How to Start Investing

No matter your age, it is never too late to start investing. While time is your most valuable ally in investing, the steps involved in learning how to invest can serve you throughout your life to manage your finances and economic well-being, irrespective of age.

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However, if you do have the opportunity, starting to invest at an early age is highly preferable. This is because the money you invest today will earn more of itself, or will be compounded, over time, allowing your dollar to stretch even further toward your goals. Additionally, starting early allows you to make mistakes and recover from them, which is important for a novice investor.

There are five basic steps to starting to invest:

— Set a specific goal.

— Determine available funds.

— Understand your risk tolerance.

— Choose an investment philosophy.

— Learn the basics.

Set a Specific Goal

Behavioral economics has shown that a goal provides two invaluable benefits:

— It gives a new investor a time frame for the investment. Different types of investments are more appropriate for different time frames, so knowing how long one has before a goal will help narrow down choices to those most appropriate.

— It provides a deadline and creates urgency in your actions.

Goals can be short term, such as saving enough to buy a new car, or long term, such as to saving for retirement. When starting, it can be advisable to plan at least one short-term goal so that a person can receive a tangible outcome for their effort. Investing involves setting money aside for the future that otherwise would be used to purchase goods and services today. When one is young, it can be hard to imagine retirement. However, when the goal is something that they can use in the near future, it makes it psychologically easier to delay gratification in order to achieve their goal.

Once the goal is determined, it’s important to place a specific dollar value on it. Successful goal-planning requires both a detailed dollar amount and a time limit in order to be motivating.

Determine Available Funds

New investors are often unsure of how much money they truly have available for investing. They may not have previously paid enough attention to the details on their paystub to understand the difference between gross and net income. Many of them have used credit cards to create and sustain their desired standard of living. Automatic drafts of utility bills and other subscriptions may have created an out-of-sight, out-of-mind mentality as to the their true cost of living needs. Historic inflation is also temporarily raising all these expenses, even though income may not be rising at the same pace.

Some potential investors may find that they will need to pay down debt before tackling an investment plan. Or, they may learn that they have excess funds in the front half of the month, but not the back half. Understanding your cash flow is paramount to sticking with a successful investment plan.

In order to determine available funds, a new investor should take the time to track their income and expenses for two to three months. This will not only enable them to see what day of the month rent is due, but also when automatic drafts are occurring for their streaming subscriptions, student loan payments and other large and small expenditures. Additionally, by tracking every dollar spent, they will learn about the money that is spent on small or impulse purchases, such as a barista-made coffee, ride-sharing services and happy hour drinks. The leakage that comes from these feel-good purchases can be far more substantial than most realize.

It is easy to write down these expenses manually or track expenses through financial apps. Mint is a free offering from Intuit Inc. (ticker: INTU) that allows users to see their bank, credit cards and loans in real time, which can then be used to create a budget and even help set financial goals. Mint also allows users to see their credit scores, which is another component of financial well-being that is important to learn early.

One advantage to tracking expenses is that many people are able to begin getting their arms around their expenditures and begin eliminating unnecessary spending. Every dollar that is not spent for short-term gratification is a dollar available to make future dreams a reality.

Understand Your Risk Tolerance

While separating short- versus long-term goals is important, understanding one’s risk tolerance is also key to a successful investment plan.

Risk tolerance is your ability to endure the swings in an investment’s performance over the time you’re invested. Some investments have considerable volatility. Some investors have a higher tolerance, while others are more conservative. Each person is unique and there is no particular profile that is better than another. Risk tolerance simply provides structure in investment choice, right along with time horizon and available funds.

Understanding your risk tolerance is important because you will be more inclined to stay the course and make prudent moves that are not based in fear and other negative emotions.

[READ: The 8 Best Investors of All Time]

Choose an Investment Philosophy

The investments that one chooses for a car purchase in two to three years differ dramatically from the investments one might make to prepare for retirement in 40 years.

The longer the time horizon, the more likely that market uncertainty and emotional decision making will enter the picture, especially if one’s risk tolerance is more conservative. It is impossible to reliably time the market. Reactive trading, buying in or selling out at inopportune times, is a common and expensive problem for everyday investors.

However, one can create an investment philosophy that will work with both short-term and long-term goals. Coupled with risk tolerance, this helps narrow the universe of potential investments. Some examples of an individual investment philosophies include the following:

Value investor. A value investor believes that the investment is currently underpriced and has an expectation that it will rise.

Growth investor. A growth investor believes that a company is generating better-than-average results and the price will rise because of their innovation or superior market positioning.

ESG investor. An ESG investor purchases investments that are aligned with their personal values in the areas of environment, social and corporate governance. ESG is also referred to as socially responsible investing.

Fundamental investor. A fundamental investor chooses investments based upon their earnings prospects, often in relationship to the stock’s price tag. Fundamental investors and value investors are very similar.

Technical investor. A technical investor chooses investments based upon past chart and technical data reflecting visual trends.

Contrarian investor. A contrarian investor selects investments that go against the prevailing direction of the crowd.

An investment philosophy is much like a fenced yard. It gives you the freedom to work and play in a specified space that is right and appropriate for your goals and needs. The fence will help keep you focused and disciplined even when the markets are unsettled.

Learn the Basics

It’s important to learn investment terminology. You will want to understand the difference between a stock and a bond, as well as why mutual funds and ETFs can create diversification. You will want to understand the allure of cryptocurrency, how inflation impacts investments differently and how tax efficiency can increase a portfolio’s return.

The building blocks of investments include:

Stocks. A stock share represents a fractional ownership in the assets and profits of an issuing company.

Bonds. A bond represents an “IOU” by the issuing company or governmental entity when they are raising money.

Mutual funds. A mutual fund pools together money from multiple investors to buy stocks, bonds and other short-term instruments from the issuer. It is an easy way to get more diversification with a smaller amount of funds.

Exchange-traded funds. Also known as ETFs, these funds are similar to a mutual fund in that multiple investors are involved, except the securities are traded on a major exchange and generally follow a specific index, such as the S&P 500.

There are many resources that go into greater depth on all these investment terms and topics. Social media can offer a lot of advice on various platforms, but new investors would be well-advised to search multiple sources before committing to an investment path. There are also excellent investing books and digital sources that are an important source of self-education.

Many new investors are intimidated by the sheer volume of information and the complexity of choice in investments. Financial advisors have historically focused on investors that have already accumulated significant assets, but that has been changing in the last few years. Today there are many more advisors catering to young investors, often charging either a flat fee or a monthly subscription. They are able to provide disciplined recommendations and help you avoid making crucial mistakes. This can not only help you get started successfully, but the individualized education they provide will help you grow faster and further with your investment knowledge.

First Steps

The best first step is simply to start investing! It’s very exciting to open your first brokerage account and see that first investment pop up in your confirmation statement. With goal-based planning, you will soon have that new car, house or bucket-list vacation ready to purchase. You will also be able to see your potential future self with choices such as wedding plans, an additional educational degree or a new business. Ultimately, your retirement will be what you invest for today. All of these possibilities are available when you take that first step.

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How to Start Investing originally appeared on usnews.com

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