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Are you thinking about investing in the stock market, but are not too sure of where to start? If so, this guide on how to invest in stocks will walk you through the process step-by-step.
We cover a variety of core metrics that need to be considered as a beginner, such as choosing an investment strategy, selecting a suitable broker, evaluating your budget, and committing to a long-term plan.
How to Invest in Stocks in 7 Steps
There’s a lot to consider when thinking about how to invest in stocks for the first time. To ensure you are not overwhelmed with information, we have broken down the process into seven key steps.
Step 1: Decide on an Investing Approach
The first metric that needs to be considered when learning how to buy stocks is whether you feel more comfortable making investments on an active or passive basis.
When opting for an active approach, you will be 100% responsible for choosing which stocks to invest in. In other words, you will be creating a portfolio based on your fundamental research.
- You might have a passion for growth stocks and decide to buy the likes of Tesla, Square, and Facebook; or
- You might decide to play it a bit safer and stick with blue-chip stocks, such as Johnson & Johnson and Home Depot.
Either way, you won’t have any assistance when it comes to the stock selection process and you will need to actively rebalance and manage your portfolio.
If, however, you prefer to take a more passive approach to stock market investing, you might want to consider a fund.
- You may choose to invest in an ETF that tracks a stock market index fund like the Dow Jones or S&P 500; or
- You might even consider a mutual fund that will look to actively outperform the wider stock market.
These passive investment options require virtually no input from you, so they suit both inexperienced and time-starved investors.
Pro Tip: Active investing requires a more hands-on approach, whereas passive investing involves less frequent buying and selling of securities which often results in investors choosing ETFs or mutual funds. It’s also worth noting that historically, passive investments have outperformed actively managed investments.
Step 2: Decide How You Want to Invest
Once you have established whether you are more suited for active or passive investing (or perhaps even a combination of the two), you then need to think about the best way to achieve this goal.
In many cases, investors will take a DIY approach, meaning that all investments are self-directed via a single broker.
- If you want to invest in Apple stocks, you would simply log in to your brokerage account, search for Apple, decide how many shares to buy, and complete the purchase.
- Then, when it came to selling your Apple shares, you would once again do this on a DIY basis through your brokerage platform.
Alternatively, you might also consider a more hands-off approach in the form of a robo advisor. For those unaware, robo advisors give you access to a pre-built portfolio based on your financial goals, risk tolerance, and time horizon.
This risk/reward trade-off is typically established when you sign up with the respective platform and answer a series of questions. Robo advisors will also take control of portfolio rebalancing, meaning that the platform will automatically add, remove, or re-write your portfolio of stocks based on current market conditions.
This ultimately ensures that your portfolio continues to align with your financial goals.
Step 3: Open an Investing Account
So far, this guide on how to invest in stocks has covered the importance of choosing an investment approach via an active or passive strategy and whether you are best suited for self-directed purchases or robo advisor services.
Next, you need to think about opening an investing account with an online broker. This process has been simplified in recent years with ever-growing interest from the retail investor sector. As such, it’s typically just a case of providing some personal and financial information, alongside some contact details.
With that said, there are hundreds of online brokers serving US investors, so there is lots to think about before selecting a provider.
The most important metrics to consider when choosing an online stock broker are as follows:
- Safety: Make sure the broker is regulated with the SEC and FINRA.
- Supported markets: Does the broker support your preferred market? Most platforms cover thousands of stocks across the NYSE and Nasdaq. But, if you want access to international equities, make sure the broker offers this.
- Commissions: How much does the broker charge in trading commissions? Many online brokers now allow you to invest in US-listed stocks and ETFs on a commission-free basis.
- Ease of use: Assuming that you are relatively new to the world of online investing, make sure the broker offers a user-friendly experience.
Now, if you are electing to invest in stocks actively via a DIY approach, you should seriously consider opting for a broker that offers retirement accounts. This will allow you to invest in a tax-efficient manner.
The main retirement account available to US traders include:
- Roth IRA: If you believe that upon reaching the age of retirement you will be on a higher tax rate, then a Roth IRA could be for you. This will ensure that your stock investment contributions can grow without paying any tax. Instead, you’ll make after-tax contributions.
- Traditional IRA: In a similar nature to a Roth IRA, a Traditional IRA allows you to invest in the stock markets in a tax-efficient way. The difference is that you will make pre-tax contributions, which is best suited for those that expect to retire on the same or lower tax band.
In addition to a Roth/traditional IRA, you should also consider setting up a 401k plan through your employer. This also allows you to allocate a segment of your salary into the stock markets in a tax-efficient manner.
Ultimately, it’s wise to maximize your chosen retirement account to ensure you minimize the amount of tax that your stock investments attract.
Pro Tip: Choosing the right brokerage and account type requires some research and due diligence to get the best out of your investments. Make sure you shop around before selecting a broker(s) for your investments.
Step 4: Decide How Much to Invest
Before you go ahead and start investing in stocks, it’s important to take a step back and assess your budget. Not only should you look at how much disposable income you are likely to have at the end of each month, but also which debt obligations you have.
