Investing 101: 5 steps to build passive income

In order to build wealth and meet your financial goals, you can’t just save money. You have to invest. Before you start investing, it’s important to clarify your strategy based around your short- and long-term financial goals. Use these 5 steps below as your guide.

Step 1: Write down your investment goals

Most people invest money with the hopes to make a profit. While this makes logical sense, your goals need to be more specific.

Whether you have one goal or many different ones, finding clarity on your why should be the first step in crafting an investing plan. This is imperative, as different investing goals may need different plans and different investment accounts. 

Step 2: Create a timeline for when you need the money

Once you make your investing goals, the next step is to create a timeline for when you need the profits.

For example, if you know you will need money to buy a home in a couple years, then you will likely make much different investments and take much less risk than if you are investing money for your kids' college over the next 10 years, or planning to build wealth over the next 20 years. What is the timeline for each of your investing goals?

Step 3: Determine how much money you plan to invest

Now that you have a list of the reasons you are investing and the timeline for when you need the money, make sure you know how much you need for each goal. Perhaps you need $2 million to retire? Maybe you want to save up $200,000 for your kid’s college, or maybe you need $50,000 as a down payment on a home. Once you know the overall amount needed, figure out how much money you want to invest each month or each paycheck to help you reach your goals.

Ideally, this should be a concrete and realistic number, and something you can start doing with your next paycheck. 

Take a look at your monthly income and spending habits. Pinpoint areas where you can cut back and write down a total amount you can use to invest each month or each year. If you have $400 to invest each month, you could consider using 75% of it to build wealth for retirement and the remaining 25% to save for a down payment on your future home. Or, maybe you carve out a special 10% of the total amount to start investing money for your kid’s college?

The amount you invest is up to you, but come up with a number you can use to invest from each paycheck to put towards each of your goals. 

Step 4: Figure out what type of investments are right for you

You can choose to invest in bonds, stocks, cryptocurrency, real estate, fine art, startup businesses, etc. The choice is yours. However, it’s wise to remember that different types of investments have different levels of risk and different degrees of profit. 

For example, buying an individual stock or investing in a startup may have the potential to make a lot of money. However, those types of investments can also come with a high level of risk, as there is a chance you could lose all of your money if the company tanks or the stock goes down in value. 

Other people choose to invest in real estate in an effort to increase their cash flow (from rent payments) and decrease their taxes (as they are able to deduct many expenses), but there are downsides as well. Some of them take on a great deal of debt, in the form of a mortgage, to purchase the properties and have other costs like maintenance and repairs to pay for. 

If you don’t know where to start, focus on the basics. Most people who are new to the world of investing purchase index mutual funds (large funds that are full of hundreds, if not thousands, of different stocks or bonds, from many companies in a variety of industries). They invest in these index mutual funds to increase diversification and minimize risk while still leaving room for a decent profit. 

One of the most common types of index mutual funds people choose when they are investing for a specific goal (that is at least 5 years away) is the Vanguard Total Stock Market ETF. This fund invests in almost all stocks available in the United States. Shares of this index fund, along with many others, can be purchased for a couple hundred bucks, or you can purchase a fraction of a share if you want to invest a smaller amount.  

These types of accounts don’t have the same level of risk as index funds or individual stocks and are similar to putting money in a regular savings account. Why? Because the amount of money put toward these types of accounts can only go up.

Stocks and mutual funds can fluctuate in price daily or yearly, but money sitting in a high-yield savings account or money market fund can only increase, so you will never lose money. The downside of prioritizing these accounts is that there is a limit to how much they can earn. 

Keep in mind, however, that unlike stocks and index funds, which could increase in value over time by as much as 8% to 10% per year, money in a money market fund or high-yield savings account may only earn 1% to 3% per year (although, in rare occasions, they can increase by up to 5%). 

Riskier investments are not guaranteed to perform well, but they can see much higher profit. Most people choose the “safe” investment if they need the money sooner, and the “risky” investment if they don’t need it for a while.

Step 5: Pick the right investment account

The last step of your investing plan is to invest money through the correct account. Many young professionals like to use apps like Robinhood to make their investments, but there may be other types of accounts that could provide greater benefits. 

For example, if you are building wealth for your future and investing for retirement, using your employer-sponsored 401k or 403b may be a good option. Another option is to open a Roth IRA—this account is not tied to your employer and allows for more hands-on investment opportunities (meaning you can choose where you want your money to go).

A Roth IRA will also allow you to take your contributions out of the account at any time, unlike an employee-sponsored retirement account, which is inaccessible until retirement (barring pre-approved special circumstances). 

The type of account you invest in—whether it’s a 401k, Roth IRA, or a taxable brokerage account—depends heavily on your investment goals, timeline, and risk tolerance.