Deciding to invest money in the stock market can be a scary proposition. After all, it can feel like you need to learn an entirely new language to understand what is going on. And then there is the question of risk.
Anyone who watches the news even occasionally knows that the stock market is usually very volatile, with prices of stocks rising and falling suddenly and unpredictably.
Investing makes it possible to earn money through an alternative means to working or owning a business.
When you commit money to an investment of some sort, you expect to earn a profit. While most people understand the reasons for investing and the benefits of successful investing, it can be difficult to figure out how to get started.
But with a little bit of knowledge to demystify the process, responsible investing in stocks can be an interesting, fun and lucrative way to make some money. In this guide, we will walk through the basics of investing in your first stock.
What is Investing?
Investing refers to the act of using your money to buy some sort of asset in the hope and expectation that the product will grow in value after you buy it.
If the product does increase in value, you can sell it for a profit.
The time frame to hold an investment and to realize the increase in value can vary greatly. Some investments can yield gains in seconds while others can take years.
This can be especially true for stocks as they are highly volatile and you may never know when they'll bring in a profit (if ever).
Types of Investments
There are several different types of investments. As a beginner, you will want to understand the options, their tax implications and risk level of each type of investment.
Investing in stocks is the equivalent of buying a small percentage of ownership in a business.
You can vote during shareholders’ meetings and you will receive profits the company allocates to company owners which are called dividends. Stocks are considered high-risk investments and their values fluctuate daily.
To earn a profit on a stock investment, the stock must increase in value.
While you are at risk of losing your investment in stocks, there is also a potential for a relatively high return on your investment if the stock you purchase does well.
The goal for investors in the stock market is to select stocks that have a good likelihood of rising in value over time.
Bonds are fixed-income securities that allow you to earn an interest on your money as well as the original amount of money you lent out.
When you purchase a bond, you are lending the money to government or companies in exchange for interest.
Bonds are a very low-risk investment opportunity as they are almost guaranteed risk-free -- meaning you will get back the amount you invest. In exchange for offering a risk-free investment opportunity, bonds offer very little return on your money.
Mutual funds are a collection of stocks and bonds that are purchased by a group of investors.
When you buy mutual funds, you give a professional mutual fund manager the ability to select the specific mix of bonds and stocks that are purchased within the fund.
The idea is you can invest without spending time and effort researching all available investments since the manager will have more knowledge of the market and potential for the fund to earn a return than you would have.
The prices for mutual funds are determined at the end of the trading day. So, if you put in a buy order in the middle of a trading day, the trade will happen at the price at the close of the stock market.
An index fund is a single investment that allows you to buy partial ownership in several different companies traded on the stock exchange.
Essentially, it is a mutual fund that tracks a certain stock market index, such as the S&P 500.
It ensures you have a diversified investment portfolio to limit your risks, and gives people with a small amount of money to get started with investing.
Exchange-traded funds (ETFs)
ETFs can be considered a basket of stocks that trade similar to stocks. Basically, it is a mutual fund that experiences price fluctuations by the second.
Therefore, you can trade ETFs at any time during the trading day. This allows you to take advantage of drastic price changes throughout the trading day.
The majority of investments fall under either stocks or bonds (or a combination, like mutual funds); but there are other opportunities for investments including FOREX, real estate and gold, among others.
As a beginning investor, these types of alternative investments are probably not the best place to get started.
7 Investing Terms You Should Know
When investing your cash, it is important to have a thorough understanding and a clear expectation as to how the investment world works.
For those just starting out, there can be tremendous confusion when it comes to the dialog that goes along with investing.
Here are 7 investing terms every beginner investor should know:
The assortment of investments a person or business owns.
A third party who serves as a middleman between those selling stocks and those buying stocks. A broker earns a commission amount on each transaction that is made between buyer and seller.
When a seller is selling a security, the ask price is the lowest price the seller will be willing to agree on for the sale.
When a buyer is purchasing a security, the bid price is the highest price the buyer will agree to pay for the sale.
A bear market refers to the time when stock prices drop for a considerable about of time in the stock market. The opposite of this type of market is known as a bull market.
An international or national company whose stock maintains a solid history of growth on a consistent basis.
The amount of money paid out to shareholders by companies for their stocks, typically using cash payments.
Where to Buy Stocks
As recently as twenty years ago, most people had to contact a professional stockbroker to buy or sell stock. Today, thanks to the Internet, anyone with a computer can buy or sell stocks right from their home.
You can buy stocks through a brokerage -- and there are many of them.
There are many websites that will, for a fee, place orders for shares of stock, sell shares of stock you own and track the value of your entire portfolio. Each website has its own rules and regulations, so be familiar with them before you get started.
