At some point in your life, you might realize that without having different streams of income, you'll keep trading your valuable time for money. This is one of the worst financial decisions one can make, regardless of the stories you've been told.
Then there's a pretty good chance you also started thinking about different ways of turning your savings into profits. And if you've already done some research, you probably already stumbled across the term "buying stocks" or the “stock market.”
More and more people are starting to realize that owning stocks can help you build savings and be an essential part of your investment portfolio and help protect your cash from inflation and taxes.
If you're thinking about investing in stocks, but you don't know where to start and feel overwhelmed by all the information out there, this step-by-step guide will take you through how to invest in stocks. It will help you to ensure you're starting and doing it the right way.
1. Choose your investment approach
Before you learn how to invest in stocks, you have to be honest with yourself and determine what type of person you are. Without knowing your financial strengths and weaknesses, there's a pretty good chance that you'll fail in the stock market before even starting.
If you don't know about the stock market, you're not good with numbers and don't have enough free time to do some proper research. As an investor, you should avoid investing in individual stocks (at least while you're still a newbie). The good news is that you can still learn how to invest in stocks regardless of your level of experience, knowledge, and available time. The only thing you need to do is choose the right way and path for your future stock investing.
The different approaches an investor can take
If you're an analytical person, are very passionate about doing detailed research, and wouldn't mind evaluating stocks daily, you're a great candidate for this type of investing. Picking individual stocks means that you're responsible for building a portfolio of stocks. You will have to read annual reports, financial statements, understand acquisition and disposal decisions, keep track of the companies you’re investing in, and generally understand how the stock market works.
While some people think it's way too complicated and even seems like intellectual and financial torture, others find it quite challenging and exciting. In case all of the terms regarding individual stocks or the stock market sound too scary or unfamiliar to you, try to avoid investing your cash in any individual stocks.
Index funds are an investment that tracks a stock market index, and such funds have so-called fund managers. Their job is to ensure that the index fund and the index perform and remain the same. An advantage of index funds is that they usually have much lower costs compared to individual stocks.
There are hundreds of different indexes you can decide to track, but the most popular is the S&P Index.
It includes the top 500 companies in the U.S. stock market, so it's a great option to start with. By using their filtering systems, you can find indexes for specific industries and country indexes or style indexes that track companies that are growing rapidly.
There are two main types of managed funds - passively (i.e., an index fund) and actively - which is more a mutual fund (discussed below). While passive stock investing is more prevalent in the stock investing world, there are also benefits of active stock investing, so it's good to learn more about the critical differences between them.
Mutual funds in a blend of securities and passes on the earnings to its shareholders. The fund manager chooses the mix according to the fund's investing strategy. Each fund has its own specific focus that dictates the type of stocks or bonds it will purchase.
For example, a technology fund will choose high-risk, high-growth stocks in the technology sector while a bond fund will opt for government bonds that provide security and a lower rate of return. For new investors, though, I recommend core mutual funds.
Core mutual funds are designed to minimize investors' risk of losing money. The fund's earnings are based on dividends from long-established companies that are expected to remain stable.
These funds are known as "core" funds because they form the foundation of a well-diversified investment portfolio. The stability of this base of core funds allows an investor to take more risks with the remainder of his fund choices without risking the loss of his entire portfolio.
The lower risk of a core fund also reduces its income and potential attraction for some types of investors. These funds are not the best choice for younger investors who have time to make up for any losses through investing before they retire. They are better suited for beginner investors or those who are closer to retirement and cannot take the chance of losing significant value.
Managers of core mutual funds look for stock in large companies with a history of stability. This often includes blue chip stocks such as General Electric, IBM and Microsoft.
The holdings of a core fund are usually more diversified than a comparable index fund. Core funds must invest in a large number of different stocks to minimize the impact of any individual stock's bad performance. However, this also prevents the fund from achieving exceptionally high returns because one profitable stock cannot do much to raise the overall earnings.
A fund manager can employ different investment strategies while still remaining a stable core fund. Large-cap blend funds invest in large companies with average stock prices. These are the most stable types of core funds.
Large-value funds focus on stocks with the lowest share price in relation to other large companies. This investment strategy allows more room for growth, but also exposes investors to more risk. Foreign mutual funds can also be considered core funds as long as they choose large, stable companies from their local markets.
Exchange-traded funds (ETFs)
The term ETF stands for exchange traded fund, and it is essentially a basket of stocks – much like a mutual fund. When an investor buys mutual funds and ETFs he or she is actually buying a piece of all the stocks contained in that fund. Some of the best known and most widely traded funds are the Total Stock Market ETF, which trades under ticker symbol VTI, and the Standard and Poors 500 ETF, which trades as SPY. In Wall Street lingo these ETFs are known respectively as Vipers and Spiders.
