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 start investing in stocks and build your financial future.
Table of Contents
- Why Invest in Stocks
- How Investing in Stocks Works
- How to Start Investing in Stocks
Why Invest 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.
You don’t want to outlive your retirement savings.
To save enough for retirement, you’re going to need to do more than put money in the bank. You will need to invest in income-producing assets like stocks and real estate that can earn more than the inflation rate.
If you don’t earn an extraordinarily large salary, you’ll likely need to invest funds in the stock market. Investing in stock ETFs and mutual funds lets you quickly diversify and reduce risk.
Then, you keep the money invested in credible stocks and funds through retirement. “Buy and hold investing” lets your investments earn compound interest and grow in value over a long period.
Buying and selling stocks does not come without risk. But historically, investors have made money when they hold a stock through the dips instead of selling.
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 17 times since the end of WWII (through 2020).
If you take time to understand the markets and invest wisely, you can mitigate that risk and come out ahead more often than not.
How Investing in Stocks Works
When you invest in stocks, you are purchasing actual shares of a public company. You can profit as the company grows and increases in value.
Earn Stock Dividends
While you don’t get to make corporate decisions, you can earn a slice of the company profits if the stock pays a dividend income.
You can choose to re-invest the dividends to buy more shares of the same company stock. These future shares can earn dividend income too.
If you don’t re-invest the dividends in the same stock, you can use the dividend income to invest in another stock or fund. You may choose this option to diversify your portfolio.
Rising Stock Prices
You can also profit if the stock shares increase in value and you sell for a profit.
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.
How to Start Investing in Stocks
There are several ways to start investing in stocks. The easiest option can be with a workplace retirement plan like a 401k or TSP plan.
But you can also invest in stocks by yourself or with the help of a robo-advisor.
No matter how you start investing in stocks, it’s important to understand how investing works to manage risk.
1. Assess Your Financial Situation
Before you begin investing, you should 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 financial situation.
Investing is important but being financially stable is more important.
Some actions include:
- Look at bank account balances
- Examine your annual income
- Calculate monthly expenses
- Review current debt amounts and monthly 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 your daily finances, you can decide how much to invest.
Read our Personal Capital review to learn more about tracking your finances.
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 your debts and spending first.
Pay High-Interest Debt First
It’s possible to pay off debt and invest at the same time.
However, it can be better to pay off high-interest debt with a 10% APR or higher first. Your interest savings can be more than the potential investment income.
The historical annual return of the S&P 500 is approximately 8%.
It’s tempting 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.
Use your extra income to reduce your debt load and pay off the highest interest rates first.
One exception to this suggestion are 401k matching contributions. You invest but your employer is giving you “free money” to save for retirement.
Make a Budget
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.
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.
Once you find a way to reduce your monthly expenses, you have more disposable income each month. Then, you can decide how much extra income to invest in stocks.
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. There are so many investment choices and not all of them may be appropriate for what you want to accomplish.
Moreover, there are different kinds of investment accounts that are designed to help with specific goals.
Some of your investment goals can include:
- Save for retirement with a tax-advantaged account
- Earn passive income
- Retiring early
- Savings for a child’s college education
- Withdraw $XX,XXX per year in retirement
Knowing your investing goals lets you decide which investment account to use, so you can calculate how much you need to invest each month to reach your goal.
Also, knowing your goals can help you choose investments with the best income potential without being too risky.
Short-term goals should invest in less risky assets than long-term goals where your investment has time to recover from a stock market correction.
4. Know Your Risk Tolerance
Managing risk can be as important as knowing your investment goals.
Your risk tolerance should shift to a more conservative strategy to avoid losing your investment gains. For example, you may start investing in stocks but gradually shift to investing in bonds that have lower historical returns but can be less risky.
When 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. Get 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.
A robo-advisor can help you invest using age-based risk tolerance investment strategy. You can also research model portfolios to rebalance your investments each year to be more risk-averse.
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 understand what stock ownership actually means.
Ask these three questions before investing in any asset:
- How does this investment make money?
- What are the potential risks?
- When and why do I plan on selling?
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 ticker symbol. (The symbol for Coca-Cola, for example, is KO. Amazon’s is AMZN, while Facebook is FB.)
When you own shares of a company and the value of the company rises, your share of the company increases with it. It’s best to invest in companies that make money, are well managed and have good future prospects.
It’s important to research any potential investment for yourself, even if an investing expert recommends a stock. You must decide if that stock fits your investment goals.
Most investing apps provide basic research tools. But you can also use stock screening tools to understand the stock fundamentals and technical data.
Some factors your might analyze include:
- Annual profits
- Total company debt
- Price to earnings ratio
- Projected growth estimates
- Are there any pending lawsuits?
- Insider buying and selling
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.
When Does the Stock Market Open?
It is wise to know the stock market opening and closing times in both the U.S. and global markets. You can only buy and sell shares while the stock market is open.
6. Contribute to a 401k
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 a no-brainer.
7. Open an Investment Account
It’s easier than ever to trade stocks, thanks to the growth of online stock brokers. These platforms allow you to purchase shares of stock for free. And, you won’t pay any service fees.
In some cases, you can buy fractional shares of stocks when you don’t have enough cash to buy a full share. For example, you can buy one-tenth of a share if you invest $100 into a stock that costs $1,000 per share.
