You know you need to begin investing, but you haven’t gotten started. Maybe you don’t know where to begin.
Possibly you’re intimidated by the massive amount of information out there. Or perhaps you’re afraid of losing money. It’s OK, this is normal.
We are here to help you learn how to get started investing in stocks and other investments so that you can begin to build your financial future.
Table of Contents
- The Case for Investing in Stocks
- Step #1 Assess Your Financial Situation
- Step #2 Clean Up Your Finances
- Step #3 Determine Your Goals
- Step #4 Know Your Risk Tolerance
- Step #5 Understand the Basics
- Step #6 Contribute to a 401k, If You Have One
- Step #7 Open and Fund an Account With a Discount Broker
- Step #8 Open an Individual Retirement Account
- Step #9 Understand Diversification
- Step #10 Learn About Mutual Funds and ETFs
- Step #11 Set up Automatic Transfers and Investments
- The Bottom Line
The Case for Investing in Stocks
You might live to age 105. Chances are, you’ll have stopped working long before then. Thus, it is vital that you accrue enough money to last throughout a potentially very long retirement.
To do this, you’re going to need to do more than put money in the bank. If you don’t earn an extraordinarily large salary, you’ll likely need to invest funds in the stock market and allow them to grow in value over a long period.
When you invest in stocks, you are purchasing actual shares of a public company. Investing in stocks offers you a path to accumulate a large sum, particularly if you allow them to grow over time.
Also, stocks can help boost your income. Plus, they may be able to help you save money for large expenses such as a home or a child’s education.
Buying and selling stocks does not come without risk. But historically, investors have made money. Consider that the S&P 500 Index, which tracks the performance of the 500 largest companies in America, has lost money on an annual basis just 16 times since the end of WWII.
If you take time to understand the markets and invest wisely, you can mitigate that risk and come out ahead more often than not.
Consider taking these steps to begin investing in stocks and building a strong financial future.
Step #1 Assess Your Financial Situation
Before you begin investing, you should take the time to get a good understanding of where you are right now financially. It’s impossible to make sensible money decisions if you don’t have a good grasp of your current situation.
Take a look at your bank account balances. Examine how much you earn and how much you spend each month. Review your current debt load and payments. It may help to sign up for Mint.com, Personal Capital, or a similar account aggregator so you can see your entire financial picture in one view.
Once you have a handle on things, you can make a smart and informed choice as to whether you are ready to begin investing.
Step #2 Clean Up Your Finances
Are you feeling crushed under a mountain of debt? Are you spending far more than you are earning? If you’d like to begin investing, work toward taking care of these problems first.
Use your excess earnings to reduce your debt load. Take time to create a budget and stick to it. Many online tools can help you with this, including You Need a Budget and others.
You may be tempted to invest in order to take advantage of market gains. After all, who wants to sit out when the stock market is on the rise? But an 8% return from the stock market isn’t helpful if you’re paying 15% in interest on your credit card balances.
This is not to say you need your finances to be perfect to start investing. But if you’re having trouble meeting basic expenses and paying off high-interest debt, buying stocks may have to wait.
Step #3 Determine Your Goals
Throwing money into the stock market only makes sense if you have a good idea of why you are doing it. That’s because there are so many investment choices, and not all of them may be appropriate for what you want to accomplish financially.
Moreover, there are different kinds of investment accounts that are designed to help with specific goals.
Are you looking to build savings over the long term in order to fund your retirement? If so, at what age do you plan to retire, and what standard of living are you hoping to achieve?
Are you saving for your child’s college education? Do you want to generate more passive income? The answers to these questions will help guide your investment approach.
Step #4 Know Your Risk Tolerance
If you are close to retirement, you may not have a high tolerance for risk, and will want to avoid the most volatile stocks. This goes along with understanding your goals. If you are younger, you may be willing to take some chances for higher returns. After all, you anticipate having time to make up whatever money you might lose in the short term.
Your personal comfort level with risk also plays a role here. Take some time to know your risk profile. That way, you can produce an investment portfolio that balances the appropriate level of risk and return based on your goals and tolerances.
Step #5 Understand the Basics
You would never purchase a lawnmower if you didn’t have the vaguest idea of how it worked. The same goes for stocks and other investments.
Before investing, you must first have an understanding of what stock ownership actually means.
When you buy shares of stock in a public company, you are literally purchasing a stake of ownership in that firm. These shares are traded on something called a stock exchange.
