Top

A Beginner’s Guide To Investing In The Stock Market

How To Invest In The Stock Market

My friend, congrats on taking an interest in your financial future. I completely understand that getting started investing can seem overwhelming at first. But you work hard for your money, isn't it time your money starts working hard for you? 

If you’re ready to begin growing your money and start creating wealth, I am here to help walk you through the process. 

With innovative and easy-to-use investing apps available today, there's never been a better time to get started. You can literally start investing right from the palm of your hand. Even more, you no longer need hundreds or thousands of dollars to enter the stock market. 

I'm all about helping the everyday investor get started investing to reach their financial goals. If you're ready to start growing your hard-earned money, then you're ready to learn how to start investing.


This guide contains affiliate links. To learn more, visit our affiliate disclosure.


One of the best trading platforms for beginners to consider is Webull. Not only do they offer 100% commission-free trading of stocks and ETFs, but they also offer a trading simulator that let's you practice trading without using real money. They've also been generous enough to offer Everyday Investing readers a free stock valued up to $1600 when opening an account and funding it with at least $100. You can see our full Webull review here.  

💎📈 Claim Your Free Stock Bonus Here


But with that being said, I'm going to break down how to get started investing in the stock market in 7 Easy Stages:

  1. Why You Need To Invest
  2. When To Start Investing
  3. How To Start Investing
  4. How To Make Money
  5. Where To Start Investing
  6. Investment Account Types
  7. Tax Basics For Investors

For starters, why should you start investing? If you’re already saving your money, isn’t that enough? Well, when you consider the following, you tell me...

Saving vs Investing

Let’s take a trip down memory lane. Remember when you were a kid, and your parents taught you to save money in your piggy bank? As you grew into your teens and early 20’s, this may have naturally transitioned into saving money in a savings account at your local bank. 

It makes sense. It’s safe, insured, and the perfect place to store your money. Such a great idea… right? 

The problem is, there is nothing false about the above truths. And that is the problem itself. Saving your money is a great way to pay off debt, tackle loans, and build an emergency fund. But, it is the WORST way to grow your money for your financial future. 

In fact, only saving your money (and not investing), is a guaranteed one-way ticket to losing money. How, do you ask?

Meet inflation: a double-edged sword. 

Inflation is the increase in prices of goods over a period of time. And as prices of goods increase, the buying power of your money decreases. All goods and services we purchase experience inflation. Each year the purchasing power of every dollar you have decreases. 

Look at the prices of any common everyday items you buy. The cost of milk, bread, gas, and rent are all more expensive now than they were five years ago. Let alone, 10, 20, and 40 years ago. 

In 2000, the average monthly rent in the United States was $602. Today, the average monthly rent for a one bedroom apartment in the United States is over $1,200 nationwide. The effect of inflation is even more apparent in majorly populated cities:

  • Miami: $1,995
  • Seattle: $2,049
  • Boston: $2,150
  • Los Angeles: $2,362
  • New York City: $2,650

In 1930, a gallon of milk cost $0.26. Today, a gallon of milk easily costs over $3.00 at any grocery store or supermarket. In 90 years, the price for a gallon of milk has increased over 1150% (nearly 12x more expensive). 

Source: Investopedia

If you had $3.00 in 1930, it would have bought you nearly 12 gallons of milk. Today, that same $3.00 will barely buy you one gallon of milk

And if you’re counting on your job income increasing to cover the rising costs of inflation, don’t. According to historical wage data, American’s paychecks are much larger than they were 40 years ago, but our purchasing power has barely moved

The truth is, the purchasing power of your dollar is decreasing every year. And there’s nothing you, I, or anyone can do to stop that. So, if saving isn’t the answer, how do you grow your money then? How do you overcome inflation?

Investing. And here’s why...

 

Stage 1: Why You Need To Invest

Remember that savings account we talked about? While it’s a great place to hold your emergency fund, it’s a terrible place to grow your wealth. The money held in your savings/checking account at your bank CANNOT outpace inflation. Simply put, it is just earning too small a rate of return.

On average, the inflation rate of the U.S. dollar is roughly 2-3% per year. Meanwhile, the average interest rate on savings accounts is under 0.10% APY, with some of the largest banks paying as low as 0.01% APY (annual percentage yield). I’m looking at you Chase, Bank of America, and Wells Fargo!  

This means that every $100 you have sitting in the bank is decreasing in value by $2 to $3 every year. Each and every year. At the same time, your bank is only earning you about $0.01 to $0.10 (yes, that’s 1 to 10 cents) of yearly interest for every $100 you have sitting there. 

How Does This Affect Your Money?

To truly put this in perspective, let’s say you have $10,000 sitting in your savings or checking account. Let’s be generous and assume you’re earning 0.10% APY interest at your bank with the historical average 2% rate of yearly inflation. 

$10,000 Today - 2% annual inflation = $9,800 in buying power one year later.

While you’ll still have your original $10,000 sitting in your bank, it will only be able to purchase $9,800 worth of goods and services just one year later. 

But wait, didn’t you earn that 0.10% APY interest? Didn’t you actually make money? Afterall… 

$10,000 Today + 0.10% APY interest = $10,010 after one year.

Simply put, you started with $10,000 and made $10 in interest. But don’t forget, due to inflation, you lost $200 worth of purchasing power

$10,000 + $10 - $200 = $9,810

The Danger of Leaving Your Money In the Bank

In the end, you lost $190 worth of buying power on the $10,000 you had sitting in the bank. And that’s just after one year! Imagine how much buying power you’ll lose year after year, and decade after decade. Not to mention, the more money you have sitting in your bank account, the more buying power you will lose:

  • i.e., with $100,000 in savings (earning 0.10% APY interest), you would lose $1900 worth of buying power each year

You may not notice the effects of inflation today, or even in a year. But as the years and decades go by, that is when you really feel it’s effect. But by then, it’s too late

So the next time your Aunt Sally or your friend Mike argues that the safest place to keep your money is in the bank… remember the negative power of inflation

Again, there’s nothing wrong with keeping your emergency fund in the bank. That’s where it should be. But anything beyond that should be invested. 

Investing is all about preserving your buying power.

Now you know why you should invest. But how do you know when is the right time to start investing?

 

Stage 2: When To Start Investing

The reason you invest is to preserve the purchasing power of your money. Unlike your bank savings or checking account, with investing, your money CAN outpace inflation

It is never too early to start investing. Whether you are in your 20’s, 30’s, 40’s, 50’s, or beyond, the best time to start investing was yesterday. The second best time to start, is now

In fact, the earlier you can start investing, the more you can grow your wealth over time. Let’s see why...

The Alternative to Bank Interest 

Remember the average inflation rate of the U.S. dollar? 

Remember the average interest rate on your savings/checking account?

Keeping your money in a savings account pretty much makes it impossible to outpace inflation, let alone, keep up with it. At best, every dollar you are saving is losing 2% of it’s purchasing power each year. 

Now, what if there was an alternative place to keep your money where you could not only keep up with inflation, but you could actually outpace it?

Meet the stock market.

The stock market is a group of exchanges where you can buy and sell securities. Securities are composed of the following assets:

  • Stocks
  • Bonds
  • Index Funds

For the purposes of this beginners guide, we’ll be focusing on stocks and index funds

What are Stocks?

A stock is a share in the ownership of a company. 

When you invest in a stock, you are investing in real companies. With every stock you buy, you become an owner in a piece of that company. As companies grow and increase revenue, your stock in that company grows in value as well. 

Index funds are simply a group of related stocks (companies) bundled together in a single investment. Index funds can be a great way for new investors to get started because not only can they take the guesswork out of picking individual stocks, but they can also help reduce risk in your investment portfolio. 

There are thousands of individual stocks and index funds you can invest in. But don’t worry, we’ll break that down more in the next stage. 

Speaking of index funds, they represent an underlying index of the stock market. Indexes help measure the performance of different areas of the stock market (i.e., the US stock market, the global stock market, tech companies, etc.)

Historical Stock Market Returns

One of the most widely used indexes of the stock market is the S&P 500 index.

The S&P 500 is a stock market index that measures the stock performance of 500 of the largest companies listed on stock exchanges in the United States. 

