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How To Invest in the Stock Market

Growing future wealth and creating financial security are two common reasons people want to learn how to invest money in the stock market. Many would-be traders are wary of the potential risks associated with stock market investing, but with the right strategies, they may be able to decrease risks and increase their earnings over time. This comprehensive guide will help take the guesswork out of learning to invest money in stocks.

Steps:

  • Set goals: Traders should think about why they want to invest so that they can choose investment opportunities accordingly.
  • Find an online broker: Through this type of account, traders can buy and sell stocks and other investments on all the major markets.
  • Start saving for retirement: An IRA or 401(k) is a low-risk way to get started as a long-term stock market investor.
  • Select investments: In addition to a small portion of individual stocks, investors can diversify a portfolio with ETFs, mutual funds, bonds, and other risk-balancing choices.
  • Make it automatic: Investing the same amount of money every month makes it a habit and often increases a trader’s potential returns.
  • Create a regular review: Rebalancing the asset mix every so often as needed can help investors shield their holdings against risk.

Getting Started as an Investor

Many people enjoy the research process, but trading on the stock market doesn’t have to mean spending hours poring over the financial pages and investment apps. Modern investment software can do all the work after the investor answers a few simple questions about their financial goals and characteristics. One example of a fund that investors can set and forget is the target retirement date fund, which is offered through many 401(k) accounts.

For investors who prefer to be more hands-on, it’s important to learn how to invest, and they can follow these steps to get started.

Set Goals

To become a successful investor, the first step is to create a solid investment plan that accounts for an individual’s budget and financial goals. The investor should decide how much money they can afford to invest in the stock market and determine the eventual purpose for those funds. Most financial experts also recommend paying down high-interest debt like credit cards before investing.

For example, stocks make sense for individuals who want to invest for retirement but plan to work for at least five more years. The stock market lacks the liquidity for short-term goals like a home down payment or vacation. Putting money in stocks for just a few months or years also increases the risk of losing the initial investment.

Find an Online Broker

An investor has to open an account with a brokerage firm to begin trading stocks. New traders who want to start small can shop around for a broker without a required account minimum or with a low minimum threshold.

After signing up with a broker, the investor can purchase stocks through an individual retirement account to access associated tax advantages. Those who are already maxed out on retirement can use a broker account to buy and sell stocks on a taxable basis.

When looking for a broker, considerations include:

  • Available research and tools for investors.
  • Diversity of investment selection.
  • Commissions and fees associated with trades.

Start Saving for Retirement

Most people first begin investing when they contribute to an employer-sponsored account, such as a 401(k) or 403(b). Many companies even match a percentage of these contributions, so employees should plan to invest enough to qualify for this benefit.

Beginning investors can also take advantage of free investing advice and other resources through their employer plans. They can select their own investments or take a hands-off approach by using the plan’s robo-advising software. Usually, these accounts allow traders to invest either a flat dollar amount per paycheck or a percentage of their salaries.

Individuals who either max out their employer plans, don’t have this benefit, freelance, or own a business can access tax-advantaged retirement savings and invest in the market through an individual retirement account (IRA). The 2020 contribution limit for an IRA is $6,000 for anyone below age 50 and $7,000 for anyone 50 or older. This reduces the person’s taxable income for the year. To max out the contribution, a person might set a recurring deposit of $500 per month to meet that max limit.

Select Investments

Image via Flickr by Robert Scoble

New traders who have concerns about losing money in the stock market should know that investors who hold stocks for the long term (at least five years) have an average historical return of about 10%.

A diverse portfolio is the key to lowering investment risk. Experts recommend a mix of exchange-traded funds (ETFs) and mutual funds, which provide access to a range of stocks and bonds at an affordable price. Most employer retirement accounts are heavy on these investments.

With ETFs and mutual funds, the investor purchases a ‘bucket’ of securities that consists of small shares of various bonds and stocks. For example, traders can purchase an ETF designed to mimic the performance of a major stock index, such as the Standard & Poor 500. This approach offers instant diversity, so it’s a much lower risk than investing in individual stock shares. Index funds that track the S&P 500 rarely perform worse than the market. Active management mutual funds have a professional investor who picks the stocks.

New traders who want to play around with individual stock purchases should dedicate no more than 10% of their holdings to that purpose until they gain the necessary experience. Those who plan to hold stock shares for at least five years can take advantage of this long position by choosing a growth stock. These shares let investors get in on the ground floor of a company poised for an impressive value increase, although they also carry the risk of failure.

Some experts recommend building an individual stock portfolio slowly by investing in 100 shares of a single company, then gradually expanding these holdings with 100 shares of another firm, and so on. Traders should set criteria for choosing companies to invest in based on their own financial goals, ethics, and other parts of the trading strategy.

Blue-chip stocks are also a smart investment since they often pay dividends. With this type of arrangement, the shareholder receives a periodic profit-share from the company (often quarterly) in addition to interest on their initial investment. The person can take cash dividends or automatically reinvest them to earn even more compound interest. Examples of stable blue-chip firms include Procter & Gamble, Coca-Cola, and Microsoft. Investors can potentially avoid commissions through a company’s direct stock purchase program.

Make It Automatic

No matter what financial assets an investor chooses to pursue, experts recommend automating investments with a payroll contribution or regular bank transfer. Traders call the strategy of spreading out investments over time dollar-cost averaging. This methodical approach takes the emotion out of the stock market and allows investors to focus on the big picture of their long-term financial goals.

Create a Regular Review

Even investors who prefer a passive management strategy over an active strategy should check the performance of their holdings every so often. Most experts recommend doing this monthly or quarterly. During this review, the stockholder should consider whether their current asset mix makes sense for their goals and risk tolerance. Changes in market value can dramatically affect the risk level of a portfolio, throwing it out of balance. In general, long-term traders should make adjustments only as needed.

Anyone who wants to create a strong financial future with investing can get started with these six steps. Learning more about the trading world allows investors to take advantage of more sophisticated strategies when they want to branch out.