Don’t be embarrassed if you’re not entirely sure how stocks work. To break it down simply, a stock represents ownership in a company.
If you buy 100 shares of Facebook, for example, you actually own a portion of the company, just like founder Mark Zuckerberg. Although your share would be quite small because Facebook has roughly 2.39 billion shares outstanding, you would still participate in the same percentage of profit or loss as every other Facebook shareholder.
If you’ve never invested, all of the names and numbers you’re hearing in the news about stocks might seem like gibberish. And if you’re like 55% of Americans surveyed by GOBankingRates who think they don’t have enough money to invest, you might be reluctant to start. However, once you put in the time and do the research, you can unlock the meaning behind confusing stock terms and learn just how important — and easy — it is to begin investing, regardless of how much money you have.
Here’s what’s covered in this beginner’s guide to investing in stocks:
- Why It’s Smart To Invest In Stocks
- How To Invest In Stocks in 6 Steps
- Step 1. Determine Your Investment Objectives and Risk Tolerance
- Step 2. Understand the Differences Between Stocks, Mutual Funds, Exchange-Traded Funds and Robo-Advisors
- Step 3. Open an Investment Account
- Step 4. Budget For Your Investments
- Step 5. Pick Your Stocks Wisely
- Step 6. How Do I Know When I Should Sell My Stocks?
- The Bottom Line
- FAQ About Investing In Stocks
Investing in the stock market is one of the best ways to create wealth over time. Although past performance doesn’t predict future results, over the long run the U.S. stock market has provided returns approaching 10% annually. Thanks to the power of compounding interest, a 10% annual return means that your money could double approximately every seven years.
Stocks are generally vehicles for capital appreciation, but they can also provide income. As of mid-2019, the average yield for the stocks in the S&P 500 index was about 2%. This cash payout comes to you in addition to any capital gains you may generate from your stocks.
Investing in stocks can also provide tax advantages. If you hold a stock for longer than one year before you sell it, you benefit from the long-term capital gains tax rate. As of mid-2019, this rate was 15% for most stocks. In an environment where ordinary income can be taxed as high as 37%, the capital gains rate of 15% offers significant tax relief.
Of course, all of these benefits are not without risk. Stocks regularly sell off 10% or more, a process known as a correction. On average, the market sees a 10%-plus correction every two years. Individual stocks can fare even worse. This is why a diversified portfolio is critical to long-term investment success.
Investing in stocks requires more knowledge than just choosing which stocks to invest in. Here’s a look at six steps you’ll need to take to start investing in stocks:
Your investment objective is what you want to achieve with your portfolio. Do you want to maximize capital appreciation? Do you need income from your investments? Generally, stock investors have a growth-oriented tilt, but many stocks carry an income component.
Your risk tolerance refers to how much money you’re willing to lose on an investment in exchange for the potential of greater gains. If you want to buy stocks that may grow 20%, 50% or even 100% in a single year, you have to be mentally prepared to lose that much money, as well. Any time the stock market suffers a garden-variety 10% correction, many aggressive stocks drop in value at least twice as much.
Stocks are individual securities that represent ownership in a company. When you see stock prices run across the bottom of a financial news channel, those prices are the dollar amount you’ll need to purchase a single share of stock.
Mutual funds and exchange-traded funds are similar in that they own a multitude of individual stocks, managed by a professional investment company, in a single investment. The primary distinction between the two types of investments is that you buy mutual fund shares directly from an investment management company, whereas ETFs trade on an exchange like a stock. Mutual fund shares are also only priced once per day, whereas ETFs are continually traded on an exchange.
A robo-advisor is a relatively new type of brokerage firm that uses technology to develop portfolios for investors. Robo-advisors ask their clients about their investment objectives and risk tolerance and use that info to develop portfolios of ETFs on their behalf.
To open an account with a broker, you’ll likely be required to provide the following personal information:
- Date of birth
- Social Security number
- Additional financial information, such as your bank name and account number
Online investing is easy, efficient and inexpensive, but there aren’t as many safeguards to prevent you from making bad trades. You’ll generally get low-cost trading, such as $4.95 per trade with Fidelity and $0 with Robinhood. Full-service brokers, on the other hand, provide a wider range of services and more professional “hand holding” for nervous or inexperienced investors, but these services come at a higher cost.
Many traditional firms, such as Charles Schwab, now offer their own automated robo-advisor services as well, such as Schwab Intelligent Portfolios.