As one of the most commonly followed equity indices, many consider the S&P 500 to be one of the best representations of the U.S. stock market’s performance

According to MacroTrends.net, a research platform with decades of historical data, the S&P 500 has averaged an 8 to 10% rate of return every year since its inception in 1926. How's that for outpacing inflation?

 

Keep in mind though, this is the average annual rate of return of the stock market over a 90+ year period. 

Some years your investments in the stock market will earn more than 10%, some years they will earn less than 10%, and some years you will even lose money. But the important takeaway is that on average, the stock market has historically given you an annual 8 to 10% rate of return on your investments.

But Before you Start Investing…

Before you jump into the great world of investing, it’s important to keep the following two truths in mind:

  1. Investing is NOT a “Get-Rich-Quick” Scheme. 
  2. Investing is best for the long term

If you are looking for hot-stock picks to double your money by next week that is a one-way ticket to losing your money. That’s not investing, that is gambling

My goal is to help you get started investing on a financial path that has much more stable, steady, and consistent growth of your money. 

When you invest in the stock market, your money will grow as the value of the stocks you invest in grow, but your investments can also decrease in value as the stock market fluctuates downward.

You may have heard of the terms “bull market” and “bear market.” In the stock market, there are two types of “markets.” A bull market and a bear market.

  • Bull Market: a period of time when stocks are rising in value. 
  • Bear Market: a period of time when stocks are falling in value. 

This is why investing is always best for the long term. In the short term, the stock market may fluctuate up or down, but over the long term the stock market has a history of increasing in value.

By investing for the long term, you can weather any short term downturns in the stock market (i.e., stock market crashes, recessions, etc.), and still come out ahead.

The stock market has historically been the simplest way to grow your wealth. You don’t have to be a stock expert and you don’t have to start with a lot of money. You just have to start, stay consistent, and stay the course

Now that you know the best time to start investing is now, let’s address the next question: 

How do you get started investing?

 

Stage 3: How to Start Investing

There has never been a better time to start investing than today. Gone are the days of relying on outdated technology and websites. 

Today you can easily get started investing right from the palm of your hand. But with that ease of entry, can also come unrealistic expectations. 

If you are looking for quick profits, investing is not for you. That is merely gambling. Those who do begin investing with the mindset of making quick profits, will overwhelmingly find themselves losing it all soon after. 

There are no guarantees with investing. Unlike saving, investing in anything involves risk

There are steps you can take to help mitigate the risk of your invested money, but it’s important to keep in mind that risk will always remain. 

This is why investing is a marathon, not a race. We’ll talk more about risk tolerance and risk management in the next stage. 

Getting Started

When you’re just starting, it may seem tempting to invest in the latest “hot” stock to make a quick return. 

Day trading is often advertised as an easy way to double or triple your money overnight. It is the act of buying and selling stocks on the same day, multiple times a day, until you walk away with profit.

You may be tempted to day trade your way to wealth after hearing promises of high returns by “stock trading gurus.” But the desire for quick profits often leaves inexperienced traders with nothing more than stress and depleted bank accounts

“Self-proclaimed” day traders can spend hours and days studying charts and data. But not even the experts ever truly know how stocks are going to perform over a given period of time

And even if they do show you proof of big day trading profits, anyone can look like a genius in a bull market

Remember how we discussed investing is best for the long term? While it doesn’t sound as flashy as day trading, I can tell you that exponentially more millionaires have been made by simply investing consistently and staying the course, than those who have attempted to day trade their way to there. 

Anything that can make money fast can also lose it just as fast, if not faster

Penny Stocks  

One strategy day traders will try to sell you on is to trade penny stocks. According to the Securities and Exchange Commission (SEC), penny stocks are stocks that generally trade at less than $5 per share

Penny stocks may also trade less frequently, meaning it may be difficult to sell your penny stocks once you own them. For this, and other reasons, penny stocks are generally considered speculative investments. In fact, the SEC warns of the pitfalls of penny stocks:

"Investors in penny stocks should be prepared for the possibility that they may lose their whole investment." - SEC.

Unfortunately, many new investors confuse penny stocks with stocks that are cheap, on sale, or simply just affordable. This couldn't be further from the truth. 

If you're looking to invest in individual stocks that are affordable, you don't want to invest in penny stocks. Instead, you want to invest in fractional shares of quality stocks.  We'll discuss the advantages of fractional shares in stage 5 of this guide. 

Jim Cramer, the host of CNBC's Mad Money, warns young investors that day trading speculative stocks is not investing. He reminds us, "they are penny stocks for a reason." 

The truth is, 90% of day traders lose money. Some traders may outperform the overall stock market over a one, two, or even three year period. But over a 10+ year investing timeline, you will be hard pressed to find many who outperformed an investment in a simple S&P 500 index fund.  

What are Index Funds?

When you are investing in individual stocks you are betting on the success and performance of a single company. And while you can “get it right,” and pick a winner, more often than not, you will have been better off simply investing in index funds.

An index fund is a selection of stocks grouped together designed to follow the performance of the underlying investments. Index funds track and replicate the performance of different areas of the stock market (i.e., the US stock market, large blue chip companies, small up and coming companies, etc.).

Perhaps you’ve heard of the age-old expression, “never put all your eggs in one basket.”

Why invest all your money on the performance of one company, when you can invest on the performance of the entire stock market? As cliche as that may sound, there is a lot of truth to it. 

Because index funds are often composed of hundreds of stocks, they provide instant diversification. And because you are not dependent on the performance of a single company, investing in index funds can be a great way to help reduce risk in your investments. 

World’s Greatest Investor Recommends Index Funds

One of the most widely tracked indexes is the S&P 500 index. As a representation of the performance of 500 of the largest US companies, it is often seen as an indicator of the overall performance of the US stock market. 

Berkshire Hathaway CEO, Warren Buffet, is often regarded as the world’s greatest investor. Buffet recommends that most Americans simply invest in a low fee S&P 500 index fund

In 2007, Buffet made a $1 million bet against the nation’s top hedge funds. He bet that none of the top hedge funds (managed by the top US fund managers) could outperform the S&P 500 index fund over a decade

Ten years later, he was right. Over that ten year period, Buffet’s choice fund, the Vanguard S&P 500 Index Fund (VOO) returned 7.1 percent compounded annually, while the basket of hedge funds his competitor chose returned an average of only 2.2 percent annually.

  • Index funds can be a great form of passive investing. They hold every stock in an index such as the S&P 500, including big-name companies such as Amazon, Apple, Microsoft, and Google. 

And because there is less buying and selling of stocks in index funds (as opposed actively managed mutual funds), fees and taxes tend to be low as well. Not only are index funds inexpensive, but they help manage risk in your investment portfolio as they aren’t dependent on the success of one single company.

The trick is not to pick the right company,” Buffett said. “The trick is to essentially buy all the big companies through the S&P 500 and to do it consistently.”

How to Invest in Index Funds

As you can see, investing in index funds is a recommended starting point for most new investors. You get exposure to investing in hundreds of major companies, you don’t have to stress about picking individual stocks, and it can help manage your overall investment risk. 

Quite simply, most new investors should start by investing in index funds. Now, is this to say that you should never invest in individual stocks? No, I am not saying that at all. 

While nearly impossible to outperform the overall market through day trading, it is possible to outperform the market by investing in individual stocks. We’ll talk more about how to invest in individual stocks in just a bit. 

With that being said, if you are just getting started with investing in the stock market, it is highly recommended to consider investing in an index fund first. 

While you invest in an index fund you can begin to learn about the stock market and build your risk tolerance before investing in individual stocks. 

When you’re ready to invest in index funds, there are two names you will often hear:

  • Mutual funds 
  • Exchange Traded Funds (ETF)

Mutual funds are similar to index funds, but there are distinct differences you need to know about. And these key differences are the reason I would recommend investing in ETFs instead.

You can invest directly into index fund ETF’s 100%-commission free on M1 Finance. Learn more about why this is one of the best platforms for new investors

What are Mutual Funds?

Mutual funds are actively managed funds that pool together money from many investors to purchase stocks, bonds, etc. 

Mutual funds are typically managed by professional fund managers at large financial institutions. Because mutual funds are actively managed by a person, or team of professionals, they often have much higher fees associated with them.

