Introduction
Investing in stocks has been one of the most popular and well-known forms of investment available to the general population throughout the last several decades. Did you know that if you had invested $10,000 in the S&P 500 index 50 years ago, you would have generated well over a million US dollars today? Believe it or not, this is a major difference that separates the wealthy from the poor today. That is, the wealthy have remained invested in the stock market, and on average have generated significant returns throughout the years, while the poor have remained on the sidelines and did not participate in one of the greatest price rallies in history.
It does not take a Harvard degree to understand the power of compound interest (or the exponential function) over time. If you earn a 10% interest annually, you would double your money in 7 years, triple it in 12 years, quadruple it in 15 years, 10x it in 25 years, 50x it in 41 years and 100x it in 49 years. Take a look at the S&P 500 index through the last 50 years.
While past performance is not an accurate predictor of future performance, this can give you an idea of how powerful investing in the stock market can be, in the long run. If you invest only in the short run, you should not expect anything similar as the price swings can be quite wild.
If you are interested in investing in the stock market, you will have to decide on quite a few things before you start. And if you are a beginner, you will probably not know where to start. So, keep reading this article to get answers to the most fundamental questions when it comes to investing in stocks.
Your Investment Approach
Before you start investing you should decide on your investment approach. That is, will you be selecting specific stocks to invest in? Will you be investing in indexes? Or will you be investing in mutual funds and let your funds be managed by professionals? All of the above are valid ways to invest, however, people will prefer different approaches. If you have enough time and willingness to actively invest on your own, then researching specific stocks and actively investing in stocks will be best for you. While it is hard, it is possible to beat the market while investing on your own. And again, it does not take a Harvard degree to understand how markets work.
Another way of investing is for those who would like to manage their funds actively, however, do not have the time to research specific stocks. In such a case, index investing is the way to go. Index funds are designed to track a stock index such as the S&P 500. Over time, the S&P 500 index has produced returns of around 10% annually and generated significant wealth for those invested.
If you would like the active investment approach, but do not have the time or the willingness to do it yourself, you can invest in a mutual fund. Whereby a fund manager will manage your funds and invest actively in the stock market for you. He or she will take a fee for that, of course, it is not a free service.
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How Much Should You Invest?
The answer to this question depends on you and your financial situation. You do not want to be in a situation where you invest all of your savings and have nothing left for emergencies or other projects in need of capital. For instance, say you or your kids wanted to pursue higher education. That would most likely incur quite considerable costs that would need to be covered. Be it full payment for tuition or interest payments, they can be quite significant. Other examples are emergency situations that would require immediate capital, vacations or other significant purchases.
That said, however, you also do not want to keep most of your savings for a rainy day. Why? Because they will simply be eroded by price inflation over time. Plus, you will have probably lost on the opportunity to make more money by investing in the stock market. So, make sure you allocate just enough capital for your investment needs so that you are not overly affected by losing a significant portion of it over a short period of time. In fact, as history has shown us, a 20% drop in stock prices is not an unusual occurrence.
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Asset Allocation
After you have allocated the funds you can risk for your investment needs, it’s time to choose how much you will want to invest in stocks versus bonds. A popular belief is to split the two according to the following rule. Subtract your age from 110. This is the percentage of funds that should be invested in stocks. The remaining – in bonds. So, if you are of 40 years of age, then 70% of your capital should be invested in stocks, and 30% in bonds.
However, in recent times the interest rates on many government bonds are close to zero. In Germany’s case, you would be paying money, not receiving it if you invested in government bonds. That means that equities are probably a more attractive investment to bonds in the current economic climate. In fact, you can easily find steady large companies paying a 4-5% dividend on a regular basis.
While equities (or stocks) generally are the more risky investment, paying money for holding it in bonds (or receiving close to zero percent) is not attractive either. So, unless you are nearing retirement age, where you will need the money right away, be sure to allocate a more significant portion of your capital into stocks than as accustomed by the general 110 rule.
Opening an Investment Account
In order to invest in stocks, you will need to open a brokerage account. Such accounts are offered by brokers such as E*Trade, TD Ameritrade, Interactive Brokers and many more. You will first need to choose the type of account that fits you best. Usually, it is either a standard account or an individual retirement account (IRA). IRA accounts have certain limits, such as the time when you can withdraw your money. If that is not a big deal and you can wait until your retirement to withdraw the money, then this is the way to go for you. Otherwise, if you are saving up for a rainy day, or would like to use the money in the near future, go with a standard brokerage account.
After you decide which account is best for you, it’s time to compare the features of different brokers’ offerings. Some are better for active investors, others are specifically geared towards beginners. Some offer additional research tools for active investors, others offer better or a better variety of trading platforms. And yet others will offer special features, such as access to foreign markets. Some will have physical branches, others only online support. These are only some of the differences between stock brokers out there. Most offer zero commissions on stocks, so you will be able to differentiate between them according to other relevant criteria.
Choosing Your Investments
If you have decided to invest actively and form your own portfolio, you will need to choose your investments wisely. There is a very important rule in investing, which is, do not put all of your eggs in one basket. In other words, do not put all of your money in one single stock. Diversify. Diversification will help you minimize your risk that comes from a single company going bankrupt, or even a single industry getting in trouble. However, it is important to understand the different industries and businesses you are investing in. Don’t invest in something you do not understand. It is okay to have a large portion of your capital allocated to only a few industries that you understand well.
As a beginner investor, it is probably best to stay away from high volatility stocks or penny stocks. You do not want to lose your capital in a matter of days. One should also remember that in a way, time is your friend since you will be learning a lot of new things every day. You will improve and your experience will grow, which will help you increase your returns in the long run.
Another important thing is investing in your education before you go live. That includes going on a demo account first, before investing real money. Another great way to learn is also to take on courses that help you learn the ropes as a beginner investor. In fact, Tradimo offers just such a course for beginner stock investors – the Investor Nanodiploma. The course offers 21 hours of content, including 6 projects and 10 courses. Amongst other topics, you will learn to read the markets, charts, evaluate stocks and make up your investment portfolio. It is a great way to kickstart your career as an investor.
Continuing to Invest and Learn
The secret to investing is probably best evidenced by one of the greatest investors of all time, Warren Buffet. His approach, while basic, is fundamental to how stock investing works. According to him, markets are a mechanism that transfers money from the hands of the impatient ones to the patient ones. In other words, there is no get rich quick scheme in markets. The best strategy is to find great companies at reasonable prices, invest in them and keep holding them as long as they remain great companies.
You will no doubt face bumps on the road, however, what is important is that you do not give up, continue to learn from your and others’ mistakes and stay persistent and disciplined.
