Getting started with stock investing has never been easier, thanks to the accessibility offered by online brokerages’ websites and mobile apps.
Stocks represent ownership shares in a company for common shareholders. Holding common stocks entitles shareholders to vote on company matters, typically with one vote per share. Some companies also distribute dividends to shareholders, providing an additional source of income alongside the stock’s market value. These dividends are subject to change based on the company’s financial performance.
Stocks are categorized as risk assets that offer potential growth and income to an investment portfolio. However, they also come with a high level of price volatility, meaning their value can fluctuate significantly over time. Beginner investors must carefully assess their risk tolerance, as higher-risk investments often offer greater potential rewards but also carry a higher chance of losses. Despite this, stocks have historically delivered strong average annual returns.
The stock market experienced a downturn in 2022 due to the highest inflation rates in 40 years, prompting steep increases in interest rates and concerns about an economic slowdown. However, the market has rebounded in the current year, largely fueled by advancements in artificial intelligence. Companies such as Nvidia Corp. (NVDA), C3.ai Inc. (AI), Microsoft Corp. (MSFT), Alphabet Inc. (GOOG, GOOGL), and Taiwan Semiconductor Manufacturing Co. Ltd. (TSM) have all shown significant gains year-to-date, influenced by the emergence of OpenAI’s ChatGPT chatbot.
This rapid shift in market trends highlights the volatility inherent in stock investing. For instance, the S&P 500, a key index of major U.S. stocks, experienced an 11.8% increase through June 8 this year following a 19.4% loss in 2022. Investors who entered the market or invested in these companies through index funds at the beginning of last year would have experienced substantial losses.
While timing the market is challenging, entering when stock prices are low is generally considered advantageous. Here are some key considerations for beginners looking to invest in stocks:
- Where to begin investing in stocks.
- Determining the initial investment amount.
- Selecting suitable investments.
- Developing an investment strategy, especially during market volatility.
- Choosing between self-directed investing or seeking guidance from a financial advisor.
- Exploring stocks suitable for beginner investors.
- Implementing dollar-cost averaging.
- Knowing when to sell a stock.
Where to Start Investing in Stocks
The initial step involves opening a brokerage account, which grants access to investments in the stock market. Many major brokerage firms, including Fidelity, Vanguard, and Charles Schwab, offer free online account opening services.
Following this, you’ll need to fund your brokerage account by transferring money from your bank account to execute stock trades. The amount you choose to invest is a personal decision influenced by various factors, as highlighted by Ryan Burke, general manager of Invest at M1 Finance. Factors to consider include your savings capacity, near- and long-term financial objectives, and risk tolerance—the level of potential loss you’re comfortable with.
While the stock market typically appreciates in value over time, short-term market fluctuations can pose risks to your investments. Burke advises a common strategy of saving and investing as much as possible to maximize potential returns over time. However, it’s important to address high-interest debt before prioritizing investments, as clearing such debt may offer better financial benefits in the long run.
How Much Should You Invest in Stocks?
Several online brokers, like Betterment, waive fees for accounts with a $0 balance and don’t impose a minimum requirement to open a trading account. This flexibility allows you to start investing with any amount. Some of these platforms also offer fractional shares, enabling you to invest in portions of company shares if you can’t afford a full share.
Discount brokers are particularly beneficial for novice investors with limited funds, as they provide stock market exposure even with smaller portfolios. However, they typically don’t offer advisory services or detailed analysis. While some discount brokers don’t stipulate a minimum account balance, others may require a starting threshold as low as $1,000.
Choosing Investments Wisely
Daniel Beckerman, president of Beckerman Institutional in Ocean Grove, New Jersey, emphasizes the importance of analyzing a company’s metrics to gauge its performance within its industry.
“For instance, elevated price-earnings or price-sales ratios can indicate when certain stocks or industries are reaching bubble territory,” Beckerman explains, citing the scenario in 2021 when many unprofitable tech stocks were trading at inflated values.
Valuation plays a crucial role in stock selection. Investors must assess factors like company profitability, projected earnings growth, management quality, and industry performance to determine whether a stock is undervalued or overvalued. According to Beckerman, understanding stock valuations provides valuable insights into investor sentiment across different industry sectors.
Stock Valuation and Investment Strategies
Understanding a stock’s intrinsic value is key, as it often differs from its market price. Investors must delve into the company’s financial history, its position within its industry, competitive standing, and various other factors to assess its true worth.
According to Alex Vela, a portfolio manager at FBB Capital Partners, investors should steer clear of speculative stocks lacking a proven track record in growth and management expertise. He recommends targeting companies with at least a five-year history and a well-defined management team.
Vela also emphasizes the significance of Environmental, Social, and Governance (ESG) policies in evaluating companies, highlighting the importance of socially sustainable business practices.
For those who find individual stock research daunting, investing in stock index funds offers a simpler alternative. Low-cost index funds that mirror the overall market provide investors with broad exposure to a diverse range of companies without the need for individual stock selection. Popular choices like S&P 500 index funds grant access to a vast array of U.S. market giants in a single investment.
Furthermore, index funds offer the advantage of diversification, as a single share typically represents ownership in hundreds or even thousands of companies, which would require substantial capital to replicate independently.
Investors can also target specific sectors or types of companies by investing in funds tailored to those areas, such as energy, financials, or healthcare, providing focused exposure to particular segments of the market.