The first fee associated with mutual funds is what’s called an expense ratio. An expense ratio is the “management expense” associated with holding the fund. It is not uncommon to see most mutual funds maintain expense ratios of 1 to 3%, or even higher. 

Dangers of Mutual Funds

Let’s assume you invest $1,000 into a mutual fund with an expense ratio of 2%. This means you will pay the fund $20 per year for every $1,000 invested. 

And while 1% may not seem like a lot, what many of us don’t realize is that an increase of 1% in fees will cost you 10 years in retirement income. 

In addition, many mutual funds have additional fees called “front-end loads” and “back-end loads.” Loads are fees charged to the investor when buying or selling certain types of mutual funds. 

With these types of mutual funds, you either pay a fee up front when purchasing into a mutual fund, or on the back-end when you sell the fund. Typically, these fees can average around 5%, but can be higher depending on the fund. 

Mutual Fund Returns

As a benchmark, the performance of mutual funds are often compared to the performance of the S&P 500. Remember, this is the index that tracks the performance of the 500 largest US companies

And while some mutual funds do outperform the overall stock market over a certain period of time, most actively managed mutual funds do not outperform the market.

But there is a better alternative. Most people don’t realize that you can easily invest in the S&P 500 through a low-fee index fund instead of picking individual socks or paying high fees for mutual funds that, statistically, won’t outperform.

Research has shown that 96% of all actively managed mutual funds fail to beat the market. 

The better choice is clear… investing in exchange traded funds (ETFs). 

What are ETFs?

An ETF is a group of related stocks bundled together in a single investment. Sound familiar? That is exactly what an index fund is!

Can you imagine how expensive it would be to buy all the stocks held in an ETF portfolio individually? Not to mention, overwhelming. 

With access to hundreds of stocks in a single ETF, they provide lower average costs than buying the individual stocks themselves. 

Do ETFs Have Fees?

Similar to mutual funds, ETFs charge fees in the form of expense ratios. But unlike mutual funds, ETFs expense ratios are drastically lower. While most actively managed mutual funds have expense ratios ranging from 1 to 3%, compare that to the expense ratios on these popular S&P 500 ETFs:

  • Vanguard S&P 500 Index ETF (VOO)
    • Expense Ratio: 0.03%
  • Vanguard Total Stock Market ETF (VTI)
    • Expense Ratio: 0.03%
  • Vanguard High Dividend Yield ETF (VYM)
    • Expense Ratio: 0.06%
  • Vanguard Total World Stock ETF (VT)
    • Expense Ratio: 0.08%

That’s right. Warren Buffet’s recommendation, the Vanguard S&P 500 Index ETF (VOO) has an expense ratio 33x less expensive than a mutual fund with only a 1% expense ratio.

To put this in perspective, imagine you had $100,000 invested in a Vanguard S&P 500 Index. Then imagine you had $1,000,000 invested. I mean, that is the goal right?

  • $100,000 x 0.03% (expense ratio) = an annual fee of $30 
  • $1,000,000 x 0.03% (expense ratio) = an annual fee of $300

Compare that to a similar actively managed mutual fund with an expense ratio of just 1%:

  • $100,000 x 1% (expense ratio) = an annual fee of $1,000
  • $1,000,000 x 1% (expense ratio) = an annual fee of $10,000

Not only are you saving a critical amount in fees every year, but those savings get to stay invested, allowing more of your money to compound and grow at an even faster rate. 

We’ll talk more about the power of compound interest in the next stage. 

One important point to note, is that not all ETFs track an index in a passive manner. While most do, there are also actively managed ETFs. And similar to actively managed mutual funds, those actively managed ETFs will hold a higher expense ratio. 

So when considering ETFs to invest in, you always want to check the expense ratio before investing. That will give you an idea if it is a passively or actively managed ETF. 

When you invest in ETFs you get the full experience of being a stock market investor without the increased volatility of owning individual stocks. 

Advantages of ETFs

Investing in ETFs give you the following benefits:

  • Avoid having to actively manage and pick individual stocks
  • Risk management through instant diversification 
  • Access to many stocks across various industries
  • Low expense ratios
  • Access to ETFs that focus on targeted industries

Disadvantages of ETFs

  • Actively-managed ETFs have higher fees
  • Single industry focus ETFs limit diversification

Some of the best platforms to invest in ETFs are M1 FinancePublic, and Robinhood

Investing In Individual Stocks

As you can see, investing in index funds is a recommended starting point for most new investors. You get exposure to investing in hundreds of major companies, you don’t have to stress about picking individual stocks, and it can help manage your overall investment risk

Again, most new investors should start by simply investing in index funds. 

But this is not to deter you from investing in individual stocks. You absolutely can. In fact, even Warren Buffet himself invests in individual stocks. 

When it comes to investing in individual stocks there are a couple of important factors to keep in mind. 

Stock Price Volatility 

Price volatility is the degree to which a stock’s price fluctuates. Individual stocks are much more volatile than the overall stock market (i.e., index funds and ETFs). This means that you can expect more drastic fluctuations in prices of individual stocks, as opposed to price fluctuations of ETFs. 

A simple method to compare the volatility of stocks is to look at each stock’s beta. A stock with a beta greater than 1 means this stock is more volatile than the overall stock market. 

 Example - Yahoo Finance

However, a stock with a beta below 1 means this stock is less volatile than the overall stock market. If you are interested in investing in individual stocks as a new investor, and want to reduce the volatility of your investments, you may want to consider investing in stocks with a beta under 1.

Blue Chip Stocks 

When it comes to investing in individual stocks, it is important to keep in mind that some stocks are more volatile than others. 

For instance, an up-and-coming technology stock, such as Tesla, is going to experience much more fluctuation in it’s stock price than blue chip stocks like Apple, Johnson & Johnson, Coca-Cola, and American Express. 

Blue chip stocks are reputable, reliable, and quality companies that have stood the test of time. 

While blue chip stocks may not experience as much growth as young up-and-coming companies still in their infancy, they can provide investors with sustainable growth and a lot less volatility along the way. 

If you are a new investor interested in investing in individual stocks, you may want to consider investing in blue chips stocks. Many blue chip stocks can be found in indexes such as the Dow Jones Industrial Average and the S&P 500 Index

Some of the best platforms to invest in blue chip companies are M1 Finance, Public, and Stash

High Volatility Stocks

On the other hand, high volatility stocks can be ideal for more active stock traders. This increased volatility creates more opportunities to buy low and sell high.

Personally, I am a long term investor myself, and not much of an active stock trader. But if you are interested in trading stocks it is highly recommended to practice first before trading with your real funds

One of the best platforms for new stock traders to practice trading with is the Webull stock trading app. Not only is Webull a 100% commission-free trading platform, but they also offer detailed charts, data, and analyst ratings to help you make more informed trading decisions

Alternatively, if you want to get started in the stock market without having to pick individual stocks and build a portfolio from scratch, you may want to consider one of the best robo-advisors, the Acorns investing app

Acorns simplifies your portfolio, by letting you choose from pre-built and diversified portfolios composed of some of the top ETFs. They even offer several investing automation features, such as automatically investing the spare change from your everyday purchases.

Risk Tolerance

Before you jump into investing in individual stocks, it’s important to establish your risk tolerance based on your financial goals. Knowing your risk tolerance will help you with risk management. 

What type of investor do you want to be? This is an important question to ask when you begin investing in the stock market. 

  • Do you want to invest in aggressive growth stocks with more growth potential?
    • Do you have a higher level of risk-tolerance and a longer investment horizon?
  • Or, do you want to invest in reliable blue chip stocks that pay consistent dividends?
    • Do you have a lower level risk-tolerance and a shorter investment horizon?
  • Or perhaps, you want a compromise, and invest in stocks that pay dividends while simultaneously having growth potential?

*Note: We'll discuss what dividends are and how they work in the next section. 

Knowing what type of investor you want to be will go a long way in helping you determine what types of companies you want to invest in.

For instance, a more conservative investor would build their portfolio around more established companies with a proven track record.

On the other hand, a growth investor may compose their portfolio a bit more aggressively, with more innovative up-and-coming companies.

