How you feel about investing in stocks depends on how comfortable you are with taking risks.
You may love the idea of playing the stock market if you’re OK with taking chances. Who doesn’t dream from time to time about getting rich by picking the next Apple?
But if caution is more your style, investing in stocks may feel like throwing your money into a Vegas slot machine.
The truth is, putting your money in stocks is rarely a way to get rich overnight. But it’s also unlikely to leave you broke if you take the smart approach. In fact, investing in stocks is the way that most people are able to build a nest egg and retire someday.
Stick with us for a few minutes and we’ll show you how to invest in stocks the right way. You’ll learn how you can achieve your goals without putting your savings at risk.
What Is a Stock, and How Do Stocks Make Money?
When you buy stock in a company, you become the owner of a tiny fraction of it. Each unit you own is called a share. If the company is successful and makes money, you make money too.
There are actually two ways your stocks make money:
- The value of your shares goes up: If other investors think the company will be profitable, share prices will rise. You’ll then be able to sell your shares for a profit.
- The stock pays a dividend: Some, but not all, corporations pass a portion of their profits on to shareholders by paying dividends. You’re more likely to get dividends if you invest in a large, established company than a smaller one with big growth potential that needs to reinvest its profits.
When you invest in stocks, you also take on a risk. If the company doesn’t do well, you could lose money. And if you own stock in a company that declares bankruptcy, your shares will probably become worthless, even if the company doesn’t close altogether. That’s because during bankruptcy, shareholders get paid only after creditors and bondholders have been paid in full.
What Are the Best Stocks for Beginners to Buy?
There are several ways to invest in the stock market. Here are some options for beginning investors if you’re looking to start investing in stocks.
Investing can be a challenge for beginners when you try to pick your own stocks. Picking individual stocks is tricky even for seasoned investors.
One mistake beginning investors make: They pick stocks based on what’s making headlines. By the time ordinary people hear that a company’s stock looks promising, the price has already surged. So you’ve missed out on the big growth. Then, they panic when the news is bad and sell when prices are low.
If you’re determined to pick your own stocks, it’s essential to invest in a diversified portfolio. Many investors recommend never having more than 5% of your portfolio invested in a single company. That means you’d need to own stock in at least 20 companies across various industries.
If that sounds overly complicated and expensive — as it is for most beginning investors — there’s an easier way to invest in stocks.
When you buy a mutual fund, you’re buying tiny fractions of lots of companies that are bundled together as a single investment.
Some mutual funds are index funds, which means they’re made up of the companies represented on a stock index, like the S&P 500, and aim to perform at the same level of the index or better. But the majority of mutual funds are actively managed, which means a human picks the investments and attempts to outperform the overall stock market.
The upside is that investing in a mutual fund is a lot less risky than investing in individual stocks because you get diversification. The downside is that mutual funds have fees, which are higher if they’re actively managed, and require an up-front investment of $1,000 or more.
Buying a mutual fund works differently than buying stocks. Stocks are traded on stock exchanges, but you can’t buy a mutual fund on the stock market. You buy it directly from the mutual fund company, and you can only buy and sell your mutual fund shares at the end of the trading day.
Exchange-Traded Funds (ETFs)
Exchange-traded funds, or ETFs, are a lot like mutual funds in that they package together many investments and give you diversification. But most ETFs are passively managed index funds; only a handful are actively managed.
That passive management style results in lower fees. Another advantage: Human managers usually don’t beat the market in the long run, so you’ll often get better results over time by going with an ETF that tracks the overall stock market.
Unlike mutual funds, ETF shares are traded on stock exchanges throughout the trading day, just like regular stocks. There’s no up-front cost to buy one beyond the cost of a single share.
Because of the low fees, ease of buying and selling, and instant diversification, ETFs are often a great choice for beginning investors.
Don’t put money in the stock market if you’ll need it in the next five years. CDs, money market accounts and high-yield savings accounts are better options for money you need in the short term.
How to Invest in Stocks With Little Money
One of the biggest myths about investing in stocks is that you need a lot of money to start. That’s completely false. Most people don’t have gobs of cash to spare when they start investing. Here are some ways to get started.
Contribute to Your 401(k)
If you work for a company that offers a 401(k) and offers a match, it’s essential that you take advantage. If you don’t, you’re leaving free money on the table.
You won’t be able to trade stocks using your 401(k), but you’ll choose from several investment options, usually mutual funds.
Open a Roth IRA
Another good option for investing in stocks is to open a Roth or traditional IRA. We’re partial to Roth IRAs for most new investors because even though you don’t get to deduct your contributions for taxes, your money grows in the stock market completely tax-free.
You’re allowed to trade stocks using an IRA — but we wouldn’t suggest doing so. You don’t want to gamble with your retirement funds.
A better option is to use a robo-advisor, which basically means your investments will be selected using a computer algorithm that considers your age, goals and risk tolerance.
Usually, when you’re a beginning investor, they’ll allocate most of your portfolio to stocks and use a small percentage to invest in bonds, which are generally a safer investment than stocks, but lack the potential for big growth. As you get older, you’ll allocate an increasing percentage to bonds and a lower percentage toward stocks.
The 2020 Roth IRA contribution limits are $6,000 if you’re under 50 or $7,000 if you’re over 50.
Open a Taxable Brokerage Account
If you’ve decided to set aside money to play with the stock market, a regular brokerage account is where we’d suggest making your trades. Many online brokerages offer commission-free trades, though we don’t recommend frequent trading. You build wealth in the stock market by holding onto your investments long term.
Once you open and fund your account, you buy stocks by placing an order.
You can place a market order, which means you’re telling your broker to buy the stock for you at whatever the going rate. You can also place a limit order, which tells your broker only to buy shares at a certain price or better.
You can also use what’s called a stop order to protect your investments. Here’s how it works: Suppose you paid $20 a share for Stock A. You could place a stop order that tells your broker to sell if prices drop to $15, though there’s no guarantee there will be a willing buyer at $15, especially if prices are plummeting.
If you know when to fold ‘em, you could also place a stop order that tells your broker to sell once share prices hit $25. That way, you could lock in a 25% profit and move on.
Use a Micro-Investing App
Micro-investing apps let you get started for as little as $1, typically by investing your money in ETFs. The low minimum investment makes them a good way to start investing if you’re living paycheck to paycheck or you still find investing a tad intimidating.
Check out our picks for the best micro-investing apps.
How Can I Learn More About the Stock Market?
Want to learn more about the stock market before you start investing?
One of the best ways to get started is simply to follow the news. Pay attention when the stock market has an especially good or bad day, and take note of why investors were feeling especially panicked or confident. (But keep in mind: The stock market’s performance doesn’t reflect how the overall economy is doing.)
You can also keep track of individual stocks you’re interested in. One good resource is Yahoo! Finance. When a stock you’re following goes up or down, read up on why.
While you’re at it, read up on the basics of investing by checking out our picks for the best investing books.
If you want to get practice trading stocks without putting actual money on the line, test the waters with a stock simulator. You can create a mock portfolio of stocks you want to invest in and trade in real time. Two options we like are HowTheMarketWorks and Wall Street Survivor.
Even the best investors never stop learning how to invest in stocks. Commit yourself to learning more about the stock market in the long term, even if you only have a few minutes to spend each week. That time will pay off as you slowly build your wealth.
Robin Hartill is a certified financial planner and a senior editor at Codetic. She writes the Dear Penny personal finance advice column. Send your tricky money questions to [email protected]