Your investments should be a separate budget item than your savings or emergency accounts. The latter accounts are both short-term in nature and should be reserved for unexpected needs so that you don’t go into debt. Your investments, on the other hand, should be for long-term goals, such as retirement or funding education for your children. If you absolutely have to raid your investment for a short-term emergency, try to sell your long-term gains first — or your losers — to minimize your tax consequences.
To help you build up your investment funds fast, stick to the old investment axiom to “pay yourself first.” Before you spend money on discretionary expenses or even pay your bills, divert some of your income toward your savings and investments.
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Before you start investing your money in stocks, it’s important you do copious research to make the best investment decisions for your money. Generally, earnings drive stock prices, so fast-growing companies are popular with investors. However, stock market performance is to a large degree determined by expectations. If a company is expected to do well, there’s not as much opportunity on the upside; and if earnings fall short, look out below — the stock price will likely tumble. If you can find stocks that continually surprise investors with earnings above expectations, you’ll likely find some winners.
Diversification refers to the addition of different types of investments to help mitigate the risk that comes with having all your eggs in one basket. You can diversify your portfolio by buying additional stocks that don’t necessarily trade in tandem. For example, if you own a tech stock like Facebook, you might add an oil company’s stock to diversify your holdings.
Another way to diversify your portfolio is to own different asset classes. For example, if you put money into a mutual fund or add ETFs to your arsenal, it’s likely that portions of your overall portfolio will rise as others are falling. This is one of the benefits of using a mutual fund or robo-advisor, as they each carry a degree of built-in diversification.
Generally, stocks are a long-term investment. Trying to time the market or trade in and out of positions rapidly is a difficult game to master, even for professionals. However, there are some times when you should consider selling some of your stocks, including the following:
- You’re stressed out over potentially losing money. In this case, your stock portfolio isn’t a match for your risk tolerance; you should consider investing in a less risky portfolio.
- You need the money in the next three years. Stocks are a long-term investment; because corrections happen on average every two years, you should trim your stock exposure if you’re saving for a short-term goal.
- The original reason for buying the stock has changed. If a stock no longer has the bright future it did when you originally bought it, it’s time to get out.
- There are better alternatives available. Don’t overlook the opportunity cost of investing in stocks; if there’s another opportunity available that looks like a better option, don’t hesitate to move out of your stock position.
- You need to diversify. If you only own a handful of stocks and nothing else, you might consider selling some of your stock position and moving into bonds, commodities or other diversifying investments.
- You need a tax break. If you sell stocks at a loss, you can write that loss off against your gains, or up to $3,000 in ordinary income.
When investing in stocks, consider which type of stock best suits your investment strategy. Before you buy an individual stock, research the reasons why the share price might go up or down. Just because a company has a name you know or creates a product you like doesn’t mean that the stock will earn you a fortune. If you’re not confident that you’re ready to be a DIY investor just yet, never fear: Between full-service brokerage houses, robo-advisors, mutual funds and ETFs, there are plenty of ways to diversify your portfolio and put a professional money manager in charge while you learn the ropes.
Learn the answers to some of the most frequently asked questions about stock investing.
Q. Is an emergency fund more important than investing in stocks?
A. In a nutshell, yes. A liquid emergency fund will protect you from having to sell stocks at an inopportune time, potentially triggering tax consequences.
Q. How many stocks do I need to own to be properly diversified?
A. You can gain about 90% of the benefits of total diversification with between 12 and 18 stocks, according to investment research firm Morningstar. Additional stocks increase this benefit slightly, but also entail additional tracking, research and possible commission costs.
Q. Should I wait to invest?
A. For a long-term investor, the best time to invest is always now. According to billionaire investor Warren Buffet, markets are unpredictable over the short-term. But “I know what [they] are going to do over a long period of time: They’re going to go up,” he said in a February 2016 interview with CNBC’s “Squawk Box.”
Q. Do I need to be rich to invest in stocks?
A. No. Many firms have a $0 minimum to open an account, and commissions can be as low as zero in the case of Robinhood, or $4.95 for firms such as Schwab or Fidelity. You can also buy certain mutual funds and ETFs for no commission.
Q. Is it risky to invest in stocks?
A. Stocks are riskier than conservative investments like savings accounts, but higher risk can lead to higher reward, too. The longer you hold your stocks, the more likely you are to generate a positive return. In fact, since 1919, the stock market has never had a 20-year rolling period in which it lost money.
John Csiszar worked for 19 years as a financial advisor both with a major wirehouse and at his own registered investment advisory firm. Along the way, he earned his Series 7, 63, and 65 licenses, in addition to a California Insurance License and a Certified Financial Planner designation.
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