Stock investing is a time-tested way to put your money to work and create wealth over time. Long-term investors around the world have historically enjoyed greater returns from the stock markets than from any other investment. Stock investing for beginners can be intimidating, but the sooner you start, the more time your money will have to grow!
Before you start investing you’ll need to understand what a stock is, how the stock markets work, and some of the methods you can use to achieve a risk-reward balance that meets your needs.
Let’s look at some basic concepts that can help you start investing in stocks.
What are Stocks?
A stock is an equity investment that gives you part ownership in a company. It entitles you to have a share in the company’s profits in proportion to your stock holding. Each share also carries voting rights.
There are two ways to gain from a stock investment:
- The value of your investment may increase if the stock price goes up. If you sell the stock for a higher price than you paid for it, you make money.
- Some companies also pay regular dividends, which distribute profits directly to investors.
Stocks can decline in value, and investors can lose money, especially in the short term. This makes stock investing for beginners a tricky business. It’s vital to acquire some understanding of stock investing before you start buying stocks.
What Type of Investor Are You?
To begin with, you must ask yourself what kind of stock investor you want to be.
Neither of these types is better than the other. Your choice will depend on how much time and effort you want to spend learning about investing and managing your portfolio. Either approach can be successful and satisfactory.
Types of Online Brokers
If you want to buy stocks you will need a broker: you cannot buy stocks on your own. Stock investing for beginners usually starts with an online broker. Most online brokers will let you invest in individual stocks, bonds, mutual funds, index funds, and ETFs (exchange-traded funds).
You can choose between a full-service and a discount broker.
Investing in Stocks Through Your Retirement Account
Tax-advantaged retirement accounts are one of the most popular ways to begin investing. If your employer offers a 401(k) plan, you can invest a portion of your monthly salary into the plan. Your employer may match a portion of your contribution.
If your employer does not offer a 401(k) or if you are self-employed or a business owner, you’ll probably need to consider some 401(k) alternatives. There are several types of 401(k) plans and IRAs, all with different rules and requirements. If you’re selecting your own plan, you’ll need to become familiar with the tax rules governing each type. Most let you select from a range of mutual funds and other investments, which usually include stock funds.
If you have a retirement account, you are probably already investing in stocks through the allocations made to mutual funds.
Mutual Funds vs. Stocks
Beginners need to understand the difference between funds and individual stocks. An individual stock is an investment in one corporation, while a fund would be invested in a package of dozens or hundreds of stocks.
Funds include both mutual funds, which are actively managed by a mutual fund company, and Exchange-Traded Funds or ETFs, which can be traded like stocks. Each has advantages and disadvantages, and you’ll want to read up on the differences between them
Funds allow you to hold a large number of stocks even with a relatively small investment, which can help to reduce your risks. Many types of funds are available, from index funds that track broad market indices to funds specializing in particular types of stocks, market sectors, or even countries. In each case, your investment will be made by professionals on your behalf.
You may choose to build your own stock portfolio by directly picking stocks of specific corporations. This approach may allow higher gains, but it can also expose you to higher risks. Here are some of the pros and cons of investing through individual stocks:
- Gives you full control over the types of companies you want to invest in.
- Highly liquid investment.
- No ongoing or annual management fees.
- Easier tax management because of greater control over capital gains (you can decide when you want to buy or sell).
- Risks could be higher than mutual funds, especially for beginners.
- If you are holding many stocks it can be hard to keep a track of each company’s performance.
- Individual stock investing requires dedicated time for research and evaluation of companies as well as for efficient portfolio management.
- Commissions are usually payable on each transaction.
In general, passive investors will prefer funds and active investors will lean toward picking individual stocks. You can combine the two approaches.
Value vs. Growth Investing
Value and growth are two primary investing styles or approaches. Stock investing for beginners requires a clear understanding of both.
Both of these approaches require meticulous analysis. Evaluating a company’s fundamental worth or growth prospects may require extensive research and a strong understanding of a company and its business.
What is Your Risk Tolerance?
Risk tolerance is your appetite for uncertainty or your ability to endure market volatility and fluctuations. To assess your own risk tolerance, you should consider factors such as your investing skills, experience, personal investment goals, how much time you are willing to dedicate to investing, your overall financial status, and your financial responsibilities.
A realistic evaluation of your capacity to stomach major market downturns for extended periods of time will help you determine your actual risk tolerance. In general, investment advisors associate risk tolerance with age, although it is not the sole factor. The thinking behind this is that younger people have a longer time horizon and have a stronger future earning capacity to survive stock market downturns. Older people have less time to wait for a market recovery. They may be more reluctant to risk a drop in that value of a portfolio they’ve been building for years.
Depending on your degree of risk tolerance, you may choose between individual stocks, bonds, mutual funds and ETFs. You may also choose to balance your stock holdings with other investments. Investors with a higher net worth might typically be in a position to afford bigger investment risks.
Diversification Can Cut Down Your Risks
Conventional wisdom suggests that you can reduce your risk level by spreading your investments out, rather than putting all your eggs in a few baskets. The future of even the best-performing companies and stocks is uncertain, and unexpected events could reduce the value of your investment in a particular stock.
A diversified stock portfolio protects you against this risk to a great extent, as long as you have chosen a mix of established companies with a long track record of performance.
Can You Invest On a Limited Budget?
You can start investing in stocks with a small amount of money. Many well-established companies have shares that cost only a few dollars. Some brokers offer fractional shares, which allow you to buy a portion of a share of a higher-priced stock.
If you have a small budget but do not want to buy individual stocks, you could consider investing in an ETF. While mutual funds may usually require you to invest at least $1,000 or more, you can buy into an ETF for the price of an individual share, which could be as low as $100 or even less.
Investing for the Long Term
A long-term approach is usually the best start to stock investing for beginners. Some of the most successful stock investors in history have advocated long-term investing.
For beginners, that usually means investing in mutual funds, ETFs, and low-cost index funds. According to seasoned investors, the average American could benefit the most over time by investing in a low-cost S&P 500 index fund. You should go for individual stocks only if you strongly believe in the long-term future of the company and think that it is its current market valuation is attractive.
For most investors, getting started with individual stocks, mutual funds or ETFs is not difficult. The hard part comes when you have to hold your investments for the long term. The power of compounding will work in your favor only if you allow your investments to compound. Short-term market gains or losses should not tempt you to act impulsively on a good investment. Markets do fall, but they rise again. Staying the course has always produced rewards.
Is Stock Investing Worthwhile?
The journey of a thousand miles begins with a single step. Investing in high-quality stocks is an ideal way to build and grow wealth. Success is not guaranteed in stock markets, but you can dramatically increase your chances of success if you are prepared to invest for the long-term.
As a thumb rule, your stock investments should use funds that you do not need for the next five years. Stock investing for beginners and experts alike is not a speculative activity that delivers overnight gains. When you buy stocks, you are buying a piece of a business. That business needs time to grow and produce sustainable returns. So, with the right investing mindset, you can get on the road of wealth creation.
If you have any questions about stock investing, let us know in the comments below!