Investing in Stocks: The Basics
Investing in stocks means buying an ownership interest in a public company. These small stocks are called company stocks, and when you invest in these stocks, you expect the company to grow and grow over time. When this happens, your shares may become more valuable and other investors may be willing to buy them for you rather than the price you paid for them. This means you can make a profit if you decide to sell them.
Investing in the stock market is a long game. A good rule of thumb is to have a well-diversified portfolio and stay invested even in the ups and downs of the market. One of the best ways for beginners to start investing in the stock market is to deposit funds into an online investment account, which can then be used to invest in stocks or equity funds.
Investing in stocks in six steps
1. Decide how you want to invest in the stock market
There are several ways to invest in stocks. Choose the option below that best represents how you want to invest and your usefulness in choosing stocks to invest in.
A. “I want to pick stocks and stock funds myself.” Read more; this article explains what actual investors need to know, including how to choose the right account for their needs and how to compare stock investments.
B. “I want an expert to guide me through the process.” You might be an ideal candidate for a robo-advisor, a service that provides low-cost investment management. Almost all major brokerage firms and many independent advisors offer these services, which will invest for you based on your specific goals.
C. “I want to start investing in my employer’s 401(k).” This is one of the most common ways for beginners to start investing. In many ways, it teaches new investors some best investing practices: make small contributions regularly, focus on the long-term, and take a hands-on approach. Most 401(k)s offer limited stock fund options but no access to individual stocks.
Once you have a preference, you can purchase an account
2. Select investment account
To invest in stocks, you usually need an investment account. For hands-on types, this usually means a brokerage account. Opening an account with a robo-advisor is a viable option for those who need a little help. We break down these two processes below.
Important point: both brokers and robo-advisors allow you to open an account with very little money.
Do-it-yourself variant: opening a securities account
An online brokerage account can be the fastest and most affordable way to buy stocks, funds, and various other investments. You can open an individual retirement account, also known as an IRA, with a broker, or a taxable broker account if you already have sufficient retirement savings in an employer 401(k) or other plan.
If you need to dig deeper, we have a guide to opening a brokerage account. You should evaluate brokers based on factors such as cost (trading commissions, account fees), investment options (if you prefer funds, look for quality commission-free ETFs), and investor research and tools.
Passive variant: opening a robo-advisor account
Robo-advisors offer the benefits of stock investing, but don’t require their owners to do the errands required to choose individual investments. Robo-advisor services provide comprehensive investment management: These companies ask you about your investment goals during the onboarding process, then build you a portfolio designed to achieve those goals.
This may sound expensive, but the management fee here is usually a fraction of what a human investment manager charges: most robo-advisors charge around 0.25% of your account balance. Yes – you can also get an IRA from a robo-advisor if you want.
Note that while robo-advisors are relatively inexpensive, read the fine print and choose your provider carefully. Some providers require a certain percentage of accounts to be held in cash. Suppliers typically pay very low interest rates on cash positions, which can significantly impact performance and lead to suboptimal allocations to investors. These required cash distribution positions sometimes exceed 10%.
If you decide to open an account with a robo-adviser, you probably don’t need to read this article anymore – the rest is for DIYers.
3. Understand the difference between investing in stocks and funds
Do you go the DIY route? Don’t worry. Investing in stocks doesn’t have to be complicated. For most people, investing in the stock market means choosing between the following two types of investments:
Equity funds or exchange-traded funds. Mutual funds allow you to buy small fractions of many different stocks in one transaction. Index funds and ETFs are a type of mutual fund that tracks an index; for example, an S&P 500 index fund tracks the index by buying shares of the companies it contains. When you invest in a fund, you also own a small stake in each of these companies. You can combine multiple funds to create a diversified portfolio. Note that equity funds are also sometimes called equity funds.
individual stocks. If you’re looking for a specific company, you can buy a stock or several stocks to dive into the waters of stock trading. Building a diversified portfolio of many individual stocks is possible, but requires a lot of investment and research. As you go down this path, keep in mind that individual stocks go up and down. When you research a company and decide to invest in it, when you start to get nervous on a bad day, think about why you chose the company in the first place.
The advantage of equity funds is that they are inherently diversified, which reduces your risk. For the vast majority of investors — especially those investing their retirement savings — a portfolio consisting primarily of mutual funds is the obvious choice.
However, mutual funds are unlikely to soar like some individual stocks. The benefit of a single stock is that smart choices can lead to great returns, but the chances of any single stock making you rich are very slim.
4. Set a budget for your stock market investments
New investors typically have two questions at this step in the process:
How much money do I need to invest in stocks? The amount required to buy one share of stock depends on the price of the stock. (Shares can range from a few dollars to a few thousand dollars.) If you want a mutual fund and are on a tight budget, an exchange-traded fund (ETF) may be your best bet. Mutual funds typically have a minimum amount of $1,000 or more, but ETFs trade like stocks, which means you buy them at the stock price—under $100 in some cases).
How much should I invest in stocks? If you invest through a fund, did we mention that this is the preference of most financial advisors? — You can allocate a substantial portion of your portfolio to equity funds, especially if you have a long investment horizon. A 30-year-old retirement investor might have 80% of his portfolio invested in mutual funds; the rest will go into pension funds. Individual stocks are another matter. A general rule of thumb is to limit these to a small portion of your portfolio.
5. Focus on long-term investing
Stock market investing has proven to be one of the best ways to build wealth over the long term. For decades, the stock market has returned an average of about 10% per year. But keep in mind that this is just an average for the market as a whole – some years will rise, some years will fall, and individual stocks’ returns will vary.
The stock market is a great investment for long-term investors, day in and year out; it’s the long-term average they’re looking for.
Investing in stocks is full of complicated strategies and methods, but all that some of the most successful investors do is stick to stock market fundamentals. That usually means spending the majority of your investment portfolio — Warren Buffett famously said that a low-cost S&P 500 index fund is the best investment most Americans can make — And only if you believe in the long-term potential growth of the company.
After you start investing in stocks or mutual funds, the best thing you can do is perhaps the hardest: don’t look at them. Unless you’re trying to overcome the odds and succeed in day trading, it’s best to avoid the habit of compulsively checking your stock performance multiple times a day.
6. Manage your stock portfolio
While daily volatility doesn’t do much for your portfolio or your own health, of course there are times when you need to review your stocks or other investments.
When you follow the steps above to buy mutual funds and individual stocks, you should review your portfolio a few times a year to make sure it still fits your investment goals.
A few things to keep in mind: As you approach retirement, you may want to convert some of your stock investments into more conservative fixed-income investments. If your portfolio is overweight in one industry or industry, consider buying stocks or funds in another industry for more diversification. Finally, pay attention to geographic diversity. Vanguard recommends international stocks make up 40% of the stocks in your portfolio. You can buy international equity funds to gain this exposure.