How to Start Investing, for Beginners

Investing is different from saving — the act of simply putting money aside for a particular goal, like buying a car or setting up an emergency fund. Investing’s purpose is to make your money grow. But this also adds a dimension of risk. Choosing the right investments depends on your investment goals, your time horizon, and the amount of risk you’re willing to take on, regardless of whether you’re a beginner or an experienced investor. Together, these factors will guide your investment selection among the four major types of investment products: cash, bonds, stocks, and funds. These products differ in many ways, but one is crucial for a beginning investor to know: the risk-to-reward ratio.

Most investments have some level of risk, and usually the higher the risk, the higher your potential investment returns will be. The word “potential” is emphasized because investment returns aren’t guaranteed. Consider how willing you are to lose some (or all) of your money in exchange for potential returns. 

In investing, if you’re a high-stakes gambler, you’re called an aggressive investor — one who actively seeks out higher-risk stocks in hope of higher rewards. Conservative investors, on the other hand, seek to preserve the amount of money they invest — known as the cost basis.⁶ As a result, they seek low-risk investments and accept lower returns.

Aggressive investment approaches work better for long-term goals because you’ll have more time to weather the market’s ups and downs. With more conservative investment choices, your cost basis is safer, so they might be better for short-term goals.⁷

Following are the four types of investments most often recommended to new investors, including how they differ in terms of risk-reward.

1. Cash equivalents. Investments like Certificates of Deposit (CDs), high-yield savings accounts, money-market accounts and treasury bills are guaranteed by the federal government and are low risk.⁸ Consequently, they also have the lowest return potential and are most suited for short-term goals and conservative investors.⁹ It’s important to consider the low risk-to-return in the context of inflation, which erodes purchasing power and may outpace the returns over time.¹⁰

2. Bonds. Bonds are a fixed-income investment, meaning they generate a steady stream of income based on a built-in interest rate¹¹ — also called the bond’s discount rate. Bonds are conservative investments, especially U.S. Treasury bonds, and usually have returns that are greater than cash equivalents but lower than stocks. Junk bonds, also known as high-yield bonds, are an exception to this rule. They’re riskier because they’re rated as more speculative and have a high risk of default.¹² When they are getting closer to the end of their investment goals, some investors sell off their higher-risk investments and buy bonds instead. 

3. Stocks. Also called equities, stocks rise and fall based on the underlying company’s financial results — provided everything else is equal. The entire stock market also rises and falls in response to changes in the economy, economic policy and political events. All of that makes stocks volatile, which simply means they sometimes have sharp swings up and down. They also require significant research before investing. Stocks are aggressive, high-growth and high-risk investments, not usually recommended for short-term investing.¹³ For more information, check out “A Guide to Investing in Stocks.” 

4. Mutual funds and exchange-traded funds (ETFs). These are typically collections of many stocks and bonds.^14,15 They are options for investors seeking lower risk than individual stocks. The lower risk comes from “diversification” — another important concept for beginning investors to understand. Diversification means spreading your investment money over an assortment of investments, particularly ones that react differently to the same economic or political event. Diversification reduces your dependence on the success or failure of any one stock. 

Mutual funds and ETFs have built-in diversification; when you buy a share of a fund you are really buying a piece of a portfolio of stocks and bonds.¹⁶ For example, an S&P 500 ETF holds stock of all 500 companies in the S&P 500 index, which is a list of the 500 largest publicly traded companies across all industries.

Some funds have different active investment strategies. Some focus on international companies, small businesses, or specific industries. Typically, more targeted investments like these require more management oversight, resulting in higher administrative fees and lower returns. On the other hand, “passive” investment strategies minimize buying and selling over longer periods of time, and therefore tend to have lower associated costs.¹⁶ Passive funds simply track an index, like the S&P 500 — meaning that the fund buys all the same stocks that make up its index.

Another option is target-date funds, which are common retirement investments. Target-date funds choose a set future date that might be 10, 20, or even 50 years away, and automatically shift their investment allocations over time, reducing risk as the “target date” approaches.¹⁶

Employer 401(k) and 403(b) funds are sound choices for investors. They are an efficient way to buy mutual funds, using the power of time, tax advantages, and possible employer matching.^17,18

To get started, you’ll need to open an account to hold your investments. Anyone over 18 can apply, and parents/guardians can open accounts for younger investors.

While there are several types of accounts, there are two categories for beginners to keep in mind:

• Brokerage accounts, which have no restrictions on accessing your money, but you likely pay tax on any “realized” returns every year — in other words, gains from investments you sold.¹⁹
• Individual retirement accounts (IRAs) and Roth IRAs, which are tax-advantaged accounts used for retirement savings and have restrictions on withdrawals.²⁰ For a better understanding of retirement accounts, read “Explaining 6 Key Types of Retirement Plans.”

If you opt for a managed account, you may have an investment advisor who can guide your investment choices and make trades for you — in return for a commission.²¹ You may want to shop around and compare trading commissions and account fees, as well as look for an advisor who offers research and guidance tools. You can check the education, registration, and disciplinary history of brokers through some of the sites you’ll find under the “Investing” section of the Consumer Financial Protection Bureau’s “Online resources for financial education” page. 

In addition, robo-advisors – software programs that choose and manage your investments based on your answers to questions about your financial goals and risk tolerance – are available with some online brokerage accounts. Robo-advisors typically charge lower fees than human advisors.²²

Even without a managed/brokerage account, you might be able to purchase U.S. bonds through TreasuryDirect.gov, where you may choose bonds based on future maturity date and amount. You can set up payroll deductions through TreasuryDirect for recurring investments.²³