In stock investing, profitability can stem from both capital appreciation and dividend payments. Dividends, either in cash or stock, are periodic payments made by companies to shareholders, akin to bonuses distributed to employees. While dividend-paying stocks appeal to investors seeking regular income, it’s essential to recognize that dividends are not guaranteed and may be subject to reduction or elimination by the company.
Crafting an Investment Strategy Amid Market Volatility
Market volatility is a natural occurrence, causing even seemingly stable stocks to experience price fluctuations during uncertain times. According to Beckerman, downturns of 10% or more occur more frequently than once every two years on average. To navigate these turbulent periods successfully, investors should maintain a steadfast approach, as observed during the 2022 market turmoil.
While volatility may unsettle beginner investors, placing trust in companies with a track record of revenue and profit growth over the long term can instill confidence despite stock price swings. Beckerman underscores the importance of assessing a company’s ability to withstand competition and adapt to changing market conditions, including inflationary pressures.
Interestingly, volatility can present opportunities for savvy investors. Bear markets, like the one experienced in 2022, can serve as favorable buying opportunities. Beckerman notes that historically, the stock market has provided positive returns averaging over 14% annually in the years following a bear market.
For investors with conviction in a company’s prospects, a dip in stock price may be viewed as a chance to acquire more shares at a discounted price.
When opening an online brokerage account, investors undergo a questionnaire to determine an appropriate investment strategy tailored to their financial goals and risk tolerance. Defining these goals is crucial, as they guide investment decisions. For instance, individuals aiming for early retirement may lean towards growth-oriented investments to maximize returns, while those saving for imminent goals like buying a home may prefer a more balanced portfolio to mitigate risks.
If navigating long-term financial goals and investment plans feels overwhelming, seeking guidance from a financial advisor can provide clarity and direction.
Choosing Between Self-Directed Investing and Professional Guidance
Before diving into stock investing, it’s essential to ascertain your investor profile. Decide whether you prefer a hands-on approach or seek guidance from a professional financial advisor to navigate wealth management decisions.
According to Jeffrey Wood, an investment advisor and partner at Lift Financial, many opt for the latter to leverage specialized expertise and alleviate concerns about potential oversights. Additionally, having a trusted advisor on hand for inquiries and reassurance can be invaluable.
Financial advisors play a crucial role in safeguarding investors from unfavorable decisions, especially when considering the risk associated with individual stock investments compared to other securities like mutual funds or exchange-traded funds (ETFs). If unsure about allocating funds to stocks, collaborating with a financial advisor to craft a tailored strategy is advisable.
However, it’s vital to weigh the costs and benefits of working with a financial advisor. While their guidance can be beneficial, the associated fees, typically a percentage of total assets (known as an assets under management fee), can impact overall investment performance over time. For those seeking simpler investment strategies, passive investing through index funds managed by professionals offers an alternative.
Alternatively, actively managed funds aim to outperform the market but often incur higher costs. While these funds may be suitable for specialized market segments like emerging markets, their long-term performance compared to passive funds is debatable.
Considering the time commitment involved in managing investments is also crucial. If time is limited, outsourcing to a professional advisor or utilizing robo advisors—an automated investment platform—may be preferable. Though lacking personalized guidance, robo advisors offer lower costs and assist in fund selection.
Moreover, financial advisors extend their expertise beyond investment management, providing assistance in various financial planning areas such as estate planning, taxation, trusts, and wills. For specialized needs, consulting with fee-based planners or specialists may be necessary.
Implement Dollar-Cost Averaging
Once you’ve selected which stocks to invest in, the next consideration is timing your purchases. While the “buy low, sell high” mantra holds merit, pinpointing the lowest point of a stock’s value is challenging.
To mitigate the pressure of timing the market perfectly, many novice investors find success with dollar-cost averaging. This strategy involves investing a fixed amount at regular intervals, irrespective of the stock’s current price.
Jeffrey Wood of Lift Financial explains that dollar-cost averaging enables investors to navigate market fluctuations more comfortably. By consistently investing over time, particularly in an overall upward-trending market, individuals can capitalize on buying opportunities during market dips, resulting in a lower average cost basis compared to the selling price.
While some investors may prefer investing a lump sum upfront, the urgency to deploy funds sooner rather than later often outweighs the benefits of waiting.
Whether through dollar-cost averaging or lump-sum investments, Wood emphasizes the importance of aligning strategies with longer-term investment horizons, as this approach historically yields more positive results.
Knowing When to Sell
Deciding when to part ways with a stock, devoid of emotional impulses, is a critical skill for savvy investors.
Establishing an exit plan prior to purchasing a stock is prudent. This plan might entail reassessing the investment when the stock appreciates by 20% or depreciates by 10%. At such junctures, it’s essential to evaluate the stock’s fair market value and the company’s current standing.
Maintaining an exit plan helps in making rational decisions, preventing emotional attachment to a stock. Businesses evolve, and companies can falter, underscoring the importance of staying objective.
For long-term investors, selling is generally advised only when necessitated by financial obligations or for tax-related strategies like tax-loss harvesting—selling investments at a loss to offset gains.
Consideration of tax implications is crucial when selling stocks. Holding investments for over a year qualifies for lower long-term capital gains taxes compared to short-term capital gains.
Renowned investor Warren Buffett advocates for a buy-and-hold approach, suggesting that stocks should ideally be held for decades rather than subjecting them to frequent buying and selling. This philosophy emphasizes the importance of patience and long-term perspective in investment decisions.
Despite market volatility, maintaining a steadfast approach aligned with long-term objectives is key, as short-term fluctuations should not dictate long-term investment strategies.
