Investing in the stock market is one of the best ways to build wealth over the long term, but it can be complicated and stressful to get started if you’ve never invested before.
The good news is that investing is more accessible than ever. Years ago, you had to work with stockbrokers who charged heavy fees and might not have your best interest in mind. Today, anyone can start investing with just a few dollars and there is a wealth of investing information and advice on the Internet.
Tips for Stock Market Investing
When some people think of investing and the stock market in particular, they think of it like a casino or a get-rich-quick scheme. Although there are ways that you can invest to make large amounts of money in short amounts of time, they’re also incredibly risky.
Most people who invest don’t use these strategies. Instead, they use time-tested techniques like building diverse portfolios and low-cost investing methods to grow their nest egg over the years.
If you’re just getting started with investing, these tips can help you build your first portfolio.
1. Handle the Basics First
Many financial experts recommend that people maintain anywhere between three and six months’ expenses in an emergency fund (we recommend a Savings Builder account at CIT Bank). That means that if you spend $3,000 per month, you should have somewhere between $9,000 and $18,000 in savings. That’s usually enough to cover unexpected expenses or to weather a period of reduced income, such as unemployment.
The last thing that you want is to have to sell your investments when they’re low to cover living expenses, so a healthy emergency fund is important.
Getting rid of high-interest debt is also essential. For example, if you have debt that charges 12% interest, making extra payments toward that debt is equivalent to investing that money and earning a 12% annual return.
The S&P 500, an index of large American stocks, has provided an average return of 9.8% over the past century or so. Depending on your risk tolerance, you should aim to pay down any debt charging an interest rate near or higher than that. A common rule of thumb is to pay down debt charging more than roughly 6% interest before investing.
Of course, there are exceptions to this rule, such as investing enough to get your employer’s 401(k) match, but making sure you pay down costly debt and have emergency savings before you start investing are important.
2. Know Your Goals and Timeline
Before you start investing, you need to know why you’re investing. Different goals necessitate different investing strategies.
For example, someone who wants to preserve their capital and draw some income from it may opt for a more conservative portfolio, focusing on less-risky companies or investing in bonds.
Someone who wants to grow their nest egg over the long term, perhaps to build retirement savings, will likely want to invest in stocks that have higher return potential.
Your timeline for investing also plays a significant role in your investment strategy. If you’re a young professional and saving for retirement, you can handle the volatility that comes with investing in high-risk, high-reward stocks. As long as you earn strong, positive returns in the long term, it’s not a huge problem if your investments lose 50% of their value in a bad year.
Someone who is saving for a near-term goal, such as paying for a teenage child’s college, will want to construct a less volatile portfolio. Instead of investing in small, risky companies, they might invest in blue-chip stocks, bonds, or even CDs.
In general, investing should be a long-term endeavor. There are three primary factors that influence how much your portfolio will grow:
- The amount you invest
- The annual return of your portfolio
- How long you leave your money invested
Building a diversified portfolio can help reduce your risk and keep your portfolio growing over the years. That means that the longer you keep your money invested, the larger your investment portfolio will grow.
3. Know Your Risk Tolerance
Another factor that will impact your portfolio is your risk tolerance. Even if you’re investing for the long term and want to increase your portfolio’s value over time, your personal risk tolerance may lead you to less risky investments.
Someone with a high risk tolerance might be willing to build a portfolio composed solely of stocks if they have a long time horizon. People who don’t feel comfortable with that risk might want to hold a mixture of stocks and bonds even if their investment goals are long-term.
4. Choose a Brokerage
There are dozens of different companies that offer brokerage accounts to people who want to start investing. Choosing a brokerage is an important part of starting to invest.
Each brokerage offers different types of accounts, features, and fees, so you want to choose one that fits with your needs.
For example, people who want to save for retirement want to work with a brokerage company that offers IRAs. People who are saving for a child’s education should find a brokerage that lets them invest in 529 plans.