For example, if you currently have large amounts of credit card debt, you are best advised to focus on reducing this first. After all, it’s all good and well targeting stock market gains of 10% per year, ut, if you’re paying more than 20% per year in credit card interest, this is counter-productive.
Additionally, you should also assess your investment budget keeping in mind your financial goals. For example, if you’re looking to reach a short-term target, consider how much you need to inject into the stock markets and for how long.
Or, if you’re looking to create a long-term investment plan via a retirement account, consider how much you need to maximize your contributions.
Ultimately, the most important thing is that you never invest more than you can afford to lose. This means that under no circumstance should you attempt to borrow capital in order to fund your stock investment strategy.
Step 5: Begin Investing in Stocks
At this point in our guide, you should have all the information you need to get the ball rolling. Now it’s time to start adding some stocks to your investment portfolio.
But, before you do, there are a few considerations that are important to make to ensure you invest in the most effective and risk-averse way possible.
You will hear a lot about diversification when learning how to invest in stocks for the first time. This is for good reason, as seasoned investors will always ensure that they have a diversified portfolio to mitigate their risk exposure.
In its most basic form, a diversified portfolio will see you invest in a diverse range of stocks from a variety of markets and industries:
- A well-diversified portfolio might contain stocks that operate in sectors such as tech, retail, pharmaceuticals, banking, and oil;
- Each sector would then contain a different type of stock to balance out the risk; and
- This might include a combination of growth, blue-chip, and dividend stocks.
Ultimately, the key benefit of diversifying your stock investments is that you will not be exposed to a single market.
For example, if you were heavily invested in tech stocks and the sector takes a turn for the worse, your entire portfolio will get dragged down. However, if you were also invested in other sectors, you wouldn’t feel the impact anywhere near as much.
On the contrary, it is hoped that your other investments counter the losses from your under-performing stocks.
Stick with What You Know
As an inexperienced investor, you might be tempted to chase that ‘big win’. By this, we mean investing in stocks that you don’t quite understand because you have a hunch that they could outperform the wider markets.
However, if you don’t have the required knowledge to perform in-depth research on the stock in question, it’s best to leave it alone. Instead, you will find much better success by investing in companies that you know and understand.
For example, if you were to stick with hallmark US companies that have a track record of dominating their respective sector for several decades, there is every chance that this will continue to be the case for the foreseeable future. Think along the lines of Microsoft, McDonald’s, Disney, Johnson & Johnson, and JPMorgan Chase. Crucially, these hallmark companies have gone through several stock market recessions but have always recovered.
Avoid Volatile Stocks
Unless you are an experienced investor that can actively research and analyze the markets, it’s best to avoid volatile stocks. Instead, opt for equities that historically grow slowly and steadily.
This is largely because newbie investors often find it difficult to deal with the emotional side of investing. For example, if you are holding a growth stock like Tesla, it is not uncommon for the shares to rise or fall by more than 5% in a single trading day.
This is great when things are going your way. But, if you can’t deal with the short-term impact of seeing your portfolio drop by above-average levels, blue-chip stocks are the way to go.
As we noted earlier, these are stocks that have a long-standing track record and have dominated their sectors for many, many years. Sure, the growth potential is going to be a lot more modest, but stock investments should always be viewed as a long-term strategy anyway.
With this in mind, you should avoid penny stocks at all costs.
Note: It’s perhaps best to start off with an index fund like the S&P 500 instead of trying to pick stocks. This will give you access to 500 large US companies at various weights, so you are instantly creating a diversified portfolio. Plus, the S&P 500 is regularly rebalanced so you can sit back and allow your money to work for you.
Step 6: Continue Investing
Unless you are looking to buy stocks to achieve a short-term goal, investing should be approached over many, many years. This will give you the best chance possible of riding out short-term market dips, which are part and parcel of investing in stocks.
The best way to invest in the stock market is via a dollar-cost averaging strategy. This will see you commit to regular stock market investments at a predetermined amount and timeframe.
For example, if you believe that you will conformably be able to afford $200 per month to invest in stocks, try and keep to this objective. In doing so, on each $200 investment that you make you will get a different stock price.
This will help smooth out your average cost price, meaning you can avoid the risk of investing when an equity peaks.
And, when a particular stock is going through a downward market correction, this allows you to buy the shares at a discounted price. Then, if and when the stocks eventually recover, you will see more favorable gains.
Step 7: Manage Your Stock Portfolio
Regardless of how active you wish to be when investing in the stock markets, you must dedicate a little bit of time to managing your portfolio. This can be something as simple — but effective, as reinvesting your dividends.
This will allow you to benefit from the long-term impact of compound growth. In other words, you will earn ‘interest on your interest’.
Here’s a basic example of how a dividend reinvestment plan works when managing your stock portfolio:
- Let’s suppose you invest $5,000 into the stock markets;
- At the end of year one, you receive a total of $250 in dividends, which amounts to a yield of 5%;
- You reinvest your $250 dividends, so your overall portfolio now stands at $5,250;
- After year two, you again receive a 5% dividend yield;
- This 5% is now based on $5,250, so the dividend amounts to $262.50;
- Crucially, had you withdrawn your first-year dividends, your payment for year two would have been $250 and not $262.50.
