When done in the right ways, investing in stocks is among the most effective ways to build long-term wealth. As an asset class, stocks have delivered 9%-10% annualized returns over long periods of time. This can deliver some serious wealth over time. But like most financial moves, there are right ways and wrong ways to invest in the stock market.
Here's a step-by-step guide to investing money in the stock market to help ensure you're doing it the right way.
The first thing to consider is how to start investing in stocks the right way for you. Some investors choose to buy individual stocks, while others take a less active approach with mutual funds. And both can be equally valid ways to put your money to work.
Try this. Which of the following statements best describes you?
I'm an analytical person and enjoy crunching numbers and doing research.
I hate math and don't want to do a ton of "homework."
I have several hours each week to dedicate to stock market investing.
I like to read about the different companies I can invest in, but I don't have any desire to dive into anything math related.
I'm a busy professional and don't have the time to learn how to analyze stocks.
The good news is that regardless of which of these statements you agree with, you're still a great candidate to become a stock market investor. The only thing that will change is how you do it.
First, let's talk about the money you shouldn't invest in stocks. The stock market is no place for money that you might need within the next five years, at a minimum. Money you need to pay your kids' tuition, finance a home renovation, or pay day-to-day expenses in retirement should be kept in less volatile investment vehicles.
While the stock market will almost certainly rise over the long run, there's simply too much uncertainty in stock prices in the short term -- in fact, a drawdown of 20% in any given year isn't unusual, and occasional drops of 40% or even more do happen. Stock market volatility is normal and should be expected.
So, here's what you shouldn't be investing:
Your emergency fund
Money you'll need to make your child's next few tuition payments
Next year's vacation fund
Money you're socking away for a down payment on a home, even if you will not be prepared to buy for a few years
Asset allocation
Now let's talk about what to do with your investable money -- that is, the money you won't likely need within the next five years. How you distribute it is a concept known as asset allocation, and a few factors come into play here. Your age is a major consideration, and so are your particular risk tolerance and investment goals.
Let's start with your age. The general idea is that as you get older, stocks gradually become a less desirable place to keep your money. If you're young, you have decades ahead of you to ride out any ups and downs in the market, but this isn't the case if you're retired and rely on your investment income.
All the advice about investing in stocks for beginners doesn't do you much good if you don't have any way to actually buy stocks. To do this, you'll need a specialized type of account called a brokerage account.
Opening a brokerage account is typically a quick and painless process that takes only minutes. You can easily fund your brokerage account via an electronic funds transfer, by mailing a check, or by wiring money.
Opening a brokerage account is generally easy, but you should consider a few things before choosing a particular broker:
Type of account
First, determine the type of brokerage account you need. For most people who are just trying to learn stock market investing, this means choosing between a standard brokerage account and an individual retirement account.
Both account types will allow you to buy stocks, mutual funds. The main considerations here are why you're investing in stocks and how easily you want to be able to access your money.
Compare costs and features
The majority of online stockbrokers have eliminated trading commissions for online stock trades. So most (but not all) are on a level playing field as far as costs are concerned, unless you're trading options or cryptocurrencies, both of which still have trading fees with most brokers who offer them.
However, there are several other big differences. For example, some brokers offer customers a variety of educational tools, access to investment research, and other features that are especially useful for newer investors. Others offer the ability to trade on foreign stock exchanges. And some have physical branch networks, which can be nice if you want face-to-face investment guidance.
Now that we've answered the question of how you buy stocks, if you're looking for some great beginner-friendly investment ideas, here is a list of our top stocks to buy and hold this year to help get you started. Note that it isn't intended as personal advice -- just some well-run businesses to help get your search started.
Of course, in just a few paragraphs, we can't go over everything you should consider when selecting and analyzing stocks, but here are the important concepts to master before you get started:
Diversify your portfolio.
Invest only in businesses you understand.
Avoid high-volatility stocks until you get the hang of investing.
Always avoid penny stocks.
Learn the basic metrics and concepts for evaluating stocks.
It's a good idea to learn the concept of diversification, meaning that you should have a variety of different types of companies in your portfolio. However, I'd caution against too much diversification. Stick with businesses you understand -- and if it turns out that you're good at (or comfortable with) evaluating a particular type of stock, there's nothing wrong with one industry making up a relatively large segment of your portfolio. Billionaire investor Warren Buffett has a disproportionate amount of money invested in financial sector stocks, because he knows the industry very well.
If you want to invest in individual stocks, you should familiarize yourself with some of the basic ways to evaluate them. Our guide to value investing is a great place to start. There we help you find stocks trading for attractive valuations. If you want to add some exciting long-term growth prospects to your portfolio, our guide to growth investing is a great place to begin.
Here's one of the biggest secrets of investing, courtesy of the Oracle of Omaha himself, Warren Buffett. You do not need to do extraordinary things to get extraordinary results.
The most surefire way to make money in the stock market is to buy shares of great businesses at reasonable prices and hold on to the shares for as long as the businesses remain great (or until you need the money). If you do this, you'll experience some volatility along the way, but over time, you'll enjoy excellent investment returns.
Don't miss this second chance at a potentially lucrative opportunity
Ever feel like you missed the boat in buying the most successful stocks? Then you'll want to hear this.
On rare occasions, our expert team of analysts issues a "Double Down" stock recommendation for companies that they think are about to pop. If you're worried you've already missed your chance to invest, now is the best time to buy before it's too late.
