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Investing in the stock market is a great way to grow your wealth over time as it offers excellent returns. This is why it's not a surprise that about 55% of adults in the United States invested in stocks in 2019.
The stock market can be risky and intimidating at the same time, but there’s no denying the fact that investing in stocks can help investors overcome the negative effects of inflation and diversify their portfolio.
In this article, we’ll talk about how to start investing in the stock market.
Why Invest in the Stock Market
Stocks offer some of the greatest opportunities for capital appreciation or growth over the long haul. The stock market has endured ups and downs over the years but the benefits of investing in stocks haven't changed.
Here’s why stocks are still a viable investment option.
You Can Start Cheap
Stocks are an excellent way to make your money work harder. The good thing is that you do not need a lot of money to get started. You can start with as low as $100 and even less.
Online brokers have opened the gates for retail investors to enter the stock market and purchase stocks for low fees or in some cases with zero commission.
There is no limit on how much money you can invest in stocks. You only need to decide where and how to invest. We'll discuss your options later in this article.
Lets You Outrun Inflation
Inflation causes your money to lose value. The inflation rate in the United States hovers between 2% and 3%. Most savings accounts and CDs (Certificates of Deposit) do not pay over 3%, which means that you will not make any profits on your money if you choose these options.
On the other hand, the average return on investment on stocks is around 10% (i.e. S&P 500 index) and some funds may even outperform their benchmark in the long haul. Ultimately, the stock market allows you to make money without losing purchasing power.
The average annualized return on investment for the S&P 500 index over the past 100 years is 10.47%.
Allows You to Diversify Your Portfolio
Diversification is the best way to safeguard your investment. The stock market allows you to opt for a variety of investment options including mutual funds, bonds, ETFs and stocks. Opting for a combination of stocks and fixed income securities will protect your investment from the inherent volatility of the stock market.
In addition to that, there are several options when it comes to investing in stocks. You can reduce your risk exposure by investing in stocks in different industries and sectors.
A Fast Way to Increase Wealth
While there's no guarantee of how your investment will perform, stocks are still considered a reliable way to increase wealth. You only need to be mindful of where you invest.
Successful investors use the power of compound interest to amass wealth over time. Compounding is basically the process in which an asset's profits (i.e dividends or capital appreciation) are reinvested to generate more profits or earnings over time. In other words, compound interest allows your money to grow exponentially rather than in a linear manner.
Help is Available
A very good thing about investing in stocks is the fact that anyone can do it. You do not need to know about the stock market to make money through stocks. You can work with a financial institution or fund manager who will invest your money on your behalf and work to give you returns.
They will charge you a fixed rate for their services in addition to a commission on the profits they bring (in some cases). In exchange, they will take care of everything from buying to selling stocks so you can make the most of your money.
Who Should Invest in the Stock Market
The answer is simple: anyone who wants to build wealth.
There are no eligibility criteria. However, most countries and states require you to be 18 before you can open your own account. If you’re under the legal age then you may have the right to invest in a custodial account.
We suggest that you only enter the arena if you’re aware of the risks. Stocks are highly volatile and they may lose value. Also, the stock market isn’t the right option for investors looking for quick gains. It is best for investors who can forget about the investment for five to ten years since it can take a while for you to enjoy good and stable returns. Investing in the stock market is a long term game.
Find Out How Much You Can Invest
Know how much money you can afford to invest. This is important because you may lose all or a part of your investment, so be careful about how much you can afford to lose.
The first step is to find out your net worth. Make a list of your assets, your liabilities, and calculate what each item is worth.
You will arrive at your net worth by subtracting total assets from your total liabilities. Your net worth will give you a good indication as to how much money you have at your disposal for investments.
Find Out How Much You Should Invest
Once you find out how much money you have at your disposal for investments, you now need to assess your personal situation and how it can affect your investments. Here are some things to consider.
- Are you going to need money in the next 3 to 6 months?
- Do you have a stable job?
- Do you have a growing family?
