17 Things You Need to Know Before Investing in Stocks
Finally, you can enter the investment world of Wall Street with confidence.
It’s not always the smartest option
“Over many decades, the investment that has provided the highest average rate of return is stocks,” says financial adviser Brian Saranovitz, president of Your Retirement Advisor. If you owe money on a credit card and are paying 18 percent interest, though, you should pay off that debt before investing. By sending the money to the credit card issuer instead of Wall Street, you’re effectively making 18 percent on your money. That type of high-paying investment—let alone a sure thing—would be hard to find in the stock market, so it’s helpful to know in a “stock market for dummies” crash course. Don’t miss these 11 money tips from people who managed to retire early.
Learn the lingo
If you can’t talk the talk, don’t try to walk the walk. Not knowing the difference between EPS (earnings per share) and ETF (exchange-traded fund) could cost you a small fortune. Did you realize the much-touted Dow Jones Industrial Average is based on only 30 stocks? Websites such as MoneyTips can provide some stock market for beginners lingo and help you learn the vocabulary of Wall Street. Most importantly, understand what investing in stocks means: that you own a small piece of a business.
It’s not all “buy low, sell high”
“Stock ownership provides multiple ways to profit—not only price appreciation, but also dividends,” says Saranovitz. With a dividend, you get paid simply for owning a stock.” A recent Hartford Funds study shows that dividend-paying stocks tend to beat the market over the long term and yield far better returns for investors than stocks that don’t pay dividends. In addition to learning the stock market for dummies, check out other easy ways to earn extra income.
Decide what kind of help is best for you
Back in the day when the Dow Jones Industrial Average was below 1,000, investors had to rely on licensed brokers who garnered large commissions with every trade. Not only has the Internet driven sales commissions way down, but new technology also allows people to rely on robo-advisers (computer algorithms) or to make their own stock-picking decisions without any human interaction. It’s wonderful that you can trade stocks in your underwear—until you lose your shirt!
“My mother has always said, ‘Life is 20 percent what happens to you and 80 percent how you react to it.’ With your financial life, you might not always have the right know-how or frame of mind if the going gets tough,” says Lynn Toomey, co-founder of Your Retirement Advisor. “A financial adviser can provide the behavioral coaching that you can’t do on your own or with a robo-adviser platform. When the market drops, an adviser can help you focus on your long-term goals instead of hitting the panic button.” With so many good stock-pickers in the industry, picking your own portfolio is a financial risk, she says.
Consider the long-term
“Trading stocks isn’t like a long weekend in Vegas,” warns Toomey. “You’re not trying to cram a ton of action into a few nights. Commit to being a long-term trader, and the odds of coming out ahead turn in your favor.” Your stocks might dip for a little while, but with the patience to ride it out, you’ll earn in the long run. Learn 26 more secrets rich people won’t tell you about their money habits.
Don’t try to time the market
When investing in stocks, try the buy-and-hold strategy as opposed to day trading. Nobel Prize-winning economist Paul Samuelson wrote, “Scores of documented statistical studies attest that not one in ten ‘timers’ ends up getting back into the market at bargain prices lower than what they sold at earlier.” In fact, you might end up doing worse damage, says Saranovitz. “Many traders panic and sell stocks too late, after a large drop,” he says. “That could be the worst time to sell.” When learning the stock market for beginners, it’s hard to calculate exactly when to sell a particular holding, but signs include a high price-to-earnings ratio, stagnating or dropping sales, and decreasing profit.
Don’t invest more than you could afford to lose. Like any investment, there are risks, especially in the short term. What if you had invested in early February, right before the market suffered through the biggest one-day drop in history? Stocks won’t go up all the time. You also need to recognize your own risk tolerance. Consider your age: The closer you are to retirement, the less time you’ll have to make up for a large loss. Saranovitz, who counsels people on controlling their risk as they get closer to retirement, says, “We’ve witnessed many people throwing caution to the wind due to the stock bull market we’ve had since April 2009. We’ve witnessed people very close to retirement wanting to keep high stock exposure in their portfolios. We recommend age-appropriate portfolio allocations to assure one is properly invested in the event of a major stock market correction or potential bear market, either of which could be on our horizon.” Use this timeline to show exactly how much to save for retirement.
Start with exchange-traded funds, index funds, and mutual funds
Buying exchange-traded funds (ETFs), index funds, and mutual funds are popular ways of buying stocks without having to choose individual stocks. Many are automatically diversified (so one event won’t ruin all your investments), have low fees, and are rated for risk tolerance. Target-date funds, which assume investors will retire in a certain year, adjust their asset allocation to get more risk-averse as one approaches retirement age. However, one study shows that most participants in these “set-it-and-forget-it” end up taking money out to actively invest in their own stock picks, despite its risks. Don’t miss the answers to your top retirement savings questions.
Try dollar-cost averaging
“Many people are introduced to stocks through an employer-based retirement program such as a 401(k) plan, where you get to choose your preferred investments from several options,” says Toomey. “Take full advantage of these programs, since many are tax-deferred and have matching components. They also make it easy to use dollar-cost averaging.” In this investment technique, you buy a fixed dollar amount of stocks regularly, such as every pay period. In “stock market for dummies” lingo, that means you’re buying more shares when the price is lower and fewer when the price is higher, removing the worry about when to buy.
Diversify in every way
“A good money manager will purchase 20 to 30 stocks to diversify a portfolio,” says Saranovitz. Not only should you pick different industries, such as consumer staples and technology stocks, but you should aim to have different countries, and both mega-corporations and small companies, he says. In mastering how to invest money, your overall investments should be diversified, too. Stocks should make up a part of your portfolio, but not all of it. “We recommend bonds and fixed-indexed annuities to our clients as well,” says Saranovitz.