The more knowledgeable you are, the more comfortable you will hopefully be with the entire process.
And finally, know how much you can afford to spend (and lose) in the stock market and stick to that amount.
To make your first investment, consider an Index Fund or make a bond purchase directly from the U.S. Treasury.
Index Fund Companies and Roboinvesting Costs
|Vanguard||$20 annually for each account if your total Vanguard assets are under $10,000|
|Fidelity Investments||No annual fees|
|TD Ameritrade||No annual fees|
|TIAA CREF||$25 annually for accounts with less than $25,000 in cash-sweep accounts|
|Charles Schwab||No annual fees|
|Etrade||No annual fees|
|Scottrade||No annual fees|
|Personal Capital||0.89% annually on the first $1 million (billed monthly) and decreases with larger assets (down to 0.49% at $10 million)|
|Betterment||0.25% to 0.40% annually|
How to Pick Which Stocks to Buy
In the world of investing, figuring out which stocks to buy is the million-dollar question.
Trying to predict which stocks are going to rise in value is extremely difficult, even for professional stockbrokers and money managers.
Factors that affect value include such things as a company’s earnings, growth and losses, the economy, the political climate and even the weather.
You can do research about companies that interest you to see what the experts are saying about their outlook.
If there is a particular industry that you think has growth potential, look for newer companies in that industry and you might be able to get a bargain.
Remember, if a company is already doing well, the price of a share of its stock is likely to be high.
After finding an industry that you’re interested in, find out if it is publicly or privately traded.
There are several things to consider when researching a stock:
The close is the price the shares sold for when the markets last closed. Open is for what they started at the beginning of trading.
Sometimes the prices may vary as they may change even after trading hours. The markets will adjust the price when it opens again.
Bid/Ask: the prices that dealers and market shakers pay and sell the shares for
The bid or offer price is what the dealer pays when a shareholder sells their shares and the ask is the price they wish to sell their shares on the open market.
Yearly Target Estimate: the average estimated worth of the shares in one year
Daily Range: this highlights the lowest and highest price for which shares are traded on a particular trading day.
Market Capitalization: look at what others would pay if the company were for sale
The number is figured by taking the quoted price per share and multiply it by the number of shares.
If there are 3 million shares and the quoted price is $40 per share, the market capitalization is $120 million.
Compare companies with similar caps and see who is making a larger profit.
Look at the stock carefully and its earnings and determine whether or not this is something that you will still have faith in years down the line.
Look at certain factors — such as if the growth is steady and how much the company has grown and been sustainable.
Growth Oriented Industries
It’s reasonable to assume that the two industries that will do well in the future will be the healthcare and pharmaceutical sectors.
If you’re thinking about taking your investments overseas, investigate the region’s internal stability as events such as a coup can cripple a country’s economy.
This can give you an idea of what the value might be. You can compare the ratios of different stocks which reflect the stock price relative to its earnings.
A reputable company with a healthy financial history can afford to pay out dividends, with increasing payouts over time.
Look out for companies that offer high dividend yields that haven’t been around for long. This may not bring a long-term stock investment.
Study the company’s financial statements and prospectus that can help you make a better decision.
How to Know When to Sell Your Stock
Stocks are generally meant to be long-term investments. Some experts even recommend holding a stock for at least 15 years to make money from it.
This amount of time may seem extensive, but history has shown that the overall value of the stock market will rise over time, even if it suffers periodic drops in value.
You may have heard of the Dow Jones Average, the Nasdaq index or the S&P 500. These are indexes of specifically selected stocks whose performances are carefully watched by financial experts as an indication of the health of the stock market in general.
When these indexes rise and stay high, we say we are in a “bull market.” When the numbers drop for a long period of time, it is called a “bear market.”
The goal is to buy stock when the price is low and sell it when the price is high so you earn a profit.
Are There Risks Associated with Investing?
Almost all investments carry some risk that the product or item will lose value instead of gain over time. Some investments, such as bonds, are very low risk because they have set terms governing their payout.
Buying individual stocks is riskier because their value depends on the volatility of the stock market, which is very difficult to predict.
Mutual funds are somewhere in between, depending on the fund and the type of stocks in it.
Generally, riskier investments have a greater potential for growth or loss. Low-risk investments do not earn the investor as much money but the money they do earn is predictable and secure.
If you want your money to grow a substantial amount, you should invest.
How to Avoid Common Mistakes
Investing allows your money to appreciate and grow over time. People invest in order to prepare for retirement, education, or recreation.
Before you begin investing, it's important to recognize your goals in order to avoid common some common pratfalls.
A primer on Stocks
Although there is no guarantee that the stock market will go up following your investment, the average return of the S&P 500 index since 1926 is slightly more than 10% per year.