Of course, if building your own portfolio from scratch is too overwhelming, you can just as easily participate in the stock market by simply investing index funds and ETFs

Two of the best platforms to invest in index funds are M1 Finance and Acorns.

Should You Invest In Individual Stocks or Index Funds?

This answer will vary from person to person. Again, if you are just getting started investing in the stock market I would recommend starting with index funds and ETFs. 

This will give you time to get comfortable with the stock market, and it's ups and downs, before immediately jumping into individual stocks. 

In deciding which investment vehicle is right for you, here are a couple of the questions you will want to ask yourself:

  1. What is my risk tolerance?
  2. For how long am I investing?
  3. Am I willing to put in the research to keep up with individual stocks?

It's also worth noting that this doesn't have to be an all-or-nothing decision. You don't have to completely choose one or the other. You can invest part of your portfolio into ETFs and part of your portfolio in individual stocks.

You can also have multiple investing accounts on separate investment platforms. This can help you avoid mixing-up investing strategies, as each account can have it's own objectives. 

  • For instance, you may have an individual retirement account (IRA) largely invested in index funds for peace of mind for the long run.
  • Meanwhile, you may have a non-retirement investing account where you invest a little more aggressively by holding individual stocks.   

How Much Money Do I Need To Start Investing?

When you’re just getting started, you may wonder if you can actually afford to invest in the stock market. For decades, access to the stock market was limited to only wealthy investors. 

The stock market is now much more accessible to the everyday investor. With advances in technology and the growing number of Fintech (financial tech) companies on the rise, anyone can start investing in real companies. 

You no longer need hundreds or thousands of dollars to start investing. Today, there are beginner-friendly investing apps that let you get started investing in with as little as $5

We’ll discuss some of the best investment platforms for new investors a little later in stage 5. 

 

Stage 4: How To Make Money

As you invest in the stock market, there are two unique ways you can grow your money:

  • Asset Appreciation
  • Dividends

But even better, as a long term investor, you can actually make money via both asset appreciation and through earning dividends. Let’s break them down:

Asset appreciation is simply the price of a stock (or ETF) increasing over time. When you purchase an asset, the goal is to sell it at a higher price in the future. 

The longer you hold a stock (or ETF) the more time it has to appreciate. When you buy “stock ABC” at $100 and it’s price increases to $120, that is an appreciation of $20. When you sell stock ABC for $120 you will have made $20 in profit

Keep in mind though, that not all stocks are the same. Some stocks are more volatile than others. 

Dividends are the second way you can make money through investing in the stock market. Dividends can be a great way for investors to create passive income. 

Passive Income: money earned that requires little to no effort to make and maintain. 

A dividend is the distribution of a portion of a company’s earnings to its shareholders. When you own a share (or shares) of stock, you are a shareholder. 

Dividends are basically a reward to investors for their trust and for investing money into the success of the company. 

While the major portion of the profits are kept within the company, the remainder is  distributed to the shareholders as a dividend. 

Dividend-Paying Companies

Larger, more established companies with more predictable profits are often the best dividend payers. These companies tend to issue regular dividends because they seek to maximize shareholder wealth in ways aside from asset appreciation. Companies in the following industry sectors typically maintain a regular record of dividend payments: 

  • Basic materials
  • Oil and gas
  • Banks and financial
  • Healthcare and pharmaceuticals
  • Utilities

Start-ups and other high-growth companies, such as those in the technology or biotech sectors, may not offer regular dividends. Because these companies may be in the early stages of development, they may not have sufficient funds to issue dividends. 

Even profit-making early- to mid-stage companies avoid making dividend payments if they are aiming for higher-than-average growth and expansion, and want to invest their profits back into their business rather than paying dividends. 

While not all, many stocks pay dividends for simply owning them. In addition, many ETFs also pay dividends for owning them as well. A stock or ETF’s dividend amount is often displayed as a dividend yield.

This is similar to the annual percentage yield (APY) interest you earn at a bank account. Except companies dividends are typically much higher than your standard bank account’s 0.01% yield. 

Here are some examples of both dividend-paying stocks and dividend-paying ETFs.

  • Stocks:
    • Apple: 1.10% yield
    • Coca Cola: 3.4% yield
  • ETFs:
    • Vanguard S&P 500 Index ETF2.24% yield

Dividends are typically paid out in the form of cash. Dividends are also typically paid out every quarter (every 3 months), but some companies pay their dividends out monthly, annually, or semi-annually. 

For the most part, companies tend to increase their dividend payments over time. They also tend to avoid dividend cuts in order to maintain their established track record of making regular dividend payments.

However, a company’s board of directors can choose to issue dividends with different payout rates during turbulent times. A dividend cut is a cut in the dividend yield. A dividend cut is usually a last resort, as it typically results in a decline of the share price, which hurts the reputation of the company.

Dividend Stocks vs Growth Stocks

Stocks are often broken down into two categories:

Income

Growth

Stocks that pay dividends are often referred to as income stocks. Whereas, stocks that are growing at a faster rate than the overall market are referred to as growth stocks. For example:

  • Income Stocks: Coca Cola, Verizon, Bank of America
  • Growth Stocks: Tesla, Amazon, Facebook

Growth stocks typically provide more potential upside than income stocks. But they also inherently bring more volatility and price swings. 

Compound Interest

You know how you work for a living to make money? How would you like your hard-earned money to work for you, so that it makes money? And then how would you like the money it made, to also work for you, to earn you even more money?

That my friends, is the principle of compound interest. And once you understand it, it will change your outlook on money forever. 

The great Albert Einstein once called compound interest the eighth wonder of the world

“Compound interest is the eight wonder of the world. He who understands it, earns it… he who doesn’t… pays it.” - Albert Einstein

Compound interest essentially means earning "interest on the interest," and it is the main reason why so many long term investors are successful.

In fact, the greatest contributors to building wealth are time and investing consistently. Together they allow your money to grow with compound interest. If there is one thing you learn today, let it be compound interest.

Essentially, compound interest means that not only does your initial investment earn interest, but you also begin to earn interest on the interest. This powerful snowball effect is the key to creating true wealth over time.

Source: CNBC

Compound interest is the foundation of which investing is built upon. Rather than paying out your interest (such as in a savings account), compound interest is the result of reinvesting that interest, so it can then earn you even more interest each dividend payment. For example:

  • Earning interest on the principal investment you made
  • + Earning interest on all the previously accumulated interest

When it comes to investing, compound interest can repeat indefinitely and the interest you earn can be exponential over the long term. This is why the earlier you start investing, the better. 

How Long To Invest For 

If stocks are a long term investment, you may be wondering how long should you hold a stock for? 

While there is not a specific answer for how long to hold a stock before you sell, you should aim to invest in a stock with a minimum of at least 1 year. And there is a good reason. Tax benefits

In the United States, when you sell an asset (stock, bond, ETF, etc.), a taxable event occurs. When you sell a stock at a profit, you experience what is called a capital gain

  • For instance, let's assume you bought some shares of ABC stock for $800, and later sold those shares of stock for $1,000. You just experienced a capital gain of $200

Capital gains on investments can be categorized into long term capital gains and short term capital gains

As if long term investing didn’t already have enough advantages, another advantage long term investors receive is significant tax benefits

If you buy a stock and sell it within one year (365 days), your gains are classified as short term capital gains and are taxed as ordinary income. This means your profits are taxed at your ordinary income tax rate (i.e., your current tax bracket).  Yes, this is the same tax rate that wages from your job are taxed at. 

However, if you buy and hold a stock for longer than one year (365 days) before selling it, your gains are classified as long term capital gains

Depending on what tax bracket you are in, this could provide you with tax savings of up to 20%. Yes, imagine keeping $20 more of every $100 profit you make from selling your stocks. 

And even better, if you fall into the 10%-15% tax bracket, your long term capital gains tax rate is 0%! Yes, that’s right, by holding a stock for at least one year, you could end up paying no taxes on your profits when you sell. See the chart below for reference: 

2020 Capital Gains Tax Rate

So just remember, while there are times it can make sense to sell your stocks in the short term, be aware that when doing so you will be paying the highest tax rate possible on your profits. 