While ETFs began their lives as a low cost way for investors to buy shares in one of the major stock indexes, they quickly grew to encompass much more than the S&P 500, the Dow Jones and the total stock market. These days there are both mutual funds and ETFs in just about any category you can name, including foreign ETFs that track either a single country or a group of countries, as well as ETFs that track the price of commodities like gold. In fact any investor considering buying gold as a hedge against inflation may want to track ticker symbol GLD, an ETF that rises and falls in value based on the price of gold.
As with any investment, there are both advantages and disadvantages to investing in exchange traded funds. As with mutual funds and other stock market investments there is no guarantee, and investors can lose money as well as make it. It is therefore essential for each investor to assess his or her tolerance for risk before getting started.
One place where mutual funds and ETFs differ is that ETFs can be traded in real time, allowing investors to take advantage of even small price changes. When an investor sells a mutual fund the price is set at the end of the trading day, but with ETFs the price changes throughout the day – a big advantage in a volatile or fast moving market. This also allows investors to set a specific price at which to buy or sell – another important advantage over mutual funds.
On the downside there is the cost associated with buying the ETFs, most notably the commission fee that must be paid to the broker. It is possible, however, to greatly reduce these costs by dealing with an online discount broker. With this strategy the cost of each buy or sell can be less than $10. In addition there may be ongoing costs to reinvest the dividends and capital gains that accrue, while with mutual funds, those dollars can be automatically reinvested at no charge.
So should you pick mutual funds or exchange traded funds? It just depends on what you want. Mutual funds are great, but they can be more expensive. ETFs are cheaper, but there’s no active management of them. Do what fits best with your financial objectives.
A relatively new type of investment advisor are robo advisors. After the Financial Crisis in 2008, this option exploded in popularity. Jon Stein and Eli Broverman of Betterment are often considered being the pioneers in the robo advisor industry. They were one of the first to advocate technology usage to lower costs for investors and streamline investment advice.
How does a robo advisor work? Robo advisors provide automated investment services, which means they invest dollars on your behalf, based on different algorithms that make the investment decisions using personal data like your age, risk tolerance, and investing goals. A great thing about robo advisors is that investors don't have to have a lot of knowledge or experience. It's not time-consuming.
They're pretty easy to use, the fees are low, as well as the minimums, and you'll get a well-designed investment portfolio. The disadvantage of a robo advisor is that they lack the customization of financial advisor portfolios, and most of them lack alternative strategies and investments.
2. Set a budget
How much money should you invest in stocks?
There is technically no minimum to start investing in stocks, it can be done with as little as $100. But if you, as an investor, want to start it right, you will probably need between $200 and $1,000. Most brokerages don't have minimums to open an account and buy stocks, so you could theoretically open it with and buy stocks with just $1. However, you should have enough cash for the following things:
- You need to have enough cash to afford a single share of stock
- You need to buy enough stocks to be properly diversified
- You need to be aware of the trading fees and protect your profits
Afford a single share of stock
Yes, investors can open an account with just $1, and you can even buy penny stocks for under a dollar. Still, if you're thinking about becoming a stock investor, it's not the right place to start. If you want to start investing, you will need to have enough investable money to afford at least a single share.
You need to buy enough stocks to be properly diversified
Volatility when you invest in the stock market is a real thing. So the goal should be to buy between 10 to 30 different positions to be adequately diversified. This doesn't mean that if you have around $2,000 to invest, that you'll have to divide it among 10-15 positions. It's completely normal and recommendable to start with just a few positions and work your way up and add more money over time.
Also consider the type of stocks you’re buying. For example, don’t invest just in growth stocks (think companies like Tesla and Apple). You want to put some money into stable businesses that provide dividend payments (even if they’re not sexy). GM is a good example.
Be aware of the trading fees
An element that many investors don't think about in the beginning is trading fees. If you're planning to start investing a small amount of money, the trading fees you'll need to cover could easily cut down your profits.
Although the fees are not high, they can damage profits in the case of small investments. On the other hand, if you're planning on playing full out and want to invest a lot of money, the trading fees are not a big deal.
A good rule to follow in the beginning is that in case you're planning to start with less than $5,000 (which is entirely normal and acceptable), start looking for a broker that offers free trades.
