When done correctly, stock investment is one of the best methods to create long-term wealth.
To help you make sure you’re investing money in the stock market properly, here is a step-by-step tutorial.
5 Steps to Start Investing
1. Determine your investing approach
How to begin investing in stocks should be the first thing you think about. While some investors choose to buy specific equities, others choose a more passive strategy.
Try this. Which of the following statements best describes you?
- I’m an analytical person and enjoy crunching numbers and doing research.
- I hate math and don’t want to do a ton of “homework.”
- I have several hours each week to dedicate to stock market investing.
- I like to read about the different companies I can invest in, but don’t have any desire to dive into anything math-related.
- I’m a busy professional and don’t have the time to learn how to analyze stocks.
The good news is that regardless of which of these statements you agree with, you’re still a great candidate to become a stock market investor. The only thing that will change is the “how.”
The different ways to invest in the stock market
specific stocks
Individual stocks are only an option if you have the time and motivation to thoroughly investigate and continuously assess stocks. If so, we wholeheartedly urge you to take action. A wise and persistent investor has a good chance of outperforming the market over time. On the other hand, there is absolutely nothing wrong with adopting a more passive strategy if things like quarterly earnings reports and straightforward mathematical computations don’t sound appetizing.
Indexed funds
You have the option to invest in index funds, which follow stock indices like the S&P 500, in addition to purchasing individual equities. We often favor passively managed funds over actively managed ones (although there are certainly exceptions). The fees of index funds are often far cheaper, and they almost always reflect the long-term performance of the underlying indices. The S&P 500 has generated total returns that have averaged 10% over time, and performance like this can generate sizable wealth over time.
Robo-advisors
The robo-advisor is a last choice that has gained enormous appeal in recent years. A brokerage known as a robo-advisor essentially invests your money on your behalf in an index fund portfolio that is suitable for your age, risk tolerance, and investment objectives. A robo-advisor may choose your assets for you, and many of them will also optimize your tax efficiency and make adjustments automatically over time.
2. Decide how much you will invest in stocks
Let’s start by discussing the capital you shouldn’t put into stocks. Money that you could need within the next five years, at the very least, should not be invested in the stock market.
Even while the stock market will almost surely increase in value over the long term, there is just too much uncertainty in stock prices right now; in fact, a decrease of 20% in any given year is not unusual. During the COVID-19 epidemic in 2020, the market fell by more than 40% before quickly rising to an all-time high.
- Your emergency fund
- Money you’ll need to make your child’s next tuition payment
- Next year’s vacation fund
- Money you’re socking away for a down payment, even if you will not be prepared to buy a home for several years
Asset allocation
Let’s now discuss what to do with your investable funds, or the money you are likely not going to need in the upcoming five years. Asset allocation is a notion that applies to this situation, and several variables are involved. Your age, unique risk tolerance, and investment goals are all very important factors.
Firstly, let’s talk about your age. The conventional consensus is that stocks eventually lose appeal as you age as a place to invest your money. If you’re young, you have decades to ride out any market ups and downs, but if you’re retired and dependent on your investment income, this isn’t the case.
Here is a brief guideline that can help you approximate your asset allocation. Add 110 to your age, then subtract it. This is roughly how much of your investable funds you should put into equities (this includes mutual funds and ETFs that are stock based). Bonds or high-yield CDs should make up the remainder of your portfolio. This ratio can then be changed based on your personal risk tolerance.
Let’s say, for illustration, that you are 40 years old. According to this approach, you should invest 70% of your investable funds in equities and the remaining 30% in fixed income. You might want to tilt this ratio in favor of equities if you’re a risk-taker or intend to work past the traditional retirement age. On the other hand, you might want to change your portfolio in the opposite direction if you don’t enjoy significant changes in it.
3. Open an investment account
If you lack the means to purchase stocks, all the novice stock trading information in the world won’t help you much. You will want a particular kind of account known as a brokerage account to do this.
Companies like TD Ameritrade, E*Trade, Charles Schwab, and many others provide these accounts. Also, establishing a brokerage account is often a simple, quick process that takes only a few minutes. EFT transfers, postal checks, and wire transfers make it simple to finance your brokerage account.
Although opening a brokerage account is typically simple, you should think about a few factors before selecting a certain brokerage.
Type of account
Choose the sort of brokerage account you require first. This involves selecting between a basic brokerage account and an individual retirement account for the majority of people who are just beginning to explore stock market investing (IRA).
You are able to purchase stocks, mutual funds, and ETFs using either type of account. The primary factors to take into account here are your investment objectives and how simple you want it to be to access your funds.
A conventional brokerage account is probably what you want if you want quick access to your funds, are only saving for a rainy day, or wish to invest more than the yearly IRA contribution maximum.
On the other hand, an IRA is a terrific choice if your objective is to amass a retirement nest egg. IRAs are very tax-advantaged places to buy stocks, but the drawback is that it can be difficult to withdraw your money until you get older. These accounts come in two main varieties — traditional and Roth IRAs — and there are some specialized types of IRAs for self-employed individuals and small business owners, including the SEP IRA and SIMPLE IRA.
Review prices and features.
Since most (but not all) internet stock brokers have done away with trading commissions, most (but not all) of them are competitively priced.
There are, however, a number of additional significant variations. For instance, some brokers provide their clients with a selection of learning resources, access to investment research, and other features that are particularly helpful for novice investors. Some allow trading on international stock markets. Additionally, some have physical branch networks, which is advantageous if you want in-person investment advice.
The trading platform of the broker’s user-friendliness and functionality are additional factors. I’ve used a good number of them, and I can attest that some are significantly more “clunky” than others. Many will allow you to test out a demo version prior to making a purchase, and if that’s the case, I strongly advise it.
4. Choose your stocks
Now that we’ve answered the question of how you buy stock, if you’re looking for some great beginner-friendly investment ideas, here are five great stocks to help get you started.
Of course, in just a few paragraphs we can’t go over everything you should consider when selecting and analyzing stocks, but here are the important concepts to master before you get started:
- Diversify your portfolio.
- Invest only in businesses you understand.
- Avoid high-volatility stocks until you get the hang of investing.
- Always avoid penny stocks.
- Learn the basic metrics and concepts for evaluating stocks.
It’s a good idea to understand the concept of diversity, which states that your portfolio should contain a range of different types of businesses. I would advise against diversifying your business too much, though. Keep your investments in companies you are familiar with, and if you find that you are particularly adept at (or at ease with) stock analysis, there is nothing wrong with having a sizable portion of your portfolio invested in that particular sector.
While investing in glitzy high-growth stocks may seem like a terrific way to increase your wealth (and it can be), I’d advise you to wait until you have some more experience before doing so. It’s better to build your portfolio’s “foundation” around dependable, seasoned companies.
Learn some of the fundamental methods for assessing particular equities if you want to invest in them. An excellent place to start is with our value investing guide. There, we assist you in locating equities with appealing valuations. And our guide to growth investing is a terrific place to start if you want to add some exciting long-term growth prospects to your portfolio.
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