If you are investing in individual stocks, have an idea of how long you plan to hold them and don’t forget to factor in tax benefits of holding for at least one year.   

 

Stage 5: Where Do I Start Investing?

Whether you want to invest in individual stocks or ETFs, you will get started investing through an investment brokerage (i.e., investment platform or an investing app).

Now while there are more traditional investment brokerages at large financial institutions, they are not very user-friendly for new investors. 

Instead we're going to focus on more modern and innovative investing apps that are much easier to use and simpler to get started with. 

 To be specific, we’re going to go over three types of investing platforms:

  1. Stock Market Investing Apps  (Passive Investing)
  2. Stock Market Trading Apps  (Active Trading)
  3. Robo Advisor Portfolio Apps (Passively Managed)

The main difference between these these different types of apps are the following:

  • Investing Apps:  (i.e. slow and steady)
    • More geared towards longer-term investing and allow you to invest in a much more passive manner without having to think about it. 
    • Often times, more diversified portfolios and offer less risk. 
    • More stable and steady growth.  

You can learn more about the best investing apps for new investors here


  • Trading Apps:  (i.e., high-risk/high reward)
    • More geared towards shorter-term investing and require much more active involvement in researching and picking individual stocks.
    • Often times, less diversified portfolios and offer more risk.
    • More potential profit but also more potential loss.  

*Tip: Tradings apps can also be used as passive investing apps if you're using them to buy and hold your stocks. 

You can learn more about the top stock trading apps for beginners here.


  • Robo Advisors:  (i.e., completely managed portfolios)
    • Investment portfolios are passively managed by an algorithm
    • Diversified portfolios that are more geared towards long term investing
    • Portfolio rebalancing is done for you, on your behalf
      • We'll cover portfolio rebalancing in just a bit.  
    • Less control over choosing your investments

You can learn more about our pick for the top robo advisor investing app here.


Investing Automation Features

Who has time to constantly manage their investment portfolio? If you’re like me, you want to work smarter, not harder.

One of the key things I look for in an investing platform is investing automation features. These built-in tools help you put your investing on auto-pilot and create a much more passive investing experience. 

Today there are several investing apps that provide you with easy-to-use investing automation features to help you automate your investing.  You don't have to use them all, but using some combination of them can be very helpful. Here are just a couple of the investing automation tools I like to use on my investing apps:

Dollar Cost Averaging 

As long term investors, we don't like to time the market. A much more efficient approach to investing is dollar cost averaging
 
With dollar cost averaging, you simply invest a consistent amount on a consistent basis, regardless of if the market is up or down. This way you invest when the market is down (for a good bargain), and you also avoid over investing when the market is at a high.
 
You get the best of both worlds without ever having to worry about timing the market. Instead, you focus on your time in the market
 
If you are interested in dollar cost averaging your investments, these are some of the best investing apps for it. 

Fractional Shares

Essentially, this means instead of having to buy a full share of a stock that may cost hundreds of dollars, you can invest in a “partial share” of it, for a much lower amount (i.e., $10 or $50 worth of that stock).

Fractional shares are slices of a full share of stock. Some investing apps only let you invest in full shares, but there are investing apps that let you invest in fractional shares. Those apps make investing much more accessible to the everyday investor.

To give you an example of fractional shares, let's say you wanted to invest in Amazon stock

The price of Amazon stock is currently over $2,400 per share. Most investors just getting started don't have a spare $2,400 lying around. With fractional shares, you can buy $50 worth of Amazon stock, and own roughly 2% of one share of Amazon stock.

Some of the best investing apps for investing in fractional shares are Acorns, Public, and M1 Finance

You can see a further explanation of fractional shares in my video below:



DRIP Investing

In the last section we discussed the power of compound interest. If you want to supercharge your investments, there is no better way than with DRIP investing. 

DRIP stands for Dividend Reinvestment Plan. With DRIP enabled in your investing account, you can automatically reinvest cash dividend payments back into the underlying stock or ETF.

This allows your dividend-paying stocks and ETFs to automatically reinvest their dividends into buying more shares of stock. For instance, if you own a share of Apple, when it pays a dividend it will automatically buy you more fractional shares in Apple. 

Essentially, with DRIP investing, your original investment begins to buy more fractional shares of itself, and then, those fractional shares begin to buy more fractional shares of themselves.

You can see a further explanation of DRIP investing in my video below:



Again, this is the exponential effect of compound interest, but now with compound dividends

And even better, DRIP works great with fractional shares. When you have DRIP enabled in your investment account, your fractional shares can grow automatically over time with each and every dividend payment. 

You may start by owning just 5% of a share of Apple stock, but as you have your Apple dividend payments reinvested into buying back more fractional shares, you can soon find yourself owning 6%, 7%, 8% of a share, and so on.  

This is why DRIP + Fractional Shares are such a powerful combination for everyday investors.

Some of the best investing apps for dividend reinvestment plans are PublicRobinhood, and M1 Finance

Recurring Investments

Recurring investments (also known as recurring deposits) can be a simple, yet effective, way to help encourage passive investing. With recurring investments, you set up recurring automated deposits from your bank into your investment account. 

Recurring investments can typically be set to occur every week, 2 weeks, or even every month. And best of all, you have complete control over the amount you consistently invest. 

Some of the best investing apps for recurring investments are M1 Finance, Acorns, and Stash

You can see a further explanation of Recurring Investments in my video below:



Round Ups 

Some investing apps let you actually invest the spare change from your everyday purchases. Talk about passive.

With round-ups, you link a debit or credit card to your investing app, and then anytime you make a purchase with that card your purchase will be rounded up to the nearest dollar. That excess change is then automatically deposited and invested for you into your investment account.

Not all investing apps offer this feature. Two of the best investing apps for round ups are Acorns and Stash

You can see a further explanation of Round Ups in my video below:



Smart Re-Balancing 

One of the important investing principles for new investors to embrace is diversification. As you diversify your portfolio with stocks and ETFs, you may notice that overtime your original portfolio allocations are no longer the same.

For instance, you may have started with 10% of your investment portfolio in Starbucks stock. But if the stock has performed well, Starbucks stock may now make up 15% of your entire portfolio. Or if it under performed, Starbucks stock may now make up just 5% of your portfolio. 

Investing apps with smart re-balancing help you manage your account and maintain your portfolio allocations exactly as you set them. Smart re-balancing is an automation tool that with just one click sells your overweight slices and buys your underweight slices to bring your portfolio back to it's target allocations. 

One of the best investing platforms for smart re-balancing is the M1 Finance app

Advanced Order Types 

This last automation feature is more geared towards stock trading, and it's all about automated buying and selling of stocks. 

If you're ever worried about having the time to constantly be watching your phone in order to trade stocks, some trading apps offers an automation feature that automatically trades for you, even when you're away from your phone. These are called order types

The following in bold are advanced order types:

  • Market Orders
  • Limit Orders
  • Stop Loss Orders
  • Stop Limit Orders

This is a great advantage for trading stocks as it allows you to automate your trades and have the app buy and sell stocks for you, at your desired price points

You can see a further explanation of advanced order types in my video below:



One of the best trading apps for using advanced order types to automate your trades is the Webull stock trading app. Webull offers all of the above advanced order types and is 100% commission-free to buy and sell stocks. 

Plus, for a limited time, they are offering readers of Everyday Investing a free stock valued up to $1600 when opening an account and funding it with at least $100.

Even if you're a long term buy and hold investor, like myself, Webull's array of built-in data and investing features make it a great investment platform to consider. 


 

Stage 6: Investment Account Types

When opening a new investment account, there are typically three types of accounts you can open at most brokerages:

  • Individual Investing
    • A taxable individual brokerage account.
  • Joint Investing
    • A taxable joint brokerage account 
      • i.e., for spouses and partners. 
  • Retirement Investing
    • IRA - Traditional Individual Retirement Account
    • Roth IRA - Roth Individual Retirement Account
    • SEP IRA - Simplified Employee Pension
    • 401(k) - Retirement savings plan offered by for-profit companies
    • 403(b) -  Retirement savings plan offered by non-profit organizations and government

Both individual retirement accounts and workplace retirement plans offer significant tax advantages over taxable investment accounts. But we'll discuss them in just a bit. 