How you plan to invest also affects the brokerage you choose. Some major brokerages like Fidelity, Schwab, and Vanguard have their own line of mutual funds and don’t charge commissions when investors purchase their funds. If you plan to invest mostly in mutual funds and exchange-traded funds (ETFs), using the brokerage that also manages those funds can be a good idea.
If you plan to invest primarily in individual stocks, finding a brokerage with its own line of mutual funds is less important. Instead, focus on avoiding costs like account fees and trade commissions so you don’t pay a huge amount to build your desired portfolio.
Pro tip: You can earn a free share of stock (up to a $200 value) when you open a new trading account from Robinhood. With Robinhood, you can customize your portfolio with stocks and ETFs, plus you can invest in fractional shares. Sign up for Robinhood.
5. Do Your Due Diligence
Whether you plan to buy individual stocks on the stock market or invest in bonds, mutual funds, or almost any other security, doing your due diligence is essential. That means researching every investment before you buy it.
Publicly-traded companies are required to submit certain paperwork to the SEC each year. These documents include information about the company’s revenues, expenses, account balances, and more. You should read these documents carefully and make sure you understand what they contain before investing. For example, if a company has high debt, low cash balances, and falling revenues, you can find that out in the company’s annual report. Given the high risk of such a company, you might not want to buy shares unless you’re willing to accept that risk.
Some popular metrics that investors look at when researching stocks include price-to-earnings (P/E) ratios, earnings per share (EPS), and return on equity (ROE). These metrics can help you compare different businesses that you might invest in.
Another strategy that some investors use when researching companies is technical analysis. Technical analysts look at stock price charts and try to identify patterns, then relate those patterns to how the share’s price will change in the future.
For example, technical analysts believe that a stock’s daily price passing above or below the price’s long-term moving average indicates future gains or losses for the stock, presenting a good buying or selling opportunity.
Regardless of the strategy that you use to research stocks, having a strategy, knowing how to implement it, and taking the time to do your due diligence are essential.
Pro tip: If you’re looking for a tool to help you research potential investments, sign up for Atom Finance. It’s free, and it gives you access to real-time price quotes, professional-grade news and analysis on companies, and it integrates seamlessly with your brokerage account. Sign up for Atom Finance.
6. Build a Diverse Portfolio
One of the most important things to do when building a portfolio is to diversify. You don’t want to put all of your eggs into one basket because a single hole in that basket could leave you with an empty portfolio.
For example, if you put 100% of your money into Enron stock, you’d have been left with nothing when the company went under. If you put 10% of your money into each of 10 different companies, even a collapse as bad as Enron’s would only cost 10% of your portfolio. Diversifying further reduces the risk even more.
Diversify on Your Own
The most basic strategy for diversifying is buying shares in multiple companies, but there are more advanced strategies that you can use.
For example, some people aim to split their portfolio between stocks with different market capitalizations. Market capitalization measures the total value of all of a company’s shares. Large-cap companies — those worth the most — tend to have lower returns but lower volatility than small-cap companies. Holding a mixture of companies of different sizes lets you get exposure to the high-risk, high-reward of small-caps while getting some of the benefit of lower volatility large-caps.
Others diversify their portfolio by holding different types of investments. For example, you might build a portfolio that is 70% stocks and 30% bonds. Stock prices can be highly volatile but bonds tend to be more steady. A mix of stocks and bonds lets you get most of the benefit from strong markets, but reduces your losses during downturns.
Diversify with Mutual Funds
One of the easiest ways to build a diversified portfolio is to invest in mutual funds. Mutual funds pool money from multiple investors, then use that money to buy securities. A single mutual fund can hold hundreds or thousands of different stocks.
Investors can buy shares in the one mutual fund to get exposure to all of the stocks in that fund’s portfolio. Instead of having to keep track of 10, 20, or more companies that they hold in their portfolio, an individual investor only has to keep track of the mutual fund they invest in.
