Investing might seem complex, but taking a little time to learn about it can really pay off. It’s one of the best ways to meet your financial goals.
Investing in the stock market can be a powerful way to grow your wealth over time. However, for beginners, it’s important to approach it with knowledge, patience, and a long-term perspective. In this guide, we will walk you through the fundamental steps of investing in the stock market.
Set Clear Financial & Investment Goals:
Before you begin investing, it’s essential to define your financial goals. Are you investing for retirement, a down payment on a house, or funding your child’s education? Setting clear goals will help you determine your investment horizon and risk tolerance.
For instances, if you are saving for retirement, you may want to invest in a diversified portfolio of stocks and bonds. You may also want to consider investing in index funds, which are a type of mutual fund that tracks a specific market index, such as the S&P 500.
Educate Yourself:
Investing in the stock market requires a basic understanding of how it works. Familiarize yourself with key concepts such as stocks, bonds, mutual funds, and exchange-traded funds (ETFs). Learn about stock market indices, valuation methods, financial statements, reading analyst reports and the impact of economic factors on market trends.
For example, in The Intelligent Investor, Benjamin Graham discusses the importance of looking at a company’s financial statements to understand its financial health. He also discusses the importance of reading analyst reports to get a professional opinion on a company’s prospects.
Establish an Emergency Fund:
Before investing in the stock market, it’s crucial to have an emergency fund. Set aside three to six months’ worth of living expenses in a liquid and easily accessible account. This safety net ensures that unexpected financial setbacks won’t force you to sell your investments prematurely.
In “The Intelligent Investor,” Graham emphasizes the importance of having a margin of safety. Graham advises that investors should always be prepared for unforeseen circumstances or market downturns by maintaining cash reserves or safe, liquid assets. This ensures you have a financial cushion to handle unexpected expenses without needing to tap into your invested funds prematurely.
Determine Your Risk Tolerance:
Assessing your risk tolerance is vital to aligning your investments with your comfort level. Generally, younger individuals with a longer investment horizon can afford to take more risks, while those closer to retirement may prioritize capital preservation. Be honest with yourself about how much risk you’re willing to accept.
Start with Index Funds or ETFs:
For beginners, a prudent approach is to start with index funds or ETFs. These investment vehicles allow you to own a diversified portfolio of stocks or bonds without having to select individual securities. They provide broad market exposure and typically have lower fees compared to actively managed funds.
Graham and Dalio both advocate for a diversified approach to investing. Graham’s concept of buying a diversified basket of stocks aligns with the idea of starting with index funds or ETFs. These investment vehicles provide broad exposure to various stocks or bonds, reducing the risk associated with investing in individual securities. By investing in index funds or ETFs, you follow Graham’s advice of spreading your investments across a wide range of assets to achieve diversification.
Diversify Your Portfolio:
Diversification is the key to reducing risk. Spread your investments across different sectors, industries, and geographic regions. This strategy helps mitigate the impact of any individual stock’s performance on your overall portfolio. Remember the adage: “Don’t put all your eggs in one basket.”
Invest for the Long Term:
The stock market tends to fluctuate in the short term. To navigate these ups and downs, adopt a long-term perspective. History has shown that the market generally trends upward over time. Resist the temptation to make impulsive decisions based on short-term market movements.
Graham’s teachings in “The Intelligent Investor” emphasize the importance of focusing on the long-term fundamentals of investments rather than short-term market fluctuations. This aligns with Dalio’s principles of having a long-term perspective and avoiding emotional reactions to short-term market movements. Both authors encourage investors to consider the underlying value and prospects of their investments, aiming for sustainable growth over time.
Determine Your Investing Style
Some investors want to take an active hand in managing their investments, while others prefer to set it and forget it. Your preference may change, but decide on an approach to get started.
If you’re confident about your investing knowledge and capability, you could manage your investing and portfolio on your own. Traditional online brokers allow you to invest in stocks, bonds, exchange-traded funds (ETFs), index funds, and mutual funds.
A fiduciary financial advisor can help you make your investment decisions, monitor your portfolio, and make changes to it. This is a good option for beginners who understand the importance of investing but may want an expert to help them do it.
A robo-advisor is an automated, hands-off option that typically costs less than working with a broker or financial advisor. Once a robo-advisor program has your goals, risk tolerance level, and other details, it automatically invests for you.
