How to Start Investing for the First Time
I f you’re looking for a way to meet your financial goals, investing for the first time can provide the returns that will help your wealth grow. Review this step-by-step guide for the first-time stock investor as you prepare to try your hand at the stock market.
- Review the different avenues through which you can purchase stocks.
- Let your financial goals and investment plan guide the amount of money you devote to the stock market.
- Educate yourself about the types of financial products you can trade on the stock market.
- Prepare to avoid mistakes that may cause first-time investors to lose money.
Why Consider Investing for the First Time?
Many people who are unfamiliar with the stock market avoid investing because they are afraid of losing money or simply don’t know where to start. In fact, investing money in stocks typically pays off as long as you plan to hold the shares and financial assets you buy for at least five years.
The longer you keep your market holdings, the more opportunity your savings will have to grow and benefit from compound interest. If you will need the proceeds of your investment within less than five years, a high-yield savings or money market account makes more sense than a stock market purchase.
To understand why the stock market is such a cornerstone of building wealth, it’s important to know the power of compound returns. As your investments earn interest, you can decide to reinvest that interest in your investment account.
For a very simple example of how this works, let’s say you have an investment account that has $1,000 and earns 7% interest. Your first interest payout, $70, will be added to your account for a total of $1,070. That means your next interest payment will be $74.90. Now, instead of earning interest on $1,000, you’ll be earning interest on $1,074.90 and growing.
Intrigued about the possibilities the stock market holds for you? These simple first-time investment tips can help you start your stock market career on the right foot.
Select a Broker
Image via Flickr by JeepersMedia
First-time investors entering the stock market have several available approaches to consider. With a managed investment account, an advisor chooses stocks and other financial assets on your behalf. However, this route does not appeal to most first-time investors because of the high fees, and many stock market newbies don’t need the comprehensive services offered.
Instead, most new investors go with a so-called robo-advisor. With this type of program, you enter your investment goals, risk profile, and other key information, and the software algorithm builds a diversified portfolio targeted to meet those specific goals. While robo-advising platforms carry fees, they are typically lower than those charged by managed investors. A common fee is 0.25% of the total balance of your account. You can also start investing with most robo-advisors with just $500.
Another option is to dive right in and manage your own stock portfolio. In this case, you’ll need to find a brokerage firm through which to purchase stocks. When reviewing potential brokers, be sure to consider:
- The availability of assistance and education for beginners.
- Commission costs.
- Trading interface.
- Available investment types.
- Requirements for minimum deposits.
- Transaction fees.
Make Your First Deposit
After you choose your investment approach, you’ll need to open and fund an investment account. Typically, you can transfer funds to this new account right from your bank account, though most firms also accept traditional checks.
The more money you invest, the higher your potential stock market gains. For this reason, many experts recommend creating an automatic transfer of at least 20% of each paycheck to your stock account. If you’re not sure how much you can afford to invest, make a budget that considers your expenses and prioritizes long-term savings.
Many people invest in the stock market for the first time when they invest in a retirement plan through their employer, such as a 401(k). This offers an easy bridge to investing since you can set up an automatic deposit for as little as 1% of your salary. What’s more, many companies provide an employer match up to a certain amount, so not funding your 401(k) is leaving money on the table.
You can also set up your payroll contributions to an employee retirement fund so they increase each year. As you rise in the ranks and begin to earn more money, your investments will automatically be increasing in kind.
Understand Available Investments
While investors can choose from countless types of financial assets, most new stock investors stick to one of just a few main asset classes:
- Individual stocks, which allow you to purchase shares in specific companies. While this can be an easy point of entry for a first-timer, it can also be expensive and time-consuming to build a diversified portfolio with adequate risk protection from single stocks. Most investors have just 10% of their portfolios in individual stocks.
- Exchange-traded funds (ETFs) and stock mutual funds, in which you make a single purchase that includes portions of many different companies. This method provides instant diversification, which appeals to risk-averse investors. You can purchase mutual funds and ETFs called index funds that reflect the performance and makeup of a specific stock index, such as the Dow Jones Industrial Average or the S&P 500.
- Bonds, which are backed by either the state or federal government, a local municipality, or a corporation. These entities sell bonds to finance capital projects starting at just $10 each. Many experts consider government bonds the safest form of investment. Some securities mature in just 30 days, while others can be held for as long as three decades.
- Real estate crowdfunding, a new investment category that provides the advantages of investing in real estate without the logistical considerations or costs associated with renting out residential or commercial property. However, new investors should know that this category carries a higher risk than other assets and usually has a relatively high minimum investment of about $5,000.
If you decide to purchase individual stocks, your initial investment will depend on the share price. Depending on your target company, the share price could be as low as a few dollars or up to several thousand dollars. ETFs typically have a minimum investment of about $100, and you can usually invest in a mutual fund starting at about $1,000. Some index funds even have no minimum investment requirement. If you have a 401(k) or individual retirement account, you can probably select mutual funds and ETFs as part of your investment plan.
Steer Clear of Common Errors
As you build your stock market knowledge, it’s important to know the common mistakes of a first-time stock investor so you can avoid these pitfalls.
Too many investors take the ‘buy low, sell high’ advice to heart without a true understanding of what low and high really mean in the context of the stock market. Before jumping into managing investments on your own, make sure you know how to use the key metrics of the stock market. Important terms to know include price-earnings ratio, dividend yield, and book value, as well as how these items relate to one another.
While penny stocks can seem like a win-win because you can purchase many shares of a company for less than $100, these investments are risky because of the low quality of the companies and rarely create significant profit. Instead, purchase fewer shares of a blue-chip or other reputable stock and hold it for as long as possible. In that scenario, you’re much more likely to come out ahead.
Failing to diversify is another common pitfall for first-time investors. Avoid placing all of your capital into a single type of asset. By investing in mutual funds, index funds, and ETFs, you can instantly create the versatility your portfolio needs to see you through dips in the market.
Never borrow money to buy more stock than you could otherwise afford. If the stock declines in price, you’ll end up losing more money than you owe and put yourself in financial constraints. By the same token, you shouldn’t put money in the stock market when you cannot afford to do so.
Tracking stock market news can often lead new investors astray. Chasing a hot tip puts your portfolio at risk. Avoid selling off stocks you’ve held for less than five years.
While you can certainly monitor your new stock market investments, it’s also fine to take an out-of-sight, out-of-mind approach to your account. Doing so will prevent panic if you see a loss since long-term investors tend to come out ahead over time. With time, you’ll become more comfortable with investing and may desire a more active approach to your portfolio as your knowledge grows.