- Do you have enough money in your savings account?
- Do you have high-interest consumer debt?
Before you invest any money into stocks, make sure to get rid of any high-interest debt and only invest money you have saved up for investment purposes. Never invest money you cannot afford to lose or money you’ve saved for other purposes. Check out our article on how to pay off debt fast. It's a great resource to get started.
Also, investing in the stock market can be a risky business. Never count on your investment to bring you out of trouble. You should create and maintain a solid emergency fund so that you do not have to sell your stocks in a hurry.
Your personal situation will help you fine tune your investment goals.
Have An Investment Goal & Approach
What are you planning to achieve? What is the purpose of your investment? You need to answer these questions before making the big leap so you can decide how to go about your investments and what your ultimate goals are.
Next, decide whether you want to be a short term trader or a long term investor. Short term traders, buy and sell stocks and hold positions that can last for seconds to several days.
Although lucrative, short-term trading can be pretty unpredictable and very risky because of the fluctuations in the market on a day-to-day basis.
On the other hand, long term investors buy and hold stocks and hold positions that can last weeks, months or even years. Ultimately long term investors profit from dividend payouts (if assets being held offer dividends) and stock appreciation.
Lastly, decide if you are the kind of investor that prefers to choose stocks and funds by yourself, or if you prefer to have someone else managing the investments for you.
Open an Investing Account
Once you have decided on your investment goals and approach, it's time to open an investing account. Here are your options.
Hire a Broker
Brokers are agents who trade securities on behalf of their clients. They earn a commission on each trade, no matter how it goes.
You can go to brokerage firms to find a broker but some also work on the trading floor at stock exchanges. Some stockbrokers charge a flat fee. Make sure to work with a licensed and registered broker who has experience handling different portfolios.
You can ask questions such as, what is the average return, some popular clients they have worked for, etc.
Hire a Financial Advisor
The job of a financial advisor is to assess the financial needs of their clients and help them with their investments. Some financial advisors may also provide advice on insurance and taxes.
Unlike brokers, financial advisors cannot trade on behalf of clients. They can only provide advice, tips, and suggestions but the client has to make the final call.
It may be a good idea to work with a financial advisor if you do not understand finances or if you have specific financial goals.
Since they provide advice on your overall financial plan, they can help you streamline all your investments, and provide advice on where and how to invest money.
Use a Robo Advisor
Robo advisors provide online investment management or financial advice with little-to-no human intervention. They provide artificial intelligence (AI) advice based on algorithms and rules.
Platforms like Betterment and Wealthsimple remove the need for human intervention. These platforms can automatically perform a variety of tasks including allocating, managing, rebalancing and optimizing clients' assets.
There are a few companies offering robo-advisor services. Make sure to pick one that's known to be safe and reliable. Most service providers charge a fixed fee and commission for their services.
Do It Yourself
If you do not want to pay fees or commissions or if you trust your knowledge, then consider doing it on your own. There are a handful of online brokers that allow you to invest in stocks and ETFs commission-free.
Using an online broker can be a bit tricky since you will have to handle everything on your own from opening and closing orders to deciding how many stocks to purchase.
Both Webull and Robinhood offer commission-free trading. These platforms also offer great research and trading tools, as well as a large selection of securities and funds. Another good option is Ally Invest. Here is a quick comparison of some of their features.
Generally speaking, there are five major investment options traditional investors have access to in the stock market.
- Individual Stocks: Buying a stock means buying a piece of ownership in the company. If the company is doing well, the value of the stock will rise and you will make a profit. On the other hand, if the stock goes down, you will be in trouble as you will be losing money. Buying individual stocks is suitable for investors who know about the industry and like the DIY approach. It’s a riskier approach for a beginner.
- ETFs: You have the option to turn to an exchange-traded fund, also called an ETF. It is an investment fund that's traded on exchanges just like stocks and holds multiple assets like bonds, stocks, and commodities. ETFs are highly liquid and can be traded throughout the day, unlike mutual funds that are only priced at the end of the day.