Regularly Review and Rebalance:
Monitor your portfolio periodically to ensure it aligns with your goals and risk tolerance. Rebalance your portfolio if certain investments have deviated significantly from their target allocation. This process involves selling some holdings and buying others to bring your portfolio back in line with your desired asset allocation.
Graham’s recommendation to periodically review and rebalance your portfolio aligns with Dalio’s emphasis on continuous learning and improvement. In “The Intelligent Investor,” Graham suggests that investors review their portfolio at least once a year to ensure it remains aligned with their investment goals and risk tolerance. Similarly, Dalio’s principles of constant evaluation and improvement encourage investors to regularly reassess their strategies and make necessary adjustments. This may involve rebalancing your portfolio.
The Costs to Invest in Stocks
Commissions and Fees
As economists like to say, there’s no free lunch. All brokers have to make money from their customers in one way or another.
In most cases, your broker will charge a commission every time that you trade stocks, whether you buy or sell. Trading fees range from $2 per trade to as high as $10. Some brokers charge no trade commissions at all, but they make up for it with other fees.
Depending on how often you trade, these fees can add up, affect your portfolio’s return, and deplete the amount of money you have to invest.
Here’s an example:
Imagine that you decide to buy one share of stock in each of five companies with your $1,000. Assuming a transaction fee of $10, you will incur $50 in trading costs which is equivalent to five percent of your $1,000.
Should you sell these stocks, the round trip (the act of buying and then selling) would cost you a total of $100, or 10 percent of your initial deposit amount of $1,000. These costs alone can eat into your account balance before your investments even have a chance to earn a positive return.
Mutual Fund Loads
Mutual funds are professionally managed pools of investor funds that focus their investments in different markets.
They have various fees that you should be aware of. One of these is the management expense ratio (MER). The MER is the fee paid by shareholders of a mutual fund (or ETF) and goes toward the expenses of running a fund.
It’s based on the total of a fund’s assets under management. The MER can range from 0.05 percent to 2 percent annually. Bear in mind that, the higher the MER, the more it impacts the fund’s overall return.
You may also see sales charges called loads. These include front-end loads and back-end loads. Be sure you understand whether a fund carries a sales load prior to buying it. Check out your broker’s list of no-load funds and no-transaction-fee funds to avoid these charges.
For the beginning investor, mutual fund fees may be more palatable compared to the commissions charged when you buy individual stocks. Plus, you can invest less to get started with a fund than you’d probably pay to invest in individual stocks.
By the way, investing small amounts consistently over time in a mutual fund can give you the benefits of dollar cost averaging (DCA) by reducing the impact of volatility.
Online Brokers
Brokers are either full-service or discount.
Full-Service Brokers
Full-service brokers, as the name implies, offer a full range of traditional brokerage services, including financial advice for college planning, retirement planning, estate planning, and for other life events and opportunities. This custom-tailored advice justifies the higher fees that they typically charge, compared to other brokers. These can include a percentage of your transactions, a percentage of your assets under management, and sometimes, a yearly membership fee. Minimum account sizes can start at $25,000.
Discount Brokers
Discount brokers used to be the exception but are now the norm. They offer you tools to select your investments and place your orders. Some also offer a set-it-and-forget-it robo-advisory service (more below). Many provide educational materials on their sites and mobile apps, which can be helpful for beginning investors.
Some brokers have no (or very low) minimum deposit restrictions. However, they may have other requirements and fees. Be sure to check on both of these as you look for a brokerage account that meets your stock investing needs.
Examples of Online Broker:
Fidelity Investments – Best Overall, Best for Low Costs, Best for ETFs
TD Ameritrade – Best for Beginners and Best Mobile App
Robo-Advisors
Their mission was to use technology to lower costs for investors and streamline. If you want an algorithm to make investment decisions for you, including for tax-loss harvesting and rebalancing, a robo-advisor may be for you. What’s more, the success of index investing has shown that if your goal is long-term wealth building, a robo-advisor may fit your style.
Examples of Robo-Advisors:
M1 Finance – Best Low Costs / Best Sophisticated Investors
Investing in the stock market can be a rewarding endeavor when approached with knowledge, discipline, and a long-term perspective. By setting clear goals, educating yourself, diversifying your portfolio, and regularly reviewing your investments, you can begin your journey as a successful stock market investor. Remember, investing is a continuous learning process, so stay curious, adapt your strategies as needed, and remain patient throughout your investing journey.
Learn More:
The Intelligent Investor by Benjamin Graham
William Ackman: Everything You Need to Know About Finance and Investing in Under an Hour | Big Think