Major online brokers have been competing in recent years to offer the lowest costs and the greatest ease to us. All of the following are SIPC members.
Top companies include:
M1 Finance lets you buy fractional shares of almost any stock and ETF that trades on the US stock markets. They also offer premade portfolios for many investment strategies.
Choosing your asset allocation can be easier with M1 Finance as you assign a target percentage for each stock or fund your hold. With each new investment, M1 Finance rebalances your portfolio.
You can open a taxable account with a $100 opening deposit or a retirement account with $500. The minimum investment is $25 for subsequent trades.
Fidelity is one of the largest asset managers and brokers, with more than $6.7 trillion in customer assets under administration.
You can buy fractions shares of stock and ETFs using the Fidelity mobile app with a $5 minimum investment.
But you can only buy whole shares if investing using the Fidelity web platform.
Fidelity also offers stock index funds with no expense ratio. You can buy these Fidelity ZERO funds in a self-managed brokerage account.
TD Ameritrade lets you trade stocks and ETFs with no trade commissions or account fees. This online broker also has impressive research tools and lots of investment options.
Read our TD Ameritrade review to learn more about this online broker.
Schwab is another pioneer of low-cost, simple online trading with plenty of investment options and research tools.
You can buy fractional shares of stocks in the S&P 500 with a $5 minimum investment.
Robinhood broke into the scene as one of the first platforms to offer trades with zero commissions. You can also buy fractional shares of stocks and ETFs with a $1 minimum investment.
While Robinhood offers many nifty investing features, some recent stock market happenings make it difficult to sometimes trade stock on Robinhood.
You might consider these Robinhood alternatives for similar investment options.
Ally Bank disrupted the bank industry by offering an online-only platform and interest rates that outpaced most competitors.
Now, Ally Invest provides investing services, including a brokerage account with stock trades for $0.
If you want a free robo-advisor, Ally Invest offers fee-free Managed Portfolios. You can choose an investment strategy that invest in stock and bond index ETFs.
While you don’t pay advisory fees for Ally Invest Managed Portfolios, the minimum cash position is 30% of the portfolio value. Your growth potential is lower during a bull market but there can be less downside risk during a stock market correction.
Buying Stock with Investing Apps
You can fund your investment account by linking it to any bank account.
It can take several business days to complete the transfer. Once the money arrives in the investment account, you can invest in the next trading session.
When you are ready to trade, you can search for the company’s stock symbol and purchase any amount you choose.
What About Robo-Advisors?
In recent years, discount brokers are facing competition from companies called robo advisors. These platforms use technology to help investors create and manage stock portfolios with little human involvement.
During the initial setup, you can share your investing goals. The robo-advisor recommends a portfolio of stocks and bonds that fits your goals and risk tolerance.
However, most robo-advisors invest in stock index funds instead of individual stocks. Doing so, keeps investing costs low and makes it easy to diversify your portfolio.
Top robo advisors include:
- 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.
8. Open an IRA
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. That means if you earn $1,000 from your investments, you’ll only keep $850.
You can reduce or avoid this tax by opening an Individual Retirement Account, or IRA.
There are two major types of IRAs. With either IRA, your investment gains are not subject to capital gains taxes each year like a taxable brokerage account.
The main difference is when you pay income taxes on the contribution amount.
A Roth IRA currently allows you to invest up to $6,000 annually (or $7,000 if at least age 50). If you open both IRA types, you can only contribute a combined $6,000 ($7,000 if at least age 50) into both accounts.
You pay income taxes on the contribution amount upfront. But 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 traditional 401k.
With a traditional IRA, all contributions are deducted from your taxable income, allowing you to pay less tax upfront.
However, you pay income taxes on the withdrawal amount in retirement as the contributions grow tax-deferred.
This means you pay taxes on the contribution amount and capital gains.
If you’re comfortable paying taxes in retirement, a traditional IRA can be worth the upfront tax deduction.
Roth IRA vs Traditional IRA
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.
Most 401k plans are “traditional” and the contributions grow tax-deferred.
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.
9. Understand Diversification
When you begin investing, it’s important to understand that you should never invest too heavily in one thing. I’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.
A diversified portfolio has these traits:
- Holds stocks and bonds
- Stocks of different sizes (i.e., large-cap, mid-cap and small-cap)
- Invests in developed and emerging foreign markets
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.
Some investors, like Bogleheads, may only invest in stocks using index funds.
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 options that 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.
According to Statista, there are currently more than 9,500 mutual funds from which to choose. ETFs are newer and less plentiful but have grown to more than 4,600.
Mutual funds and ETFs are available to trade through all major discount brokers, including Vanguard and Fidelity. Many funds trade with zero commissions to buy or sell.
11. Set up Automatic 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.
Dollar Cost Averaging
Making consistent, periodic stock purchases stock can make investing a habit.
This will also allow you to potentially reduce the cost of your 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.
But similar to saving for large expenses with a sinking fund, you invest new money each month. You can build wealth no matter what is happening in the world.
Investing in stocks can be a great way to build wealth over time. However, buying your first stock can be intimidating.
Don’t let fear hold you back. You don’t have to start investing huge sums of money before you feel prepared. A small investment can still earn passive income.
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 overtime.
All opinions expressed in this article are the authors. We are compensated by businesses that are mentioned in this article through affiliate links.