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For people new to investing, understanding how to invest in stocks can feel intimidating. Typical questions beginners may have are where to go and how much money to start. However, there is often more than just the mechanics of investing in stocks. Investors must also understand their financial goals before investing.
The following is a beginner's guide to stock market investing. This article covers everything from setting up an account to investing money in stocks.
How Do You Open an Investment Account?
The first step is to decide if you would like to manage your account–actively yourself or with a more hands-off approach and have someone else handle it.
1. Financial Advisor
Advisors are available at banks and other financial institutions to help manage everything for investors, from opening accounts to making stock picks based on the investor's investment goals.
Investors need to know about the costs of management and trading fees before considering that service. A low-cost option is with a Robo advisor. Robo advisors are popular because they are a fraction of the cost that human advisors charge. This approach is suitable for many.
2. Manage Independently
Do you enjoy researching? Do you have the time to commit to managing your account? Do you keep up-to-date with different companies and their operations? Do you like crunching numbers?
These are just a few questions investors should ask themselves when deciding whether to self-manage or hire somebody. Investors that choose to invest independently can open a brokerage account online. This DIY approach is quick and the most cost-effective way to invest.
Investors should do some initial legwork, such as evaluating the different brokers based on fees and investment selection. Some brokers also offer various research and educational tools to help make investment decisions. In addition, investors should ensure the online platforms are easy to navigate and look for any other additional features that can make a broker more attractive than the others.
What Type of Investment Account?
Investors can open a regular investment account, but the income would be taxable. A taxable income account is more suitable for people who already have a separate account for retirement savings.
Investors looking for a retirement savings account can open either an Independent Savings account (IRA) or a 401(k) if they have a retirement plan through an employer.
When investing for retirement, its imperative for investors to understand their financial goals and level of risk tolerance as it will influence the investment selection that is suitable for them.
Also, investment accounts such as 401(k)s may have limits in terms of allowable investments. For example, the plan may not allow for individual stock investments as they tend to be volatile and riskier.
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Types of Investments
Stocks are also known as equity investments. When purchasing an individual stock, the investor then owns shares of that company. The price of a stock can fluctuate throughout the day as shares are constantly bought and sold on the stock market. Many factors influence the stock price, such as industry news, news releases on earnings and profits of the company, new products that are selling well, product recalls, layoffs, and takeovers, just to name a few.
With these price fluctuations, if investors have only a few individual stocks in a portfolio, this could cause quite a bit of volatility. Some investors may not have the risk tolerance for this and would benefit from some diversification.
Investors who still want to invest in stocks may not realize that other investment vehicles are available that also contain stocks. They may be good options for investors with lower risk tolerance or just want a portfolio with more diversification. The following are some investment options to consider:
1. Mutual Funds
Mutual funds are professionally managed funds that use money from investors to purchase a large pool of investments like individual stocks, bonds, and money market instruments. However, it is possible to buy mutual funds that are equity funds, meaning they only invest in stocks.
Equity funds allow investors to buy shares of several companies in one transaction. In addition, the equity funds can focus on particular businesses, such as sector-specific funds, funds based on the cap size of the company stocks, and index-specific funds.
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As mutual funds often contain shares of hundreds of different companies, they are less volatile than individual stocks. Another difference between stocks and mutual funds is that investors can only trade shares of mutual funds through a manager and only at the end of the trading day when they calculate the price or Net Asset Value.
2. Exchange Traded Funds
Exchange-traded funds, or ETFs, are investment funds that, similar to mutual funds, contain a large pool of investments such as stocks, bonds, commodities, and more, all in one fund and divide ownership of the securities into shares.
There are different investment options with ETFs, such as index ETFs where the fund tracks a market index, equity ETFs, and sector and industry-specific ETFs, to name a few.
The main difference between ETFs and mutual funds is that the shares can be bought and sold on a stock exchange at variable prices throughout the day. ETFs can be actively or passively managed. Many of them track the market index. Therefore they usually have lower management fees than mutual funds, which are mostly professionally managed.
Another difference between ETFs and mutual funds is that they require a much lower minimum investment and are tax-efficient.
3. Index Funds
The purpose of an index fund is to track the performance of a specific market index. For example, the Standard & Poor's 500 (S&P 500) or Dow Jones Industrial Average have funds that mimic their composition of companies. For example, the S&P 500 tracks the performance of the 500 largest companies in the U.S. Therefore, a fund tracking this index would own shares of the same 500 companies and experience fluctuations similar to the market index.
Index funds are low-risk investments with low fees, minimal transactions, and passive management.
All three investment vehicles, mutual funds, exchange-traded funds, and index funds, contain stocks but offer diversification and passive management for the investor.
How Do You Choose the Investments?
Even if an investor works with a financial advisor or another service, they will first ask about financial goals. Discussing financial goals will help determine the purpose for the investment, the timing of when the funds will be necessary, and the overall risk tolerance.
Goals can range from retirement to kids' education to money to start a business. In addition, people have various needs for saving money, influencing the investments investors should select.
If a financial goal is only a few years away, such as retirement, it isn't a good time to invest heavily in stocks. Instead, investing in stocks is better for long-term investors who can withstand market fluctuations.
As mentioned above, fluctuations are an inherent part of the stock market. Therefore, for risk-averse investors, stocks may not be a suitable investment.
Stock investments are more appropriate for investors with a longer time horizon, goals that are further in the future, and higher risk tolerance.
How Much Money Do I Need?
After considering any minimum investment amounts required and commissions and trading fees, how do you know how much to invest?
The best way to figure this out is to create a budget. A budget will help investors set aside their fixed, variable and discretionary expenses and money for an emergency fund to see how much money they can put into savings.
Some experts recommend that at least 10% of after-tax income should go towards investments. Investing the complete 10% in a stock or equity fund is acceptable. However, if investing in individual stocks, the investment should be smaller, with the rest going towards more conservative funds.
Investors also can look into setting up automatic transfers into investment accounts regularly.
What is a Good Investment Strategy to Follow?
Some investors follow the value investing strategy like investment guru Warren Buffett. Buffett's philosophy is to buy shares in great, undervalued businesses and hold on to the stocks' long-term. Whether investing in individual stocks, mutual funds, or exchange-traded funds, the best strategy is to ride out fluctuations and hold for the long term.
Once investors decide to manage their accounts or seek the help of an advisor, the path to how to invest in stocks is clear. Investment goals will help provide better direction to investors about the type of account, selection of investments, and amount of money they should invest.
This post originally appeared on Hello Sensible.