named to Investopedia’s list of the top 100 financial advisors many years running.
Here’s what we’ll cover:
- How the markets work
- Understanding your risk tolerance
- Active vs passive investing
- Goal setting
- Your portfolio
- Where to invest
- Behavioral finance
Let’s get started.
How the markets work
The stock market goes up, and the stock market goes down. From 1951 to 2021, the market was positive 53.7% of the time, and down 46.3% of the time. Through good times and bad, the market has historically made its way up:
There are three terms I want go over:
A bull market is a sustained period of time when the market is going up.
A bear market is a period of time when the market has dropped at least 20% from its highs. This is also a period of economic uncertainty.
A correction technically occurs when there’s a 10% or greater drop in value. More common than “crashes,” corrections can be opportunities to purchase high-quality investments at a discount.
Understanding your risk tolerance
Having a good understanding of your risk tolerance is one of the most important things for an investor. Your risk tolerance informs the types and amounts of your investments, as well as your psychological comfort level.
Being too risky can expose you to losses. Being too conservative can make it difficult to achieve your long-term objectives. The goal is to figure out what kind of investor you are.
We do this by utilizing a risk tolerance assessment. The assessment will also tell you what your investor profile (conservative, moderate, aggressive) is, which will help you to understand what your asset allocation (investment mix) should be.
While that sounds like a lot, it’s actually pretty straightforward. The goal is to not only help you invest in the right vehicles, it’s also to make sure you feel comfortable. The last thing I want is for you to be stressed out about your investments.
All investing carries with it the potential for gains as well as rewards. The key is to figure out how aggressive you want to be.
Active vs passive investing
Active investors are trying to “beat” or outperform the market. Passive investors are trying to get the same returns as the market.
Commonly, active investing is more expensive because it requires more resources such as time and attention. Passive investing is less expensive and considered low-cost because it’s considerably less time and energy intensive.
The argument for which approach is better has been going on for quite some time. My personal belief is that there is a place for both. As you progress on your investing journey, this will be an area I encourage to learn more about, and to formulate your own opinions and beliefs.
You’ve gotta know where you’re going, otherwise you won’t know when you get there. Just as in every other aspect of life, goal setting is important to successful investing. One of the key things to keep in mind is time horizon.
You have short-term, mid-term, and long-term financial goals. Your investment approach will be different for your short-term goals vs your long-term goals.
In service of helping you to get crystal clear in what you want to accomplish, you can access our Goals course for free.
There are five traditional investor profiles; Conservative, Moderate Conservative, Moderate, Moderate Aggressive, and Aggressive. The results of your risk profile quiz will inform which investor profile is right for you.
For our purposes, I’m going to use the Moderate Aggressive Investor Profile. Here’s how it breaks down by percentages.
8% – Short-term fixed income
12% – Fixed income
23% – Small/mid US equity
28% – International equity
29% – Large US equity
Let’s take this one step further and assume we’re talking about your 401(k) account. Within most 401(k) plans is a fund lineup. The fund lineup are the mutual funds or ETFs (Exchange traded funds) you can choose to invest in. There are normally around 20 options.
Based on your profile, you’ll choose to invest in the funds corresponding to the percentages:
8% will be invested in cash or a cash-equivalent fund
12% will be invested in a fund which invests in bonds
23% will be invested in a fund (or funds) which invests in companies located within the United States that are considered small and mid-size companies (Small companies have valuations between $300 million to $2 billion. Mid-size companies have valuations between $2 billion and $10 billion)
28% will be invested in a fund which invests in companies located outside of the US
29% will be invested in a fund which invests in within the US that are considered large (Large companies have valuations over $10 billion)
Investments outside of your 401(k)
Stock trading has gained in popularity due to the rise of apps like Robinhood. While increased interest is a positive, the results have been poor. The vast majority of people using trading apps lose money. While that’s true for many reasons, the primary reason is too much risk.
You should never put more than 5% of your net worth (total wealth minus liabilities) into one concentrated investment (like an individual stock or crypto currency). Buying individual stocks carries with it the potential for high reward, as well as high losses.
If you’d like to dig deeper into this, learn more in this post.
Where to invest
We have access to many places to save and invest money. Here are some of the most common accounts and what you can use them for:
Checking/savings/money market accounts
Use these accounts for everyday spending, your emergency fund, as well as other short-term priorities.
These are examples of qualified accounts designed to help you save and invest for retirement. When you contribute to these accounts, think of putting it away for your future-self.
Taxable brokerage accounts
These are accounts which can be used for mid and long-term saving and investing.
Depending on what you’re trying to save and invest for, it’s important to educate yourself on the best options within each category.
Our brains are wonderful and are the main reason we’ve been the dominant species on the planet for as long as we’ve been. But they’re not great at investing.
The same part of our brain that responds to mortal danger also responds to financial loss. This means that when you open your 401(k) statement and see it’s gone down by 20%, your brain gives you the same response as if you’d smelled smoke- get out!
Intellectually, we’re supposed to buy when things are low, and sell when they’re high. But every ounce of us tells us to do the opposite. Our FOMO tells us to buy when investments are at their all-time highs. Our general fear tells us to sell when things are at their lowest point.
Here’s an interesting way to think about buying low and selling high: If you’re 35 and intend to retire at 65, you want the stock market to be terrible for the next 30 years. Why? Because you’d rather buy your investments when they’re “on sale,” versus full price. Would you rather buy shares of Apple at $10, or $1,000? I’d rather buy at $10 a share.
Back to the example: the only time I want the market to go up is on the day I intend to sell my investments. So, I’d love to buy Apple at $10 a share for 30 years. When I hit 65 and retire, I’d love for the price to shoot up to $1,000. In that scenario, I bought low for 30 years, and sold high.
What’s important about behavioral finance is that we make many of our money decisions based on emotion, not logic. The more we can recognize how we’re feeling about our money, the better our odds of making a bad decision.
Remember to buy low and sell high.
Become the CEO of your financial life. There’s never going to be anyone who’s more interested in your financial success than you are.
You’re well on your way to getting there, keep it going.
If you’re interested in learning more about stock trading, fantastic. There are a lot of people out there who consistently beat the market, and who earn a living doing it. That’s possible for you, but it will require you to dedicate the time to learn how to do it.
Here are some podcast episodes to help:
If you’re ready to take control of your financial life, check out our DIY Financial Plan course.
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