The stock market fantasy is familiar to many: you take a relatively small amount of money, buy shares in an up-and-coming company, and before long, your nominal investment has turned into huge dividends. We would all love to have had that foresight, and in some instances, smart investing can in fact make you quite well off. But many people also invest in stocks and mutual funds as a way to slowly grow their money or prepare for retirement, growing their investment slowly over the course of years or decades.
But where to begin? How do you even buy stock in the first place? How much money can you stand to lose if things go south? This month’s installment of Finance 101 takes a look at the world of buying stocks. As usual, any financial maneuver should be undertaken with the utmost seriousness, research, and professional guidance. While the potential for making tons of money in the stock market is an appealing prospect, you don’t want your own financial future to sustain its own Great Depression!
Generally, there are two major ways in which people can invest in stocks: purchasing individual shares of a company or purchasing mutual or index funds.
Purchasing individual shares is the most common conception of playing the stock market. You buy shares in a company, and each of these shares will increase or decrease in value according to its performance on the market. These tend to be the riskiest investments and you’ll pay taxes on the money you’re investing in, but these investments tend to be the ones that yield the highest returns.
However, Rob Berger at Forbes.com writes that investing in the stock market shouldn’t be looked at as a quick way to get money. “Investing in stocks is for the long term,” he writes. “If you will need the money in a couple of years, keep it in a high yield savings account. Investing in stocks should be for a minimum of five years, and ten years is preferable.”
A less risky bet than stocks are index funds and mutual funds, which are investments in a pool of stocks and bonds. For example, if you bought funds that follow the Standard & Poor’s 500 index or the Russell 2000 index, your money would be invested in companies and industries on these indices. In the case of mutual funds, your money won’t be tied to the performance of just one stock or bond, which makes for a less-risky investment.
Your goals for investing will also determine the kinds of investments you make. If you are interested in investing for your retirement, for example, IRAs, or Individual Retirement Accounts, might be the best bet. IRAs are typically comprised of low-risk stocks and bonds, and many IRAs are tax-deferred, meaning you don’t pay taxes on the money you invest until you withdraw it.
“You don’t have to swing for the fences” when it comes to investing in stocks or funds, says Jason Beaver of Guerra Investment Advisors. “You can build wealth with steady growth.”
You generally have two options when it comes to buying stocks: doing so on your own through an online broker, or investing through a stock broker or financial planner who will do the work on your behalf.
Beaver recommends working with a broker due to the complicated nature of the stock market, but he also notes that most brokers charge a commission for their services, and in many cases, there will be a charge any time you buy or sell a stock. Nerdwallet advises that you should “aim to keep fees under 0.25 percent of each stock, though it may stretch higher for niche funds.”
It is possible that trading fees could negate any profits if you frequently buy and sell your stock, Beaver says. There are, however, a number of funds that you can invest in without paying fees. Consult with your broker or financial planner about these options.
Diversify your bonds
Fans of “Chappelle’s Show” probably remember rapper RZA’s sage advice: diversify your bonds. By this he means invest in a variety of industries and companies, and not just one or a few. Putting all of your eggs in one basket rarely works out well regardless of the field, and the same is certainly true for stocks.
“It is better to be diversified across several different sectors such as real estate, consumer goods, commodities, insurance, etc.,” writes Jim Miller at Investopedia, who also suggests “diversifying across asset classes as well by keeping some money in bonds and cash, rather than being 100 percent invested in stocks.”
Ariel O’Shea at Nerdwallet writes that someone investing for retirement might have 80 percent of his or her portfolio in stock funds, while individual stocks make up ten percent or less of one’s investment portfolio due to their inherent riskiness and the work it takes to maintain them. And as Investopedia notes, diverse investing means that any hard lessons learned along the way are less costly.
Do your research
You may be tempted to throw money at a young company that seems to be revolutionizing a certain field, or you may invest based on a sure tip offered by someone you know. But neither of these are smart reasons for investing.
“If your reason for investing in a certain stock is because a friend told you to, most of the time, those investments fail,” Beaver said.
Investing in the stock market should only take place after thorough research, Beaver added. He recommends doing research on individual stocks and even reading a “Stock Market for Dummies”-style book to get you acquainted with the technical aspects of investing in the stock market, as well as the risks.
“There’s no simple way to go about it,” he said. “You could spend a year studying and still not know what you don’t know. The learning curve is really steep.”
When you are starting to invest, it is best to start small and take the risks with money you are prepared to lose, but according to Investopedia, “as you become more adept at evaluating stocks, you can start making bigger investments.” You can even invest fake money on virtual stock simulators, which may give you some indication of what it is like to actively invest in the market.
No matter how you invest, experts recommend developing a plan outlining your expectations and intentions before you begin, which can be used as the blueprint for your investing.
“It’s all too easy to panic and pull out at the wrong time or get swept up in a rally and invest more than you can afford in what feels like a winner,” says Nerdwallet’s O’Shea. “But it’s important to stay the course, as long as you have a long-term plan you feel good about.”