In the United States, most stocks are traded on either the New York Stock Exchange or the NASDAQ and use a special ticker symbol. (The symbol for Coca-Cola, for example, is KO. Amazon’s is AMZN, while Facebook is merely FB.)
Generally speaking, when you own shares of a company and the value of the company rises, your share of the company increases with it. Knowing this, you’ll realize that it’s best to invest in companies that make money, are well managed and have good prospects for the future.
Supply and demand also drive the price of shares of stock. So, if people have an overwhelming desire to own shares of a company, they will rise in value.
In this case, the investor must take time to learn whether share prices are appropriate based on the company’s financial performance, or driven by speculation and hype.
In addition to potentially growing in value, stocks can also produce income for the investor. Many stocks offer dividends to shareholders every quarter. This means that the company distributes a portion of its net earnings to investors. These payments can range anywhere from a few cents to even a few dollars each quarter.
Step #6 Contribute to a 401k, If You Have One
If your employer offers a 401k plan, this is the first place you should consider to invest your money. That’s because the plan comes with some nice tax advantages, and you may even get free money.
With a 401k plan, you can automatically take out a portion of your paycheck to invest in a selection of mutual funds. That money is deducted from your taxable income, thus reducing the amount you will pay in taxes.
Many employers will match employee contributions up to a certain percentage. So, for example, if you contribute 4%, an employer might contribute half of that (2%), bringing your total contribution up to 6%.
The only caveat to a 401k plan is that you can’t withdraw the money without a penalty until at least age 59 ½. Given the tax advantages and potential free contributions from employers, investing with a 401k plan is practically a no-brainer.
Step #7 Open and Fund an Account With a Discount Broker
It’s easier than ever to trade stocks, thanks to the growth of online brokers. These platforms allow any individual to purchase shares of stock for just a few dollars a trade. (In some cases, you’ll pay no commission at all.)
Major online brokers have been competing in recent years to offer the lowest costs and the greatest ease to us.
Top companies include:
The first major online broker (involved in online trading since 1983). It allows you to trade stocks for just $6.95 per trade. Many investments are offered with no commission at all. The company oversaw more than $600 million in customer assets as of August 2019.
Fidelity is one of the largest asset managers and brokers, with more than $6.7 trillion in customer assets under administration. The company allows you to buy and sell stocks and other investments for just $4.95. It made headlines in 2018 when it announced it would offer a selection of index funds with no minimum investment requirements, no commission and no expense ratio.
On October 3, 2019, TD Ameritrade announced it would reduce all fees on stock trades to $0, the first of the major online brokers to make such a move. TDAmeritrade offers access to virtually every publicly traded stock, plus mutual funds, exchange-traded funds, bonds and more. The company administers more than $1 trillion in client assets.
Schwab is another pioneer of low-cost, simple online trading. Schwab joined with TD Ameritrade, announcing that on October 7, 2019, it would be eliminating all commissions on the trading of stocks, essentially making it free to invest.
Robinhood broke into the scene as one of the first platforms to offer trades with zero commissions. It is one of the first companies to provide a smartphone app as the primary way to buy and sell shares. You can also buy exchange-traded funds, but no mutual funds are available.
Ally Bank disrupted the bank industry by offering an online-only platform and interest rates that outpaced most competitors. Now, with Ally Invest, it provides investing services, including a brokerage account with stock trades for just $3.95.
The brokers above and others will allow you to open an account with no minimum balance. You can fund the account by linking it to any bank account.
Then when you are ready to trade, you can search for the company’s stock symbol and purchase any amount you choose. (You may be able to buy a single share of stock, but it’s usually more cost-effective to buy more.)
In recent years, discount brokers have faced competition from companies called robo advisors. These businesses use technology to help investors create and manage stock portfolios with little human involvement. Top robo advisors include Betterment, WealthFront, WealthSimple, Ellevest, and SoFi Invest.
It’s important to recognize that when you open a regular brokerage account, any money you earn on your investments is subject to capital gains taxes. To avoid this, you may want to consider opening an Individual Retirement Account with the same broker. That brings us to the next step.
Step #8 Open an Individual Retirement Account
When you invest, it’s crucial to think about the impact of taxes. Capital gains from investments are taxed at anywhere from 10% to 20% depending on your earnings. Most people will be taxed at a 15% rate. So that means if you earn $1,000 from your investments, you’ll only get to keep $850.