Individual Investing Accounts

An Individual investing account is a brokerage account that is taxable. Any time you sell any investments in this account, a taxable event will occur. Typically, taxable events occur when you earn any of the following types of income from your individual investing account:

  • Capital Gains 
    • Any income you earned from selling stocks for more than you paid for them. 
  • Dividends 
    • Any dividend income you earned from dividend-paying stocks you owned.
  • Interest
    • Any interest you earned on un-invested cash in your investment account.
  • Miscellaneous Income
    • Any extra income you earned from your investment brokerage. This may include earning any free stocks, referral income, or other reward income.  

Joint Investing Accounts

A joint investing account is a brokerage account that is also taxable. Everything that applies to individual investing accounts above, also applies to joint investing accounts. The only difference is, joint investing accounts are for two people, whereas individual investing accounts are for one person.  

You can open both individual and joint investing accounts at both your bank or any traditional brokerage. However, most bank and traditional brokerage websites and mobile apps are outdated and not very user-friendly.

If you would like to open an individual investing account at a more easy-to-use investment platform, I would recommend considering Public, Webull, or Robinhood

If you would like to open a joint investing account with a spouse or partner, I would recommend considering M1 Finance

We'll discuss Traditional IRAs, Roth IRAs, and 401(k)'s in the next stage. 

 

Stage 7: Tax Basics For Investors

It is true, nothing in life is free. And much like the income you earn from your job, income you earn from your investments is also taxable in the United States.

To recap, in the United States, when you sell an asset (stock, bond, ETF, etc.), a taxable event occurs. When you sell a stock at a profit, you experience what is called a capital gain

For example, let's assume you bought some shares of ABC stock for $800, and later sold those shares of stock for $1,000. You just experienced a capital gain of $200

Capital gains from investments can be categorized into two types:

  • Short Term Capital Gains 
  • Long Term Capital Gains

The good news is, there are certain investment account types and strategies that can be used to reduce your tax burden.  

Below are some tips on how to reduce your taxes on capital gains and dividends in both individual and joint investing accounts.

Capital Gains and Taxes

Remember, when holding stocks for over one year, you are taxed at the long term capital gains rate (rather than the short term capital gains rate)

If you buy a stock and sell it within one year (365 days), your gains are classified as short term capital gains and are taxed as ordinary income. This means your profits are taxed at your ordinary income tax rate (i.e., your current tax bracket).  Yes, this is the same tax rate that wages from your job are taxed at. 

However, if you buy and hold a stock for longer than one year (365 days) before selling it, your gains are classified as long term capital gains

Depending on your tax bracket, this could provide you with a tax savings of up to 20%. And even better, if you fall into the 10%-15% tax bracket, your long term capital gains tax rate is 0%! 

Yes, that’s right, by holding a stock for at least one year, you could end up paying no taxes on your profits when you sell. See the chart below for reference: 

2020 Capital Gains Tax Rate

Dividends and Taxes 

When it comes to taxation of dividends, they are categorized into two categories:

  • Ordinary Dividends
  • Qualified Dividends

Ordinary dividends are taxed as ordinary income (at your ordinary tax rate, based on your tax bracket). Qualified dividends are taxed at a lower rate.

Ordinary dividends are taxed between 10% to 37%, based on your tax bracket. (This varies by year).

Qualified dividends are taxed at rates of 20%, 15%, or 0%, This also depends on your tax bracket. Please refer to the chart below:

2020 Dividend Tax Rate

In order for dividends to be qualified, they must meet two criteria. The first is pretty easy to meet, but the second criteria is a little more detailed:

  1. The dividends must be issued by a U.S. corporation, or by a foreign corporation that readily trades on a major U.S. exchange, or by a corporation incorporated in a U.S. possession.
  2. The shares of stock must have been owned by you for more than 60 days of the "holding period." This holding period is the 121-day period that begins 60 days before the ex-dividend date.

The "ex-dividend" date is the date after the dividend has been paid out and after which any new buyers would then be eligible to receive future dividends.

For instance, if a stock's ex-dividend date is May 1st, then the shares must be held for more than 60 days in the period between March 2nd and June 30th of that year in order to count as a qualified dividend.

As you can see, you can experience significant tax savings on both capital gains and dividends earned by holding your stocks for at least one year before you sell. Another reason why investing is best for the long term. 

Capital Losses and Tax Deductions

Let's be honest. Nobody chooses to make an investing mistake. But at some point, you'll inevitably lose money from a bad investment. When you do, using capital losses and capital loss carryovers to your advantage can help you earn back a good percentage of what you've lost.

Capital losses are the exact opposite of capital gains. Capital losses occur when you sell an investment for less than you paid, (.i.e., selling it at a loss)

  • For example, let's assume you bought some shares of XYZ stock for $800, and later sold those shares of stock for $600. You just experienced a capital loss of $200

Fortunately, when you sell stocks at a loss, your capital losses can be used as a way to reduce the tax burden of both current and future capital gains

You can claim capital losses up to the full amount of any capital gains that you have. Essentially, capital losses from bad investments can help offset taxes owed from your profitable investments.

Beyond that, you can use up to $3,000 of additional capital losses to offset other sorts of ordinary income. Ordinary income is any type of income earned that is taxable at ordinary tax rates (i.e., income from your salary, wages, interest, dividends, etc.).

Let's give two examples:

Using capital losses to offset capital gains:

  • Let's assume you have a $200 capital gain on one investment you sold, and you also have a $200 capital loss on another investment you sold. 
    • The gain and the loss would offset each other on your tax return.
    • You would now owe no tax on your original capital gain of $200. 

Using capital losses to offset ordinary income:

  • For example, let's say your ordinary income from your salary was $50,000. If you had a $1,000 capital loss and no capital gains, you would only have to pay taxes on $49,000 of your ordinary income. 
    • This essentially ends up acting as a $1,000 tax deduction on your tax return. 

*Note: There is a $3,000 cap on how much of your loss you can use to offset ordinary income. Individuals can only deduct up to $3,000 worth of capital losses per year. For married couples who file separate married returns, each spouse can deduct only $1,500 against ordinary income.

Any amount of capital losses over $3,000 can be carried over to the next year. This is known as a capital loss carryover.

  • For instance, let's say the stock market had a bad year and you had $10,000 in capital losses. You also had no capital gains that year.
  • First, you would use $3,000 of the loss to offset your ordinary income. The remaining $7,000 would carry over to the following year.
  • The following year, if you have $4,000 in capital gains, you could use $4,000 of your remaining $7,000 loss to offset it. You could then use the last $3,000 of carryover loss to deduct against your ordinary income for that year. 

There's also no limit on how many years you carryover capital losses

Essentially, capital losses and capital loss carryovers can act as a type of tax deduction for investors. They make it possible for investors to recoup part of their losses on their tax returns, by offsetting capital gains and other forms of ordinary income, potentially for years to come. 

How To Pay Your Investment Taxes

You may be wondering, how are you supposed to keep track of all your investment income in order to accurately pay your taxes? The good news is, most investment brokerages completely take care of this for you

  • They have automated systems that track all your stock buys, sells, dividends, etc., in a given year. Then every year come tax season, most investment brokerages will provide you with what is called a 1099 tax form. 

Generally speaking, the 1099 tax form calculates all your investment income (capital gains, losses, dividends, and interest) earned in the previous year. Your 1099 tax forms sum up everything you need to know for filing your investment income along with your regular tax return. 

Your 1099 tax forms can then either be imported into tax software such as TurboTax, or handed directly to your CPA or tax professional

TurboTax Tip: When importing your 1099 tax form into TurboTax, it will automatically calculate all your capital gains, losses, dividends, interest, etc. Depending on if you have more capital gains or losses for the given year, the software will instantly adjust the tax you owe, or your tax refund amount, on your regular tax return. 

*Note: I am not a tax professional. Always consult your CPA or tax professional for any individual tax-related advice or guidance. This is just a brief overview of the 1099 tax form. 

You can learn more about how to import your 1099 tax forms into TurboTax in my video below:


 


Nice job! 👏 You now have a brief overview of how taxes play into investing in the stock market. 

But did you know that there are tax-advantaged investment accounts? Ones where you can either earn tax deductions on contributions you make, or completely avoid paying taxes on your investment earnings all together?

