How to Invest in the Stock Market
Introduction
The stock market provides one of the highest investment returns available, but it can also be a little confusing or even intimidating to beginner and even novice investors.
This series of articles has been specifically written for beginner stock investors and provides the minimum basic information needed to start investing successfully.
So if you’ve been putting off investing in the stock market, the time to begin is now. Like any new endeavor it may not feel comfortable at first but that will pass as you gain experience.
Many successful stock investors treat investing as a hobby and unlike most hobby’s that cost you money, this is one hobby that can significantly increase your future wealth.
It’s not unusual for beginner stock investors to feel overwhelmed and not knowing where to start. After all, there’s a lot of conflicting advice floating around, so we are going to keep things really simple and focus on the things that work over the long-term. This will allow the beginner stock investor to develop good long-term investing and financial management skills.
We take a common sense approach that is based on many years of investing in the stock market.
Setup an Investment Plan
Building wealth takes time and beginner stock investor’s should start with basic passive investing and hold their investments for the long-term (preferably 10-years or more).
As the beginner stock investor gains some experience they can then manage their portfolio for the market cycles. This can involve reducing or even exiting their portfolio in adverse market conditions and restating their portfolio for the next market cycle.
A time proven method for stock investors to build their wealth is to regularly invest their surplus cash. This can be done monthly, quarterly or even annually.
Regularly adding money to the market is a fantastic way to significantly increase your portfolio worth as the magic of compounding returns works in the stock investors favor.
To participate in the stock market is very simple. All the stock investor needs to do is either buy some shares of public companies (we call these stocks) or buy a Fund (which owns the stocks).
The beginner stock investor can now carefully consider the following topics and setup their own investment plan.
Investment Plan Considerations
- The first step is to consider your investing time frame.
- If more than 10-years consider holding stocks only.
- If less than 10-years and more than 5-years you should consider including bonds within your investment portfolio.
- If less than 5-years consider investing a large portion into bonds (such as 75%).
- The second step is to consider whether you are going to make regularly contributions to your investment portfolio or whether you just want to invest an initial lump sum with no further contributions. Regular contributions (also known as dollar cost averaging) can be made monthly, quarterly or even annually. The initial investment amount can be any size but there are some practical minimum limits.
- The next consideration is whether to invest in stocks, funds or bonds. To a certain extent this is a personal preference, however the beginner investor should be aware of the brokerage costs for buying stocks and the management fees for owning funds. Another consideration with Funds is the minimum initial investment required. Also beware that brokers generally charge a brokerage fee if buying funds.
- If you are employed you should consider contributing to a 401(k) or other employer sponsored plan where the employer co-contributes. Depending on the employer you may get $0.50 or even a dollar for every dollar you contribute, and there are tax advantages. They are great for long-term investing into the future, but they are a retirement plan so if you need to withdraw your money before retirement a retirement plan may not suit your financial goals.
- US residents should consider whether an IRA (Individual Retirement Account) suits them. Again there are tax advantages which makes them an efficient strategy for building future wealth but they are also a retirement plan.
- You can use a conventional investing account (which does not have any tax benefits) if the 401(k) or IRA do not suit or if they do and you have more money to invest. With a conventional account you can withdraw money at any time without penalties.
- You will need to open an account with a stock broker to buy stocks. Most brokers have both IRA and conventional account types. Employers will generally set up 401(k) accounts but the self employed can set up their own.
- Funds can be bought through most stock brokers but they generally charge a brokerage fee. Funds can also be bought directly from the company that operates the Fund without a brokerage fee. You will first need to open an IRA or conventional account with the fund company as this account is used to buy the Fund. If you are only investing in Funds and buy them directly from the fund company you do not need a stock broker.
- Beginner investors do not have to start fully invested. You can start with any amount you like. Some beginner investors feel more comfortable starting slowly. You can always invest more money at a later stage as your confidence increases.
Initial Investment
An important consideration that needs to be discussed is the size of the initial investment.