So, how much should you invest? There is no simple answer to this question. Investing any extra dollar wisely could be worth much more in the future. However, you still have to protect your health and your financial future. For this reason, never invest money you'll need in the next five years, or that could put your entire financial future at risk. You should also avoid investments that cause way too much stress. It's just not worth it.
Deciding how much of your money you want to invest in stocks is just a part of the equation, so before we start talking about different types of investment classes, let's go through the list of don*ts when it comes to investing your money in stocks.
The first thing you should keep in mind is that if you're planning on investing in stocks, it's a long-term investment, so you don't want to invest any money you'll need within the next five years.
Here are some of the examples of savings that you should not invest in stocks:
- your children's college funds
- your emergency fund
- your next years holiday season or vacation fund
- your home saving fund
Investing in any of the funds mentioned above could do more damage than good, so you should forget about them completely when thinking about how you want to invest in the stock market.
The money you want to start investing in stocks is the money you won't need within the next five years. This concept is commonly known as asset allocation. It allows investors to achieve their returns while reducing stock market volatility to keep the risks of permanent loss of their capital as low as possible. Asset allocation means that the investor divides the money into different assets (cash, bonds, stocks, and real estate). Each of the asset classes can be divided into sub-sectors.
A few factors play an essential role in asset allocation (like your age, your investment objectives, and your risk tolerance).
For example, if you're still in your 30's, you still have years and years of retirement planning in front of you, so even when there are some downs on the stock market, you'll have plenty of time to wait for the ups and wait for the right move when the right time comes.
But what if you're almost retired? In this case, any stock market downturn would pose a considerable risk to your investment. For this reason, the desire to start investing in stocks typically decreases with age.
The question is - how to establish a well-set asset allocation? A rule of thumb you can follow is to subtract your age from 110, so you could get the recommendable investment percentage. Let's say you're 45 years old. In this case, using the formula would mean that 65% of the money you want to invest should be invested in stocks, while the remaining 35% should be in fixed income.
3. Open a brokerage account
It’s not hard to find a good brokerage firm these days. So getting started with your own investment account is usually easy. However, you should think about the type of brokerage account that will be suitable for you and your long-term investment goals.
If you're still a beginner in the whole stock world, choosing between a taxable investment account and an individual retirement account (IRA) is an excellent place to start.
If you're looking for an easy way to access your account and want to ensure some side money you can count on, or want to start investing more money than the annual IRA limit allows, then you're a great candidate for the standard brokerage account. You can also sign up with one of many discount brokers to save extra cash, too.
On the other hand, if you're thinking about your future retirement and want to build up a financial fund you can use when you're older, you should start thinking about opening an IRA account. A great this about IRAs is that they offer many tax advantages. Still, the downside to this account type is that you can't count on your money until you get older when you can withdraw it.
Here's a list of some of the current best online brokers you can start with:
- TD Ameritrade
- Interactive Brokers IBKR Lite
- TD Ameritrade
- Merrill Edge
- Zacks Trade
- Ally Invest
- Charles Schwab
- Fidelity Investments
4. Decide which stocks you'll invest in
With so many stocks to choose from, how do you go about selecting the ones worth buying? Although the decision is entirely up to you, there are some things you should do to stay on the right track.
Don't invest in stocks you don't understand
As with any other thing in life, if you pick a sector you don't know anything about, you'll end up feeling drained, financially and emotionally. Pick an industry that interests you and explore what's happening in the stock market. It's much easier to follow the trends when you're researching an industry you already like.
Determine your goals
One of the first steps you'll need to take is to decide your portfolio's purpose. Whether you want to generate an income for your retirement or you're more focused on creating or preserving wealth, the goals you determine require different investment strategies, so you need to be clear about them right from the start.
Do your research
It seems that almost everyone has an opinion when it comes to stocks. Be wise enough to do the research independently and take every piece of advice with a grain of salt. Of course, if you know some extremely successful stock investors, following their mentorship and example can be a great advantage. But even if that's the case, at the end of the day, your investments and your goals are just yours.
5. Make it a priority to keep investing
Hopefully by now you have a better understanding of how to invest in stocks. One of the easiest things you can do is buy shares of successful businesses for a reasonable price and hold on to the shares as long as the company remains successful. You won't avoid volatility along the way, but you can count on excellent investment opportunities if thinking long-term.
The legendary investing guru Warren Buffett defined investing as "…the process of laying out money now to receive more money in the future."
Having money work for you while you're busy with your life is one of modern society's most significant advantages. If done the right way, investing in stocks is one of the best ways to secure a successful financial future. And it's about time that you finally join the club.