You don't have to be rich to learn how to invest in stocks.
Only 55% of Americans invest in the stock market in 2019. That's down from 63% of Americans who were invested in stocks directly (through equities), or indirectly (ETFs, mutual funds or retirement savings accounts) in 2004. Of those who invest, some people enlist the help of a financial advisor who makes a lot of the necessary investment decisions for them. But not everyone has the time, money and faith needed to use a financial advisor. The good news? Investing in the stock market has a lower barrier to entry than ever before. Here's a brief breakdown of how to invest in stocks for beginners.
Make sure you're ready and able to invest.
Just as one walks before they run, so too does one save before they invest. That seems obvious, but this might not be: the rule of thumb is to have at least six months' worth of living expenses saved up should catastrophe strike before you can start buying stocks. On top of that, all credit card debt should be paid off before you set off to become Gordon Gekko 2.0. The interest you pay on credit card balances is typically 15% to 25%. Paying that down is the easiest way to guarantee yourself a return that high on your money. With free trading apps like Robinhood, there's no amount too small to start with -- although starting with $1,000 to $2,000 makes things much easier.
Saving up for a car? House? School? Retirement? Do you want to get rich quick, or are you content to earn market returns on whatever extra money you can? These are all very different objectives, and honestly defining your goal is the first step to successful stock market investing -- for beginners and veterans alike. If you know exactly how much money you want and when, you can calculate what you'll need to regularly invest, assuming certain rates of return. Investors "should have realistic goals and make sure they are also using realistic rates of returns on their projections. Using a 12% rate of return is very different than using a 7% or 8% rate of return," says Ryan Marshall, certified financial planner and partner at Ela Financial Group.
Establish your timeline.
Do you know why Warren Buffett is the single best stock market investor of all time? He invests with enormously long time horizons in mind. One of the many famous quotes from the Oracle of Omaha is that his favorite holding period is "forever." On a practical level, it's important for average investors to decide how long they want to hold a stock before they even buy it. If you're saving for a house you want to buy in two years, you might not want to bet the farm on Wall Street, due to its unpredictability. If you're saving for retirement, and come across what seems like a cheap stock to buy, it doesn't matter as much if shares don't immediately rise -- you're in for the long haul.
Assess your risk tolerance.
This is arguably the most important thing to understand about yourself before investing in stocks. In fact, the old aphorism "know thyself" is a core tenet of successful investing, and is echoed in goal setting, establishing a time horizon and defining your risk tolerance. Investing in smaller or higher growth companies entails more risk than buying all blue chip stocks or a portfolio of large cap dividend stocks. In other words, small cap stocks are generally more volatile than large caps, and typically face a bigger risk of bankruptcy. In times of market sell-offs, can you hold your stocks as they lose 20%, 30%, 40% on paper? If you still believe in them, are you willing to double down? Know this about yourself before you start investing.
Choose your ideal types of investments.
The rise of low cost index investing, which didn't even exist until the '70s, has arguably done more than anything else to help bring Wall Street's historically impressive returns to the masses. Investors have more choice than ever when it comes to where to invest: active or passive funds, stocks or bonds, ETFs, cryptocurrencies, etc. While buying individual stocks can be fun, Vanguard and other low-cost fund families give individual investors opportunities they've never had before. "The best way to implement the key principles is with low management fee index funds, which help you diversify, minimize costs, stay disciplined and capture market returns wherever they may occur," says Dejan Ilijevski, president at Sabela Capital Markets in Munster, Indiana.
Find a compatible brokerage.
Once you've figured out everything else on this list, the hard part is over. The journey from wondering, "How do I invest in stocks?" to the point where you become an actual shareholder is filled with deep questions about who you are, who you want to be and how you plan to get there. And now, you're almost done. After you've researched some possible investments or decided to buy one or two in particular, consider what type of broker best fits your wants and needs. Most online brokers offer everything the retail investor needs, so do your own research and determine which features are important to you. Low commissions? Great trade execution? Research tools? Integration with another financial provider?
Select an order type.
After you've chosen a broker and know what funds or stocks to buy, you've gotten all the way down to the literal mechanics of how to invest in stocks. After you've funded your account, you just need to pick what order type you're going to use to buy the stated quantity of your preferred investment. A "market" order will execute at the prevailing market price, while a "buy limit order" buys the quantity you specified if and only if the share price is at or below the price you set.
Rebalance regularly and check in on your goals.
"I would say this might be the hardest area for clients to grasp," Marshall says. Rebalancing a portfolio is often done once or twice a year to ensure investors remain sufficiently diversified. There are different philosophies on when to let something run versus when to pare back a position if it's become too critical to the portfolio, but oftentimes emotions make investors reluctant to change their allocations. "In essence you would be selling positions that have done well for positions that might be out of favor," Marshall says. Checking in on goal progress is less demanding and controversial. "Clients should revisit their goals and make sure they are on track at least annually," Marshall says.
Eight steps to start investing in stocks:
-- Make sure you're ready and able to invest.
-- Define goals.
-- Establish your timeline.
-- Assess your risk tolerance.
-- Choose your ideal types of investments.
-- Find a compatible brokerage.
-- Select an order type.
-- Rebalance regularly and check in on your goals.
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