Initial Investment Considerations
- Starting with $100
Beginner stock investors starting with very small accounts like $100 have very few options. There are a handful of Mutual Funds with a $100 minimum initial investment. Buying stocks will cost way too much in brokerage and most Funds have minimums significantly higher than $100. - Starting with $2,500
Beginner stock investors starting with small accounts with a minimum of $2,500 should probably start investing the full amount to begin with. When buying stocks the investor would ideally buy 10 stocks which means a minimum of $250 per stock. The brokerage will be around $7 using an online broker (which represents a reasonable 2.8% of the stock value). When buying Mutual Funds a lot of funds have $2,500 to $3,000 minimums so the investor has a plenty of funds to pick from. - Starting with $10,000
Beginner stock investors starting with a moderate account size of $10,000 could start investing the full amount but if buying stocks they should consider starting with maybe halve and consider buying say 5 stocks to begin with and add some more latter as their experience and knowledge increases. If only buying funds consider investing the full amount. - Starting with $100,000
Beginner stock investors starting with large accounts of $100,000 or more should consider starting by only investing a portion to begin with (maybe 25% or perhaps 50%) and increase the amount invested over time as your experience and knowledge increases. Large accounts can easily accommodate stocks and Funds.
The following article How to Select Stocks and Funds provides the beginner investor with some stock and fund ideas and you can consider whether they would be suitable for inclusion in your portfolio.
Regular Contributions
If you are going to regularly contribute to your investment account there a few things to consider if buying stocks.
Most Mutual Funds do not have any restrictions with contributing to the fund after the initial purchase. So the investor can add any amount at their desired interval.
However with buying stocks there are some practical limitations. The brokerage cost is around $7 to $10 using an online broker and the stock price needs to be considered.
Contribution Considerations with Stocks
- Adding $20 per month
Realistically you will have to wait until you have accumulated several hundred dollars in your account before you could buy some shares in one stock. If you bought one share of a $10 stock it will cost you upwards of $10 to buy it. Now that’s 100% of the initial cost meaning the stock price would have to increase 100% just to break even. Realistically you would have to accumulate around $300 first and buy 30 shares in that $10 stock (the brokerage would now only represent around 3%). - Adding $100 per month
Similarly you will have to wait some months until you have accumulated several hundred dollars in your account before you could buy some shares in one stock. Buying one share of a $90 stock will cost around 10% of the purchase price. But if you wait and accumulate $300 you could buy three shares of the $90 stock and brokerage would only cost around 3%. - Adding $500 per month
You have enough to buy a stock or maybe two. The brokerage cost will be a few percent which is reasonable. As the months go by you should buy a variety of stocks so that your portfolio remains diversified. In other words “don’t put all your eggs in one basket”.
With the smaller contributions you should seriously consider adding to a Mutual Fund as the brokerage costs with buying stocks becomes excessive which significantly diminishes your net returns.
The article How to Select a Stock broker. provides some guidance for the beginner stock investor in selecting a stock broker (if you require one).
Passive Investing vs. Active Investing
Passive investing means buying stocks and/or funds and holding these for the long-term (generally 10-years or more). Most passive investing strategies involve managing a portfolio for the market’s cycles.
Active Investing involves actively monitoring and managing a portfolio during each market cycle and requires more time from the stock investor. Active investing is best done by investors with some experience in the markets.
With passive investing you are investing for the future value of the companies. Stock prices can be quite volatile in the short-term and these prices are best ignored by the beginner stock investor who should keep their focus on the future rather than on the present.
Most of the stock investors that are still around today who started a decade ago are those with a long-term portfolio who applied portfolio management strategies.
Speculation and Trading
This guide has been written for beginner stock investors who are looking to invest for the long-term and is not appropriate for speculation or trading.
Speculation and Trading is highly active and requires a considerable amount of time.
The potential for profits is high but there is a real possibly of substantial financial loss. Speculation and Trading is high risk and its best if beginner stock investors refrain from these until they are more experienced.
What To Do Next
Now that you have a better understanding of investing it’s a good idea to write down your own investment plan using the above information as a guide.
Always keep in mind your own personal goals and don’t be influenced by other people as their objectives are probably different to your own.
Once you have your written investment plan, the next step is selecting the stocks and/or funds for your portfolio.
The following article How to Select Stocks and Funds provides some stocks and funds for you to consider and you can decide whether they are appropriate for your investment plan.