The above example is oversimplified as it does not factor in the rise or fall of your stocks in terms of share price fluctuation. It also fails to factor in the frequency at which you are likely to receive dividends, which is usually distributed by companies on a quarterly basis. But, the key point here is that by constantly reinvesting your dividends back into the stock markets, your capital has the potential to grow much faster.
Note: Managing your portfolio on a regular basis is as important as selecting your initial investments. Rebalancing your portfolio helps you bring back in line your asset allocation.
Benefits of Investing in Stocks
Still on the fence as to whether or not the stock market is right for you? If so, below you will find the main benefits of investing in stocks:
- Growth potential: US banks are still paying a small fraction of 1% in interest to savers, which is significantly below the rate of inflation. By investing in stocks, you have the potential to see your wealth grow at a much faster pace. For example, since the S&P 500 was launched in 1926, it has generated average annual gains of more than 10%.
- Low barrier to entry: Investing in the stock markets for the very first time has never been easier. Now, all you have to do is open a brokerage account, make a deposit, and choose which stocks interest you. As such, the process can be completed at home with ease.
- 0% Commissions: Most leading US brokerage sites now allow you to buy US-listed stocks without needing to pay any commission.
- Fractional stocks: A number of leading trading platforms offer fractional stocks, meaning that you can buy a small portion of a single share. This is great in terms of diversification and modest budgets, especially when you look at how much stocks like Amazon and Tesla are trading at
- Liquid: When you buy stocks listed on the NYSE or Nasdaq, your money is never tied up. This is because these two exchanges benefit from large trading volumes, so you can cash out your stocks at any time during standard market hours.
- Diversification: With tens of thousands of stocks to choose from, never before has it been so easy to create a highly diversified portfolio. This is especially the case when using a broker that supports fractional shares.
Downsides of Investing in Stocks
There are also some downsides of investing in stocks that you need to consider before risking your capital.
- Risk of loss: There is no guarantee that you will make money when investing in the stock market, especially if you are choosing individual equities over an index fund like the S&P 500. There are countless examples of stocks that are no longer here to tell their story. In many cases, there are stocks that are now worth just a fraction of their former glory, so always consider the risks.
- Emotions: One of the biggest barriers that inexperienced traders find when investing in stocks is the emotional side of things. Like all asset classes, the value of stocks will go up and down throughout the day. When your chosen stocks are going through a prolonged downward trend, this can be difficult to handle.
- Time: If you’re looking to actively pick and choose stocks on a DIY basis, then you need to be prepared to invest more than just money. That is to say, you will need to also invest your time to research and analyze the markets on a regular basis. The best way to counter this time requirement is to opt for a diversified index fund like the S&P 500.
FAQ: How to Invest in Stocks
We’ve found some of the most frequently asked questions with regards to investing stocks, here are our answers:
Are Stocks a Good Investment for Beginners?
The most important thing to remember is that the stock markets go through cycles, which is why you should always view investments as a long-term way of growing your wealth. In doing so, you will avoid the need to worry about short-term market volatility.
What Is the Best Stock Investing Strategy?
The best stock investment strategy – especially for beginners – is to select an ETF that tracks an established index fund. The S&P 500 and Dow Jones are great examples, as they have a long-standing track record of many decades.
You might also consider a mutual fund that focuses on the stock markets. Both options are 100% passive from your perspective and allow you to invest in a diversified manner.
Which Stocks Should I Invest In?
There is no ‘secret sauce’ when it comes to selecting stocks on a DIY basis. Instead, you need to learn how to research companies yourself so that you can make an informed decision on the financial viability of the stock.
Once again, as a newbie, it’s best to just focus on an index fund.
Can I Invest in Stocks with a Low Budget?
If you’re looking to invest in the stock markets but have a small amount of money at your disposal, there are several online brokers that support fractional shares. As the name suggests, this allows you to buy a fraction of one share.
For example, if you invested $30 into Amazon and the stock is priced at $3,000, you would own 1% of a single share. Additionally, at many online brokers, there is no minimum deposit requirement.
The icing on the cake for those on a small budget is that lots of trading platforms now allow you to buy US-listed stocks and ETFs on a commission-free basis. This means that you won’t be penalized for investing small amounts.
This guide has explained everything there is to know about investing in stocks as a beginner.
We’ve covered the fundamentals of choosing an investment strategy, what to look out for when selecting a broker, and discussed some tried and tested strategies that can help you reduce the risks involved with stocks.
The most important thing is that you diversify your portfolio well to ensure that you are not over-exposed to a small number of companies.
And of course, consider an index fund like the S&P 500 or Dow Jones if you want a low-risk and hands-off way of investing in stocks. In doing so, there’s no need for you to dedicate lots of time to researching and analyzing the markets.
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Kane is a highly-skilled researcher and writer with expertise in finance, trading, and cryptocurrencies. Academically, Kane holds a Bachelor’s Degree in Finance, a Master’s Degree in Financial Crime, and he is currently engaged in a Doctorate. He is passionate about researching the money laundering threats of the virtual economy — notably, cryptocurrencies and blockchain technology.