You can reduce or avoid this tax, however, by opening an Individual Retirement Account, or IRA. There are two major types of IRAs. A Roth IRA currently allows you to invest up to $6,000 annually, and you can withdraw your money tax-free as long as you wait until at least age 59 ½.
Thus, if you invest early and often, it’s possible to accumulate hundreds of thousands or even millions of dollars without losing a chunk to the government.
A traditional IRA, meanwhile, also offers tax advantages, but in a manner more similar to a 401k. With a traditional IRA, all contributions are deducted from your taxable income, allowing you to pay less tax upfront. The gains, however, will be taxed when you retire.
Determining whether to place money in a Roth or traditional IRA can be tricky. Some advisors suggest using a Roth IRA if you already have a 401k plan.
In contrast, some propose opening both kinds of IRAs and funding them equally to take advantage of the two different tax benefits. A conversation with a financial advisor will help you decide what’s best for you.
Some other kinds of IRAs may be appropriate, depending on your situation. A Simplified Employee Pension Individual Retirement Arrangement (SEP-IRA) is a plan that allows small business owners, primarily the self-employed, to provide retirement plans for themselves and their employees.
A SIMPLE IRA is another plan that is similar to a 401k and offered by small business owners, usually with 100 employees or less.
Step #9 Understand Diversification
When you begin investing, it’s important to understand that you should never invest too heavily in one thing. Buying shares of an individual company’s stock can be enjoyable. But it’s best to try and build a broad, diverse portfolio that will protect you against sharp market downturns.
Think of your portfolio as a pizza, with slices containing different cheeses and toppings. A properly diversified portfolio will have a mix of stocks, bonds and other investments.
It should be invested across different industries and sectors. Accordingly, it will contain stocks of various sizes (large-cap, mid-cap, and small-cap), and even include a mix of investments from markets overseas, including emerging markets.
Step #10 Learn About Mutual Funds and ETFs
Are you baffled as to which stocks to buy? Are you unclear how to build a diverse portfolio of stocks? You are not alone. That’s why many people buy pooled investments known as mutual funds or exchange-traded funds (ETFs), which give you exposure to a broad set of investments in a single trade.
It’s possible to buy shares of a mutual fund that invests in all companies in the S&P 500, for example. These are called index funds because they are designed to mirror the performance of a specific stock index.
There are mutual funds and ETFs for just about everything, including stocks of small, medium, and large companies, and stocks representing nearly every industry, sector, and geographic location.
Many asset managers also offer mutual funds designed to adjust allocations over time as your investment goals change. Target date funds allow an investor to select their year of retirement and access an investment that changes its distribution to the correct risk and return level for your age.
When you are young, the fund will be invested largely in stocks, which have the potential to generate more returns over time. As you approach retirement age, the investments shift to bonds and other investments designed to preserve your savings.
Mutual funds and exchange-traded funds are similar. The key difference is that ETFs trade throughout the day, just like a stock, while mutual funds are priced at the end of the day. ETFs also generally have lower expense ratios.
Mutual funds and ETFs are available to trade through all major discount brokers, and many are available to trade with zero commission.
Step #11 Set up Automatic Transfers and Investments
Rather than trying to time the markets, it’s best to set up regular, consistent contributions into your investment accounts. You can set up automatic withdrawals from your bank account and even, depending on the broker, automate the investment purchases.
Making consistent, periodic purchases of stock can allow investing to become a habit. This will also allow you to potentially reduce the cost of your stock purchases over time, by taking advantage of something called dollar-cost averaging.
The idea behind dollar-cost averaging is that you are reducing risk in your portfolio by purchasing stocks at various times and various prices. When stocks are more expensive, you’ll buy fewer of them. When they are cheap, you’ll buy more.
This method also may allow you to save money on your taxes. For instance, if some of your shares rose in value while others fall, it may be possible to sell the losing shares. By doing so, it offsets the gains from profitable shares, reducing or eliminating capital gains taxes.
The Bottom Line
Investing in stocks can be a great way to build wealth over time. However, it can be intimidating to get started.
Don’t let fear hold you back. You don’t have to start investing huge sums of money before you feel prepared. But you should think about assessing your financial picture, cleaning up your finances and educating yourself about the easiest ways to access the stock market.
If you have an employer-sponsored retirement plan, consider taking advantage of it. If not, take a look at how an Individual Retirement Plan might help you achieve your financial goals. The sooner you start, the more money you have the chance to earn over time.
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