- Mutual Funds: It's a financial vehicle made up of a pool of money collected from a variety of investors to invest in different stocks. Mutual funds are managed by professional managers or firms who charge a commission and other fees for their services.
- Index Funds: These funds are actually mutual funds designed to track an index. Index funds are cheaper than regular mutual funds as they don't require an active fund manager. For example, you can invest in an index fund that tracks the performance of the S&P 500.
- Bonds: You basically lend money to a government, municipality, institution or corporation. In exchange, you will receive interest from these loans. Bonds are typically viewed as a safer investment than stocks.
As a beginner investor, the safer approach is to turn to mutual funds or ETFs. Funds are professionally managed, provide diversification and exposure to a number of sectors and industries.
Stock Market Tips for Beginners
Now that you know how to invest in the stock market, check out some tips on how to ensure your investment gives good results.
Be a Long Term Investor
If you want to enjoy high returns then forget about your investment for the next five years, at least. Some experts believe that stocks can take between 10 and 15 years to mature. There is typically no cost of selling stocks but doing so may cause you to reduce your potential return.
Also, do not get rid of a stock just because it appears to be going downward. Dumping may not always be the best option unless you’re sure that the value of the stock will never go up. For example, if a company is about to go bankrupt then you may get rid of the stocks, but if it’s seasonal fluctuation then hold on to the asset.
Stock prices will tend to go up in value if the company is healthy. However, to eliminate the uncertainty of knowing when to buy a stock, we suggest building up positions gradually instead of going all-in at once (i.e. Dollar-Cost Averaging). By doing this, you are basically removing the possibility of buying when the market is high.
Understand Your Risk Tolerance
Stocks are highly volatile. The value of stocks often changes within a few hours and it isn’t uncommon for stocks to lose or gain 50% of its value in a single day.
You should know exactly how much you can afford to lose before you invest your money into stocks. We recommend you to only invest the amount you can afford to lose so that you can handle the loss if things go wrong.
Beginner investors should start investing in low-cost index funds or mutual funds as these are some of the less risky investment options in the stock market. Then, once you feel comfortable to begin investing in stocks, you should always do it gradually.
As a general rule of thumb, your positions in one investment security should never be more than 5% of your overall investment portfolio.
Do not put all your money in a single stock. Find multiple stocks in various sectors and industries to reduce risk. Diversification will reduce your investment risks.
If a company fails, you’ll still be able to cover the losses from the profits you earn through other investments. Plus, diversification will also help you stay afloat when the market goes down. This is because, in most cases, some industries continue to do well even in poor market conditions.
Investing in index funds, mutual funds and ETFs is a great way to diversify your portfolio.
Control Your Emotions
“Success in investing doesn’t correlate with IQ … what you need is the temperament to control the urges that get other people into trouble in investing,” suggests Warren Buffett.
When it comes to investing, you should never make emotional decisions. This is why you should always invest in a company you trust, not because you like it, but because it makes sense from an investment perspective.
Working with a broker or financial institution oftentimes creates an emotional layer between you and your investments. Professional brokers look at your investments from a neutral angle.
Invest in What You Know
Some argue that investing in stocks is based on luck. However, we know there are financial models and tools that can help you make the right decisions. Whether you’re investing on your own or with the help of a professional, it is important to invest in what you know.
Stay away from companies that you know nothing about, even if they look good or promising. Invest in companies that have a track record of performing well in various market conditions.
If you like a stock, then study it, check past performance, read financial statements, talk to experts about it, and then invest. It's important to note, however, that past performance is not an indication of how well a stock will perform in the future. Keep this in mind.
Investing in the stock market is an exciting way to build wealth over time. It doesn't have to be hard or complex as there are lots of free tools and resources available to help you make the best decisions for your investment goals. It is paramount that you keep yourself informed and educated on changing market trends, make wise decisions based on knowledge and research, and do not make rash emotional decisions.
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