Mutual funds can use all sorts of different investing strategies. Some aim to track specific stock indexes, like the S&P 500 or the Russell 2000. Others hold shares in companies that operate in a specific industry, like health care or utilities. Some use an active trading strategy where the fund’s managers try to find good opportunities to buy and sell shares to beat the market.
Some mutual funds even hold a mix of stocks and bonds, or adjust their holding over time to reduce risk as time passes closer to a target date.
Mutual funds do charge a fee for their convenience and management services, but passively-managed funds tend to be quite inexpensive and the simplicity, diversification, and peace of mind they offer is worth the small cost.
Diversify with Robo-Advisors
One service that has grown popular recently is robo-advisory.
Robo-advisors are programs that invest on your behalf. When you sign up for a robo-advisory service through a company like M1 Finance, you’ll usually have to answer some questions about your investing goals, risk tolerance, and financial situation. The program uses that information to construct a portfolio for you.
Once the robo-advisor builds a portfolio, all you have to do is deposit and withdraw funds as needed. The software handles all of the day-to-day for you, such as buying and selling shares or rebalancing your portfolio if one asset class outperforms or underperforms the rest of your portfolio.
Robo-advisors also offer other perks. A common one is tax-loss harvesting, which sells shares for a loss and reinvests the money in similar securities. This lets you deduct the paper losses from your income when filing your tax return, reducing your taxable income in the short term. Deferring those taxes to later can help increase the size of your portfolio.
Robo-advisors charge a fee for their service, typically as a percentage of your invested assets. Many claim that their benefits lead to higher returns that offset the fee, but it’s up to each individual to decide whether robo-advisors are right for you.
Pro tip: When the stock market is as volatile as it’s been, being diversified is crucial. Companies like Masterworks give you the ability to invest outside of the stock market. With Masterworks, you can invest in shares of fine art from some of the world’s most renowned artists. Get started with Masterworks.
7. Invest Logically, Not Emotionally
Whether you choose to invest on your own or to let a mutual fund or robo-advisor manage your investments, it’s important to make sure you don’t invest emotionally.
It can be easy to let your emotions and sentimental attachments to certain companies or brands make you want to buy their shares. However, liking a company isn’t the best reason to buy its stocks. You should base your investments on a sound strategy and research.
Similarly, it can be incredibly stressful to watch your portfolio’s value plummet as the stock market drops, to the point that you want to pull your money out of the market.
History shows that the most important part of investing is keeping your money in the market. Even the worst market timer in the world outperforms an investor who regularly moves money in and out of the market.
8. Avoid Leverage
For new investors, it can be very tempting to use leverage — borrowed money — to invest, especially if you don’t have much money to start investing. This is doubly true because many brokers have made it easier to access leverage than ever before.
A 10% gain on a $100 investment is just $10. If you borrowed another $900 to invest, bringing your total balance to $1,000, that same 10% gain would be worth $100, which makes the gain much more exciting.
The important point to remember is that leverage can be incredibly dangerous. Investing is never a sure thing. You could lose some or all of the money you invest, even if you buy shares in an incredibly stable business.
If you invest $100 and your stock loses 25%, you’ve lost $25 but still have the other $75. If you borrowed $900 to increase your investment to $1,000, a 25% loss means losing $250 — more than twice the amount of money you had to invest to begin with. If that happens, you have to sell the shares at a loss and find a way to repay the remaining $150 of debt that you now owe.
Advanced investors sometimes use leverage when executing specific investing strategies, but for most individuals, and especially beginners, it’s usually best to avoid leverage.
Investing in the stock market can be exciting and is an important part of building wealth. Making sure you understand how to invest and research potential investments before starting is important.
You should also take the time to consider different investment accounts. While investing in a 401(k) or an IRA is good, many people could also benefit from a taxable brokerage account. Understanding the different types of accounts you can use can help you make the most of each dollar you invest.
Have you invested in the stock market before? What tools do you use to research investments?
Originally posted at https://www.moneycrashers.com/stock-market-investing-tips-guide-checklist/