Author: Craig Adeyanju
Estimated read time: 9 minutes
Publication date: 4th Dec 2019 22:40 GMT+1
Stock investing is one of the most reliable ways to build wealth over the long-haul. You may not know it, but the value of a $10,000 investment in the S&P 500 index 50 years ago would close to $1.2 million today.
Many people ask themselves “Is stock trading for beginners?” The good news is: yes, it is. Stocks are a good investment vehicle for beginners for a couple of reasons discussed here. However, like most things, you need to begin by learning about the art of investing. To many, investing might seem like a scary, convoluted maze of numbers, terminologies, fees, taxes, and interest but it’s not as complicated. Here’s a step-by-step guide to help you invest in the stock market.
Investing in Stocks 101
These four high-level checklists are a good place to start.
Let’s go over each of these points...
You can approach stock investing in two ways.
The first approach is investing in individual stocks. This is ideal for investors who have the luxury of time to conduct their due diligence on the underlying businesses. This would require that you learn a bunch of investment lingo — such as price to earnings ratio (PE) and free cash flow (FCF) — and their respective applications. There are tons of resources online about stock research. It could be daunting at first, but it is entirely doable to beat the market in the long haul.
The second approach is to invest in structured stock-based assets, where someone has done all the work of researching and picking individual stocks and presenting them as a single investable asset. These are called investment funds and they’re set up and overseen by a fund manager.
Retail investors can access investment funds by putting money in stock-based mutual funds or exchange-traded funds (ETFs). One of the key differences between a mutual fund and an ETF is that the former is usually actively managed while the latter is typically managed passively. This means that the fund manager routinely assesses a mutual fund and alters the asset allocation as they deem fit. Many ETFs, on the other hand, are set up to track the performance of specific market indexes. This reduces the need for regular assessment, which leads to active management.
As you can probably tell, the investment fund approach doesn’t require you to go waist deep into stock research, making it a good starting point for beginner investors. It may be easier to start learning about stock research and picking through the work already done by professional managers.
Before deciding how much money to put in the stock market, you need to first identify the money that shouldn’t go in there. Winning at stock investing requires a long-term mindset and as such, you shouldn’t put any funds you’ll need in the short-term in the stock market. Think your child’s next few tuition fees, your emergency fund and the down-payment on saving up for your mortgage, just to name a few. Such funds are better off in a high-yield savings account.
That said, the amount to invest depends on your age and economic reality. However, the 50/20/30 budget rule, popularized by American senator Elizabeth Warren in her book “All Your Worth: The Ultimate Lifetime Money Plan,” may help. The rule states that you should allocate 50% of your income after tax to settle your needs, 30% towards your wants and 20% toward savings and investment.
Unlike a few decades ago, when you’d need to seek out a stockbroker in order to invest in stocks, online stock brokerage platforms have simplified the process of getting started. If you have all the required information available, you should be able to open an account in a matter of minutes. You’ll first need to decide what kind of brokerage account you need, though. For beginner stock investors, the choice is typically between a standard stock brokerage account and an individual retirement account (IRA). The type of account you pick would depend a great deal on your investment objectives and the ease of access to capital that you desire.
If your aim is to invest for retirement, you’ll want to open an IRA account. IRAs offer a range of tax benefits, which are designed to encourage individuals to invest toward retirement. The U.S. tax office IRS sets an annual limit for how much you can put in an IRA. For 2019 and 2020, the limit if $6,000 — or $7,000 for individuals with the age of 50 and above.
The two most popular types of IRA are:
The 401(k): This is offered by employers. Deductions are made directly from your paycheck, and your employer matches your contribution, up to a limit.
Traditional IRAs: If you don’t have a 401(k) account or you’re already contributing to one and want to invest separately, this is a great option. The upside is that your contributions are tax-deductible. If you are self-employed, there are some IRAs specifically designed for you such as the Solo 401(k), SEP IRA, Simple IRA, etc. IRAs are attractive as they are tax-deductible. The downside to IRAs is that you will be subject to fees and taxes if you withdraw before retirement.
While an IRA could be a tax haven, you should note that there are penalties for withdrawals made before the age of 59.5 years.
Although this discussion here has been centered on U.S. investors, non-U.S. investors might be able to open some sort of tax-advantaged retirement account. Many governments have such structures in place to encourage citizens to save for retirement. You’ll want to research the types of retirement accounts offered in your country to decide which is best suited to you.
That said, if you’re likely to need your money sooner than retirement, a standard investment account would suffice. There are a few options here as well, depending on how much time you want to dedicate and how much control you want over the stocks you own.
Online Brokers: This is the quickest way to trading in stocks and other investment options. It allows you to exercise more hands-on control over your investments, including buying stocks, bonds, and other instruments. This is the ideal option for people who want to personally decide their investment choices and want a large pool of investment options to pick from. To trade with an online brokerage account, you have to open an account with an online broker. Many online brokers show you how to buy stocks, walking you through the intricacies of stock-buying.
Robo-advisors: This option is usually offered by portfolio management companies. Robo-advisors utilize computer algorithms to build and manage your stock portfolio, mainly determined by your investment goals. A major selling point for robo-advisors is the fact that you are not required to do any of the heavy-lifting or legwork. Robo-advisors usually charge annual fees in the range of 0.25% to 0.50%, less than professional human advisors.
Robo-advisors usually invest via funds, and might not be the best option for you if you are considering investing in individual stocks.
Before opening a brokerage account with a broker, you should evaluate a number of factors such as costs and fees, investment selections, and the research materials and tools available to you to help you make the right investment choices.
There are two major ways you can make money from stocks:
Of course, you don’t have to choose one over the other. It makes sense to hold both types of stocks. Always do your research about the best kinds of stocks to invest in at any given time.
With your account now set up, you can now start buying stocks. Here are a few things to bear in mind as you start out.
Avoid investing in businesses you don’t understand
First, to get the best results, and for your own sanity, you should avoid buying stocks of companies whose business you don’t understand. Stocks can be volatile, and a host of confusing market commentaries will appear at every point. The commentaries can be confusing because they might all make sense and that makes it more difficult to follow anyone.
However, understanding the business behind the stocks you buy will help you sift through the noise to make educated decisions.
Maintain a diversified portfolio
Diversification means that you should hold an assortment of different types of companies in your account. And no, this isn’t a go-ahead to invest in companies you don’t understand. In simple terms, keeping a diversified portfolio limits the chances that the crash of a single stock will wipe away your investment.
Pay attention to Costs
Irrespective of the investment approach you choose, you want to pay close attention to the costs. As a matter of fact, the cost of investing should be a key determinant of the platforms you choose and the investment products (like ETF and mutual funds) you buy.
Source: U.S. Securities Exchange Commission
The chart above, gotten from an SEC report, shows how much fees, as small as they may seem, can impact the value of your portfolio. It’s for a portfolio that returns 4% annually, with annual fees of either 0.25%, 0.5% and 1%.
Disclaimer: The writer is an experienced financial consultant who writes for Finscreener.com. The observations he makes are his own and are not intended as investment or trading advice.
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