Yes, it is true. These tax advantaged accounts are called retirement investing accounts. Each offers a different advantage, and best of all, you can open one as soon as you turn 18. Remember the power of time and compounding?

 

Retirement Investing Accounts

401(k) and 403(b) Plans

Both 401(k) and 403(b) plans are offered exclusively to employees, through employers who offer retirement plans.Typically, with 401(k) and 403(b) plans, your retirement savings are invested into a selection of pre-selected mutual funds.

  • 401(k) - Retirement savings plan offered by for-profit companies to eligible employees who contribute pre or post-tax money through payroll deduction.
  • 403(b) -  Retirement savings plan offered to employees of non-profit organizations and government.

Often times with workplace retirement plans, you do not have much control over your investments. Your employer selects a provider, and you can only invest in the limited selection of mutual funds offered by the selected provider. However, it is still recommended to contribute to your workplace retirement plan, especially if they offer any employer contribution match, [also known as employer match].

For example, some employers will match your 401(k) contributions up to 3%. This means, if you contribute 3% of each paycheck to your 401(k) retirement account, your employer will match that and contribute the equivalent amount from their end, each paycheck. 

Once you find yourself contributing up to your employer's match percentage (assuming they offer an employer match), it is recommended to then open an individual retirement account to invest any amount beyond that employer match percentage. 

Advantages Of Opening An IRA

An individual retirement account (IRA) is a type of tax advantaged account that you can use to save for retirement, outside of a workplace plan. Inside your IRA, you can hold investments such as stocks, bonds, mutual funds, etc. 

Unlike workplace 401(k)'s and 403(b)'s, IRAs offer a lot more control over what you invest in and where you invest

There are three types of IRAs:

  1. Traditional IRA
  2. Roth IRA
  3. SEP IRA

All 3 types of IRAs offer tax advantages. The main difference between them is how and when you receive potential tax benefits.

Roth IRA vs Traditional IRA 

To Roth or not to Roth, that is the question...

  • The Traditional IRA allows people to make pre-tax contributions. It is built for people who expect to be in the same or lower tax bracket in the future.
  • The Roth IRA allows people to make after  tax contributions. It is built for people who expect to be in a higher tax bracket in the future. 

With traditional IRAs, you deduct contributions now and pay taxes on withdrawals later. With Roth IRAs, you pay taxes on contributions now and get tax-free withdrawals later.

Whether you think your annual income and tax bracket will be lower or higher in retirement is a key factor in determining which IRA type to choose. There are more detailed nuances to consider when deciding which is the right IRA type for you, but they are beyond the scope of this beginner's guide. In my opinion, below are just a few of the key differences. 

Traditional IRA: Tax Deductions and Tax Credits

Traditional IRA contributions are tax-deductible on both state and federal tax returns for the year you make the contribution. As a result, withdrawals, which are officially known as distributions, are taxed at your income tax rate when you make them, presumably in retirement. 

Contributions to traditional IRAs can also lower your taxable income in the contribution year. By lowering your adjusted gross income (AGI), this can help you qualify for other tax credits you wouldn’t otherwise qualify for.

Roth IRA: Tax Free Growth and Tax Free Withdrawals

With Roth IRAs, you don’t get a tax deduction when you make a contribution, so they don’t lower your adjusted gross income that year. But, as a result, your withdrawals in retirement are generally tax-free. Essentially, you paid the tax bill upfront, so you don't owe any taxes on the back end.

The reason I am such a big fan of the Roth IRA, for most long term investors, is because you get tax-free growth on your contributions and you get tax free withdrawals come retirement age.

In addition, with a Roth IRA you can withdraw your contributions (not any gains) at anytime without penalty.  You can not withdraw contributions from a traditional IRA without facing early-withdraw penalties up to 10%, (i.e., withdrawing before retirement age).  

Traditional IRA Benefits

  • Contributions act as immediate tax deduction on your upcoming taxes.
  • Taxes are deferred until you withdraw at retirement age.
  • Can help you qualify for more tax credits by lowering your taxable income. 

Traditional IRA Disadvantages

  • Taxes are owed when you withdraw at retirement age.

Roth IRA Benefits

  • Tax-free growth of your contributions.
  • Tax-free withdrawals (distributions) at retirement age.
  • Can withdraw your contributions at anytime without penalty.

Roth IRA Disadvantages

  • Does not offer an immediate tax deduction.

Yearly IRA Contribution Limits

Annual contribution limits restrict how much you can contribute to your IRA each year. This amount can adjust yearly. As of 2020, the annual contribution limits to both Traditional and Roth IRAs are the following:

  • Under age 50: $6,000 annual contribution limit 
  • Age 50 or older: $7,000 annual contribution limit

In case you want the benefits of both types of IRAs, you can actually own both a Roth and a traditional IRA. However, your total contributions in all accounts must not exceed the overall IRA contribution limit for that tax year. 

SEP IRA

The SEP IRA is an optional IRA for self-employed persons. Because self-employed individuals don't have a workplace retirement plan, such as a 401(k), the SEP IRA offers additional retirement savings to make up for that.

  • The SEP IRA is built for self employed individuals. It has a higher annual contribution limit than individual IRAs. 

The SEP IRA is taxed as a traditional IRA, not as a Roth. Much like with traditional IRAs, with SEP IRAs, you deduct contributions now and pay taxes on withdrawals later


You can open Roth, Traditional, and SEP IRAs at your bank or any traditional brokerage. However, most bank and traditional brokerage websites and mobile apps are outdated and not very user-friendly.

If you would like to open a retirement investing account at a more easy-to-use investment platform, I would recommend considering one of the following options: Acorns Later, M1 Finance Retire, Stash Retire, or a Webull IRA

You can learn more about the differences between a traditional and Roth IRA in my video here: 



 

Food For Thought?

If retirement accounts offer such significant tax savings over taxable investment accounts, why would anyone open a taxable non-retirement investing account?

Well, there are actually good reasons to use both account types

IRAs vs Taxable Accounts 

Pros of Tax-Advantaged IRAs

  • Traditional IRA contributions provide immediate tax deductions each year. 
  • Traditional IRA taxes are deferred until withdrawal at retirement.
  • Roth IRA provides tax-free growth and no taxes owed at withdrawal time. 
  • Ideal for saving for retirement age. 

Cons of Tax-Advantaged IRAs

  • Can only withdraw after retirement age.
    • Currently age 59½ in the US. 
  • Face early-withdraw penalties up to 10% if withdrawing early
  • Annual contribution limits restrict how much you can invest each year. This amount can adjust yearly. Currently:
    • Under age 50: $6,000 annual contribution limit 
    • Age 50 or older: $7,000 annual contribution limit

Pros of Taxable Individual Investing Accounts

  • Can access and withdraw your money at anytime, without any restrictions or penalties. 
  • No limits to how much you can contribute every year. 
  • Ideal for growing money you plan to access before retirement age. 

Cons of Taxable Individual Investing Accounts

  • They are not tax-advantaged. 

 

Bonus: 7 Key Investing Principles

Before you start investing in the stock market, there are a couple key investing principles you should be aware of. These principles can help you create a sustainable investing plan to both grow your money and avoid costly mistakes. 

1) Don’t Try To Time The Market

You may have heard of the term, “timing the market.” When you hear others discussing “timing the market,” it refers to jumping in and out of the market by buying when the stock market is low and selling when the stock market is high. 

While it sounds great in theory, it is not so feasible in real life. Even expert stock analysts can’t predict when the stock market will have a drastic up or down fluctuation. 

Successful long term investors will tell you that most of the growth of your money doesn’t actually come from timing the market, but rather, from time in the market

Those who try to time the market often think that selling their stocks when the stock market is high, and rebuying those stocks when the stock market is low, is the best thing to do. But consider this:

  • If you sell your stocks when the market is at a high, expecting it to drop back down, what happens when the prices of stocks continue to rise higher? You just missed out on potential gains

As a result, you may experience FOMO (fear of missing out), and end up rebuying your stocks at a higher price point than you originally had. 

