When done correctly, stock market investing is one of the most successful methods of building long-term wealth. Here’s a step-by-step tutorial on stock market investing to avoid making mistakes.
5 Steps to Stock Market Investing
1. Determine your approach
When beginning to invest in the stock market, you should first and foremost consider your approach. For example, are you planning to buy stocks individually or take a more passive route?
Regarding how to invest money, there are two main camps: active investing and passive investing. We believe both methods have advantages; all you have to do is concentrate on the long term rather than merely looking for quick returns. However, your lifestyle, budget, risk tolerance, and hobbies may influence your selection. The only thing that will vary is how.
2. Decide how much to invest.
Let’s start with the money you should avoid investing in equities. The stock market is not the place for cash that you might need within five years, at a bare minimum.
While the stock market will, in all likelihood, increase over time, there is too much volatility concerning stock prices in the short term – a drop of 20% or more in any given year isn’t out of the ordinary. In 2020, during the COVID-19 pandemic, for instance, stocks plummeted by more than 40% but then quickly rebounded and hit an all-time high within a few months.
You should not be investing the following funds:
- Your child’s upcoming tuition payment
- Your short-term vacation fund (i.e. next year)
- Your emergency fund
- Money you’re saving for a down payment, even if you don’t plan on buying for many years
If you don’t plan on needing your investable money for at least the next five years, asset allocation comes into play. Moreover, your age primarily plays a role in this, how much risk you’re willing to take on, and your investment goals.
Let’s begin with your age. As you get older, stocks become a less attractive place to keep your money. On the other hand, if you’re young, you have decades ahead to weather any market turbulence, but this isn’t the case if you’re retired and reliant on investment income.
Use this quick rule of thumb to establish a ballpark asset allocation. First, subtract your age from 110. This is the rough percentage of your investable money that should be in stocks (this includes mutual funds and stock-based ETFs). The rest should be in fixed-income investments like bonds or high-yield CDs. Depending on your risk tolerance, you can adjust this ratio up or down.
Let’s assume you’re 40 years old. According to this rule, 70% of your investable funds should be in equities, with the remaining 30% in fixed income. If you’re a risk-taker or plan to work past retirement age, you may want to move this ratio toward stocks. On the other hand, if you don’t want your portfolio to swing wildly, you might wish to shift it in the opposite direction.
3. Open an investment account
If you don’t have access to a stock market, all the advice about investing in stocks is useless. To do so, you’ll need a brokerage account.
To name a few, TD Ameritrade, E*Trade, and Charles Schwab offer these accounts. Furthermore, it is usually a quick process that takes only minutes to open up a brokerage account. Then, you can fund your account electronically via EFT transfer or wiring money.
A brokerage account can be a great way to invest, but you should compare brokers and consider a few things before opening an account.
Type of account
Before you start investing, find out which type of brokerage account will work best for your needs. For many novice investors, this decision is between a standard brokerage account and an individual retirement account (IRA).
Using a money market account, you may invest in equities, mutual funds, and exchange-traded funds. The most important questions to ask yourself are why you’re investing in stocks and how easily you want access to your cash.
A standard brokerage account is perfect for anyone who wants easy access to their money, is only investing for a rainy day, or wants to exceed the annual IRA contribution limit.
If you’re interested in saving for retirement, an IRA account is a great option. Traditional and Roth IRAs are the two main types of these accounts. Still, some specialized versions are for self-employed individuals and small business owners, like SEP and SIMPLE IRAs. One of the benefits of investing in stocks through an IRA is that they’re tax-advantaged, though it can be tough to access your money until later on down the road.
Contrast costs and features
Most online stock brokers charge no commission for trades, so they have levelled the playing field regarding cost.
However, there are several more significant distinctions. For example, some firms provide clients with a wealth of educational resources, access to investment research, and other services that are especially useful for newcomers. Others can trade on foreign stock exchanges. And others have physical branch networks that can be handy if you want face-to-face investment advice.
Another thing to consider when choosing a broker is how user-friendly their trading platform is; some are much more difficult to use than others. However, many brokers will let you try a demo version before deciding whether or not to commit any money, which is a great idea.
4. Choose your stocks
Now that you know how to buy stock, you have to decide which stocks to buy to get you started.
Of course, in such a short article, we can’t go through everything you should think about when selecting and analyzing equities, but here are the key ideas to grasp before you begin:
- Invest in a variety of assets.
- Only invest in businesses you comprehend.
- Steer clear of high-volatility stocks until you have a firm grasp on investing.
- Avoid penny stocks always.
- Learn the fundamentals of stock evaluation.
The diversification of your investment portfolio is an important concept to learn. Diversifying means having a wide range of firms in your portfolio. However, we advise against excessive diversification. Stick with companies you are comfortable with. There’s nothing wrong with comprising a large portion of your portfolio of businesses from the same sector.
Buying high-growth equities may seem like a great way to create money (and it can be), but we advise you to put off these for now. Instead, starting with a “base” of reputable, established firms is better before diving into the sector.
If you’re looking to invest in individual equities, it’s a good idea to understand some of the basic techniques for evaluation. We can help you locate stocks with low prices in our value investing guide. Our growth investing resources are also a fantastic beginning point if you want to add some exciting long-term growth prospects to your portfolio.
Related: When to Sell A Stock
5. Continue investing
According to Warren Buffett, one of the secrets to investing is that you don’t need to take extreme measures to earn exceptional profits. (Note: Warren Buffett is the most successful long-term investor of all time and a great source of wisdom for your investment strategy.)
The best way to earn money in the stock market is to purchase shares of excellent businesses when the prices are fair and then hold on to those shares for as long as the businesses remain great. Of course, there will be some ups and downs, but patience is a virtue for investors! With time, you should see exceptional investment results.