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Investing Basics: A most concise guide

2018-07-04, Michael Thompson

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Investing Basics: A most concise guide

Last updated Oct 1, 2021

This article explains what you need to know to get started investing. It has been made as concise as possible. Links are given where you may want additional information.

Foreword

There’s no single investment strategy or portfolio that’s best for everyone. Money saved to buy a house in 2 years should not be invested like money being saved for retirement in 30 years!

Differences in personality also play a role. The stock market has had major downturns. Some people panic in these situations, selling shares at huge losses. Such people shouldn’t hold excess stock—it’s too likely another downturn will occur. Only those with the tolerance to hang on will truly reap benefits from stocks.

How much should I invest?

Of course, the answer here is highly dependent on your goals. The first step in investing is to write down your goals. How much money do you need, and when do you need it?

Most investment goals are related to retirement. A typical goal is to retire around 65-70 with the ability to maintain pre-retirement, inflation-adjusted spending. This goal typically requires workers to invest about 15% of their paycheck for retirement. This topic is discussed further in our article "How much to save for retirement."

Before investing any money, most experts recommend you pay off high-interest debt and build an emergency fund. Your emergency fund should be enough to cover about 3-6 months of expenses without your salary.

Don’t forget savings for other needs or desires. The typical family will need to save for kids’ education, a house down payment and retirement.

What should I invest in?

The primary investments are stocks, bonds and real estate. If you own or plan to purchase a home, then that alone may be enough to check off the real estate box.

Other assets like cryptocurrencies, gold and other commodities are less reliable. They don’t generate cash flow or have any intrinsic reason for growing value, but if/when they grow in popularity, they can generate positive returns. Experts are divided on whether the average investor should buy these speculative assets. However, most agree these should be limited to a small percent of your portfolio, given the high risk of little or no return even over long time horizons.

The table below lists various types of assets, including their percentage of a typical portfolio. There are some major variations in the left column—people have vastly different goals and opinions when it comes to asset allocation. A key consideration is reducing exposure to more volatile investments like stocks and cryptocurrencies as you approach a time when you’ll need to withdraw/use the money. (You don’t want to sell your investment at a large loss right after a crash.)

In the right column, we included popular funds that you can purchase from most brokerages in the US. These funds offer good diversification within the asset class with minimal fees. For example, VXUS holds stocks in almost every public company in both developed and emerging markets outside the US, including small-, mid- and large-cap businesses. You get all that for an expense ratio of just 0.08% at the time of this writing.

Notice that cash is not listed in this table. Experts agree (and history shows) that holding excess cash almost guarantees a loss of purchasing power over the long term.

If you're interested in some other asset not discussed here, we recommend reviewing this information from the SEC.

Percent of total investmentAsset classRecommended fund
20 to 90US StockVTI
10 to 50International StockVXUS
0 to 35Long term US treasury bonds (20yrs+)VUSTX
0 to 25Real estateVNQ
0 to 15Intermediate term US treasury bonds (7-10 yrs)FIBAX
0 to 15US Treasury inflation protected bonds (TIPS)VTIP
0 to 10GoldIAU
0 to 8CommoditiesGSG
0 to 5CryptocurrencyBitcoin

How do I get my money into these investments?

Please see our quick start guide for more information about getting your money invested. We recommend using Vanguard if you plan to passively invest in Vanguard funds (Jack Bogle and Warren Buffett recommend this approach). As covered in our quick start guide, you'll start by creating an account with one of these brokerages and then wiring money to them from your bank account.

Anything I should do with my 401k?

If your employer matches a reasonable percentage of your 401K contributions (over 25%), most experts recommend taking full advantage of that. A 401K (and IRA) has the added benefit of reducing your taxes—the IRS removes your traditional 401K contribution from your income when computing your taxes! We recommend setting aside a few hours to investigate the investment options (mutual funds) available in your 401K, along with the expense ratio of each. High expense ratios (over about 0.5%) typically lead to subpar performance. See the first table here regarding the impact of seemingly small expense ratios over time. We recommend passively managed index funds (e.g. VOO and VTI have a 0.03% expense ratio). You may want to redistribute the money in your 401k to different funds, but beware of transaction fees too!

Who to go to for help.

Experts recommend consulting a fiduciary financial advisor. You may have to pay a bit more to get a fiduciary (as opposed to a non-fiduciary advisor), but experts highly recommend this to ensure your advisor is looking out for your best interests. Click here for more information about the differences.

Other notes from the experts.

  • Roth IRA or 401K. Roth accounts (IRA or 401k) are an alternative to traditional IRAs and 401ks. The difference is the way they are taxed. A Roth is taxed on the initial investment, at the time the investment is made. You pay no taxes when you withdraw money during retirement. Traditional 401Ks and IRAs are taxed when the money is withdrawn (no taxes until then). Although no one is sure, most experts expect taxes to increase significantly in the future, which could make a Roth a better option.
  • Jumping in. If you’ve been saving cash, the thought of suddenly investing it all and then experiencing e.g. a stock market crash is daunting. This prevents some people from investing. Experts agree that holding too much cash is the most likely way to fall behind financially, long term. One strategy to avert this fear is to gradually invest the money over time (e.g. see dollar-cost averaging).
  • Life insurance. Surprising to some, life insurance can be a good deal, primarily due to tax breaks. Money invested in these policies can be invested, grown, and withdrawn tax-free (no taxes at any step). However, one must be careful to select a beneficial policy. Policies from not for profit organizations like TIAA-CREF are recommended.

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