The longer you are invested in the market, the longer time horizon you have to weather any short term stock market downturns and come ahead on the other side. Not only that, but the longer you are invested in the market, the longer the time frame you have to experience the full power of compound interest.

The best time to start investing was yesterday. The second best time to start investing is now. Always remember, your investing success will come from time in the market, not timing the market. 

2) Avoid FOMO

As we previously mentioned, FOMO often causes new investors to rush to buy a hot stock whose price is quickly rising. 

For instance, a few years back in 2017, you may remember Bitcoin came on the scene in a big way. 

The price of Bitcoin quickly rose from $2,500 to nearly $20,000 within about 6 months. However, by the time it became mainstream, the price of Bitcoin was over $15,000 for just a single coin. 

Many new investors flocked into Bitcoin once they saw how quickly the cryptocurrency was shooting up. They did not want to miss out on this "hot investment." 

Unfortunately, I was one of the new investors who had FOMO once the price surpassed $10,000. I began to pour a lot of money into the hot cryptocurrency, thinking it would only keep going up

I, along with thousands of other investors poured a lot of money into Bitcoin, and bought the cryptocurrency at all time highs.

Wouldn’t you know, within 2 months the price of Bitcoin plummeted from nearly $20,000 per coin all the way down to $7,500 per coin. And within one year of that December 2017 high, the price of Bitcoin was sitting at just $3,000 per coin

Yes, this is an extreme example unrelated to stocks, but the lesson here holds true. Never be pressured into investing a large amount of your money into a “hot” investment because you’re afraid of missing out

3) Don’t Be Afraid To Buy Stocks On Market Dips 

At the end of the day, whether you’re investing in stocks, ETFs, or anything else, do not feel pressured to buy at all time highs

Remember, the stock market fluctuates up and down. There will always be opportunities to buy stocks at a discounted price.

Conversely, when stock prices drop, new investors believe this is the worst time to buy stocks. But consider this:

When you go shop at your local Target or Walmart, would you not stock up on your favorite household items when they go on sale?

Yet, when the stock prices of Target or Walmart go on sale, we are hesitant to buy it. 

As long as you are investing in quality blue-chip companies, buying stocks when their price dips can be one of the greatest ways to get quality investments at a discount.  

One of Warren Buffett’s most famous quotes is, “be greedy when others are fearful and be fearful when others are greedy.”

The underlying value of a stock does not change in the short term, only the stock's price does. There will be times where the stock's price may be high simply due to investor's rushing in due to FOMO. Other times, the stock's price may be low simply due to investors rushing out. Again, due to fear.

4) Only Invest In What You Understand

  • “Buy, Buy, Buy!”
  • “Sell, Sell, Sell!”
  • “This stock’s going to explode, guaranteed bro!” 

These are just some of the things you might hear, from everyday novice traders all the way up to experts on Wall Street.

But this is not an investment strategy. This is just following a hot-stock tip, and hot stock tips are just a quick way to lose your money. 

Instead, the best investment strategy is to simply invest in what you understand. Think of quality and innovative companies you know, shop at, or buy services from, and then, do your research on them.

Not only will your money be invested in quality and sustainable companies, but you’ll sleep better at night knowing exactly what your money is invested in. 

5) Diversify, Diversify, Diversify

You may have heard of the expression, “don’t put all your eggs in one basket.”  

As you begin to build your portfolio, it is important to consider diversifying your investments. 

Remember, when you only invest in one stock, or a few stocks, you open yourself up to more risk. Your overall investment portfolio is dependent on the performance of a single company, or a few single companies. 

  • This is why index funds and ETFs are such an efficient way to create instant diversification. A single ETF can hold 50, 80, or even hundreds of individual stocks. 

Even more aggressive investors recommend to never invest more than 20% of your money into any single investment. And more conservative investors would likely tell you that 20% of your money in any one stock is still far too risky. 

Again, this all depends on your risk tolerance, investing time frame, and personal investment goals. The key takeaway here is that no matter how great a particular company may seem, you don’t want to place all your money on that single stock

Yes, it can be tempting to invest all your money in that one hot up-and-coming stock that’s price has increased over 200% in the past year. But at some point, it will decrease. And if you went all in at a market high, it could be a very painful lesson when it drops. 

6) Stocks Are A Long Term Investment

Remember, in the short term, the market can fluctuate both up and down. But over the long term, the stock market has a history of increasing in value. 

Most successful investors recommend that you should have a minimum time horizon of 3-5 years when investing in a stock. When you are investing in a shorter time horizon, you are not making an investment, but rather, a speculation. 

Statistics have shown, that simple long term investing has been the most reliable strategy for millions and millions of successful investors to become millionaires. It is proven, sustainable, and easily manageable over time. 

I am a long term investor. This is my investment approach. I do not have any courses on day trading or short term trading. That is not my area of understanding. But what I can tell you, is this: When I first began investing in the stock market, I was lured in by the “flashiness” and promise of day trading. 

I made some quick profits at first. But as the weeks went on, I began to lose all of it. I soon realized that day trading was not going to be a sustainable strategy for me. 

Investing is sustainable growth over the long term. Trading offers potential profits in the short term. But they are completely different strategies

It takes a dedicated type of person to be a consistently profitable trader. Active stock trading requires daily research, analysis of charts, and most of all, a very high risk-tolerance. 

While it is not impossible to be a successful trader consistently, just know that it will take a lot of dedication and practice. However, if you are willing to put in the work to be a successful trader, then there is no better platform to practice on than Webull

Millions of investors have become millionaires simply from long term investing in quality stocks and indexes over decades. Only a handful have become millionaires from day trading. 

Remember, as we learned earlier, statistics show that 90% of day traders can’t outperform a simple S&P 500 index over the course of a few years. Imagine trying to outperform it over the course of decades and decades. 

7) Invest, Don’t Gamble

Whether you are investing in individual stocks or index funds, you want to build the foundation of your portfolio around quality companies

One of the best books on investing in the stock market is a book called The Intelligent Investor, by Benjamin Graham. 

Graham, is widely known as the “father of value investing,” and the mentor to Warren Buffet. In his book, Graham goes into great detail about understanding the difference between an investment and a speculation. The following quote summarizes his distinction.  

“An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.” - Benjamin Graham

According to Graham, if you feel the need to speculate with your money, you should not invest more than 5% of your overall portfolio into speculative investments.Graham suggests that when you invest in any company that is not turning a profit, you are not making an investment. Instead, you are making a bet, a speculation. You are betting on that company achieving profitability before they go bust. 

When you make a speculative investment in a hot penny stock, or company that is not making a profit, you are taking a gamble. But if you must, do so with no more than 5% of your overall portfolio

 

Final Thoughts

Always remember, investing is a long term process. In the short term, the stock market can fluctuate both up and down. It is over the long term where the stock market has a history of increasing in value.

No matter how much or how little you have to get started with, anyone can grow real wealth with time, consistency, and compound interest. Below are some core ideas to keep in mind:

  • Most new investors should simply start by investing in an index fund.
  • One of the most efficient ways to invest in index funds is through ETFs. 
  • If you want to invest in individual stocks, consider investing in reliable and time-tested blue chip companies.
  • You can make money in the stock market from both asset appreciation and dividends.
  • Look for investing platforms with easy-to-use investing automation features, like these
  • Before trading stocks with real money, consider practice trading with this app first.

 

Congratulations! 🙌

Nice job, you have completed the beginners guide on getting started investing in the stock market! 👏

If you'd like to learn more about any of the investing apps I mentioned in this guide, feel free to check out our in-depth reviews of each platform here

There's not a single app that's perfect for every investor, but there's a perfect app that's right for each investor. Together, we'll help you find the perfect investing app that's right for you.

Happy Investing,

Erik

 


Other Recommended Guides:


Best Investing Apps For New Investors

Top Stock Trading Apps For Beginners

 

Need help with investing? We can help you find the right investing platform for your financial goals.

COMPARE INVESTING PLATFORMS

Grab Your Free Investing For Beginner's Guide Below! 👇

GET GUIDE

Or Go Back To The Blog 👈

TAKE ME BACK
Close

50% Complete

Two Step

Lorem ipsum dolor sit amet, consectetur adipiscing elit, sed do eiusmod tempor incididunt ut labore et dolore magna aliqua.