Stock investing is one of the best ways to build long-term wealth and put money aside for your future. However, if you’re new to the stock market, it’s not always easy to know where to start. That’s why we’ve put together this guide on investing in stocks for beginners. Keep reading to discover our five step approach for first-time investors.
1. Choose your approach
There are a variety of ways for you to start investing in stocks as a beginner.
- Individual stocks. Individual stock investing is when you put all your capital into a single stock, e.g. a share in a company. If you’re mathematically minded and you’re prepared to do your research, this could be a good option for you. However, this approach is not recommended for beginners because it’s time consuming and more risky than, say, investing in an index fund.
- Index funds. Index funds are investment funds which follow a specific stock index, e.g. S&P 500 or Nasdaq 100. This is a low-cost and comparatively safe investment option for beginners, since the fund is almost guaranteed to match the performance of its index over time. For example, the S&P 500 has produced total yearly returns of about 10%, which is a steady way to build your wealth over time.
- Robo-advisors. A robo-advisor is a smart brokerage that invests your money for you in a portfolio of index funds. It selects your investments based on a range of criteria, including your age, risk tolerance, and investment goals. What’s more, some robo-advisors can make your investments more tax efficient with automatic adjustments.
The approach you take will be determined by how “active” you want to be. Investing in individual stocks involves a lot of research, patience, and risk vs. investing with a robo-advisor who will manage all of that for you.
2. Decide how much to invest
The stock market is highly volatile. In 2020, the market dropped by more than 40% at the start of the pandemic, only to reach record highs a couple of months later. Even when the world’s not in lockdown, it’s not unusual to see stock prices fall by 20%. Of course, the purpose of investing is to make a profit. But you should only invest money you are prepared to lose.
Once you’ve determined how much that is, and how much capital you have, then you need to decide how you’re going to allocate it. One of the biggest factors that will come into play here is your age.
Generally speaking, the younger you are, the more desirable stocks are as a place to keep your money (and potentially grow your pot), because you have more time to weather the ups and downs of the market. When it comes to asset allocation, this quick trick can help you work out how much of your money should go where:
Take your age and subtract it from 110. This will give you a ballpark figure for how much of your capital should be invested in stocks. The rest of the money should be invested in fixed-income assets, e.g. bonds. But you can always modify these numbers depending on your risk tolerance and investment goals!
3. Open an investment account
In order to buy stocks, you will need to open a specialized account known as a brokerage account. You can set up an account quite easily with a licensed brokerage firm, e.g. Charles Schwab, Fidelity Investments, E*TRADE, or TD Ameritrade.
With lots of different brokerage options available to you, it’s important to look into the following, to help you determine which of them is the most suitable:
- Type of account. As a beginner, you’ll likely be choosing between one of two types of account: a standard brokerage account or an individual retirement account (IRA). You can buy stocks and invest in mutual funds and EFTs with either account type. Your investment objectives will determine which kind you go for.
If you’re investing to build capital and you want easy access to your money, you’d be better off with a standard brokerage account. But if you’re investing for the purpose of building a retirement fund, an IRA can help you do that. IRAs are very tax efficient, but the downside is, they are very tricky to withdraw from before you reach retirement age.
- Costs and features. Most online stock brokers are about on a par with each other when it comes to the cost of opening a brokerage account. However, for roughly the same fee, different firms give you access to different features. Some offer educational resources, while others give you the option to trade on foreign stock exchanges. Consider what you need to reach your investment goals.
4. Choose which stocks to buy
It’s important to buy the right stocks. But as a beginner, it’s not always easy to know which those are. Here are four steps to take to help you decide which stocks you should buy:
- Learn how to evaluate stocks.
- Do your research.
- Know which stocks to avoid as a beginner (penny stocks; high volatility stocks).
- Diversify your portfolio.
Diversification (having a range of stocks, bonds, and other assets in your portfolio) is a good way of mitigating risk, because it prevents any one asset from damaging the whole of your portfolio. Compare this to investing in individual stocks, where all your money is in one place. If the share price plummets then, you stand to lose a lot more.
The best way to diversify your portfolio is by investing in an EFT or mutual fund. This type of investment is designed to be diverse – and saves you having to do an analysis of the individual companies on the index.
5. Start now
This is advice from Dan Keady, who’s the Chief Financial Planning Strategist at TIAA. There’s never going to be a “right time” to invest, because when you invest you’re playing the long game. So, there comes a time where you just have to take the plunge. He says:
“One of the core points with investing is not just to think about it, but to get started. And start now. Because if you invest now, and often over time, that compounding is the thing that can really drive your results. If you want to invest, it’s very important to actually get started and have […] an ongoing savings program […]”.