Even in this era of high-risk economic climate, investing is a good bet because just allowing your money to stagnate will not provide for a comfortable retirement.
Even if you were not able to begin investing at the age of 20 (or even 30), starting late is still better than not starting at all. Through compounded returns, you can make up for some of your lost time anyway.
One very important tip: You shouldn't start investing while you are paying off credit card debt. It's much smarter to pay off your debt (which accrues interest) than to put the same amount into the market.
Choosing the right way to save
Once you're debt free and ready to invest, the next step is to make sure you know how much money you'll need in the next few years and what money you can afford to set aside and let grow. Once you have evaluated your situation, you’ll need to choose how to split up your assets.
The stock market is typically better for longer-term investments while CDs usually better suit short-term investments. A Money Market fund might work better than stocks if you'll need money for a down payment on a house or for a vacation next summer.
While not every expense can be planned in advance, it is not financially viable to continuously trade in and out of the market. Fees for frequent withdrawals could offset returns, and gains from long-term investment could be missed if you don’t display the patience necessary to let them mature.
Play it safe or take some risks?
The biggest question you will have to ask when coming up with an investment strategy is if you want to play it safe or take a more risky approach. As a strategic rule, always make sure you are taking advantage of programs offered through your benefits package, such as a 401(k) with matching contributions — essentially free money.
Beyond programs like those, there's really no such thing as a safe bet, so keep in mind that long-term stock investments will offer long-term rewards and that daredevil opportunities with high rewards are likely to come with some high risks.
The math is simple: If you start with time, add patience and multiply by the funds you possess now, you could be better off in 10, 20 or 30 years than you are today.
Why You Should Invest Your Money
When you were a child, you probably kept your money in a piggy bank or some equivalent container in your bedroom.
You dropped coins or stuffed bills in the top and then shook them out of the bottom whenever you needed a little cash.
If you put every cent of your allowance into your bank and did not spend it, over time you might have saved a couple of hundred dollars, but the only money inside was money that you put in yourself.
Putting your money into a savings account at your local bank is not much different than keeping it in a piggy bank at home.
While a bank will pay you interest on the money in your account, interest rates on savings accounts are low and the amount of money you have will increase at a very slow rate.
Put Your Money to Work for You
Most people are taught in order to make money, they have to go to work or run a business. In other words, to increase your income, you have to work more hours.
Even if you are successfully able to work more and make more, you no longer have time to enjoy any of the money you earn if you are tied to your job all week long!
Investing your money in stocks, bonds, or mutual funds allow you to earn a return for the money you commit to the investment and through the power of compounding interest, the money can continue to grow without you trading your labor hours for a profit.
While you are working in your job or running your business, your investments can also be earning money.
Compound interest generates earnings on your asset’s reinvested earnings. The longer your money remains in a particular investment, and the more frequently the interest is compounded -- the more money you will earn.
This is why the younger an individual is when he or she begins investing, the greater their potential for earnings will be.
You're Never Too Old to Start Investing
There is often panic among those who have not been saving enough towards their retirement.
Their saving ability has not been at the level they had hoped and they have not been able to invest in their retirement as they should.
Many people will just give up too easily and figure if they haven’t started early, why bother starting at all.
Being too old to invest is a complete myth that many people buy into and, as a result, fail to make the right financial choices for their future, no matter how close their future is.
The good news is being too old to invest is a myth and you can start investing right now to prepare for a better future.
Look at the realities of today
The reality is you are responsible for your financial future and you can no longer depend on the Social Security funds to be there for you when you are planning to retire to ensure your financial needs are taken care of after you stop working.
As many people are living paycheck to paycheck, finding it hard to have ‘extra’ money to save, there is less saving and investing in one’s future.
Even if this has been your situation for much of your working life, you still have time to turn things around.
Start planning now
To properly budget your income you should start including retirement savings in your daily plans.
Even if you have to cut out some of your current expenses, the sacrifice will be worth it in the long run.
Experts recommend putting your cash into retirement vehicles before you save for other things like college tuition. As there are loans and financial aid available for perspective students, no such financial help exists for retirees.
Working individuals are encouraged to start stashing $5,000 into their retirement savings each year starting with their first job to ensure they retire with upwards of a million dollars.
As a young worker, you do have many more options for saving towards retirement with smaller amounts being put into savings and the ability to take more risks with your investments.
As an older worker headed towards retirement, you will have to invest more of your cash and likely will be advised to take less risk with your money.
If you feel completely overwhelmed with the prospect of investing and retirement savings, it is no excuse to do nothing.
Consulting with a financial advisor can help get you on the right path towards your future retirement goals.