Investing in the stock market takes several steps to achieve your investment goals and financial needs. We’re going to give you a step-by-step beginners guide on how to invest in the stock market.
Below is our list of what steps you need to take to invest your money in the stock market the right way.
1 – Do you want to be an active investor or passive investor?
As we’ve mentioned in our how to invest guide, generally stock investing is divided into two categories or methodologies. They are
- Active investing
- Passive investing
As the name suggests, passive investing is where you either have someone else do the work for you (in terms of what to invest) like a financial advisor/planner, or you passively put your money into a few stock indexes, then let the money grow over time with the stock market indices, choosing fixed times to add money into your investment account.
It’s a very hands-off approach where you passively invest without much decision making.
For those of you with very little time or interest in learning about the stock market, we suggest this approach and that you should consult your financial advisor.
On the other hand, active investing is where you actively choose which stocks to invest in, when and for how long.
It’s important to understand this does take more time, along with building your knowledge of the stock market and skills required to do so.
I would like to note the wealthiest investors are not passive investors, but active investors. If you like building new financial skills, don’t mind doing a little research on your time off, and would like to invest in specific companies, then we recommend active investing
2 – What are your investing goals?
What your specific investing goals are will greatly determine how you should invest in the stock market.
Are you a millennial that has at least 30-40 years before retirement? If so, you can probably take on more risk than someone in their 60’s or 70’s.
Are you wanting a lower risk investment approach so you can steadily build your income with lesser risk to your investment funds? If so, you’ll want to invest in stocks that have lower price volatility, and ideally a strong market share + low competition so they can retain their stock value.
Hence, your investment goals will determine what stocks or stock indexes you invest in, thus it’s important to have a clear goal in terms of what your reason for investing in the stock market is, how much time you have till retirement, and how much risk you are willing to tolerate.
3 – What to invest in?
There are generally two major protocols for investing in the stock market. They are:
- Index funds
- Individual stocks
Index funds track major stock indices like the NASDAQ and S&P 500. An index funds are designed to match the long-term performance of the index they are trying to track.
For the Nasdaq, it’s the QQQ, and for the S&P 500, is the SPY. Both index funds offer a dividend and have low costs in terms of fees.
It should be noted the S&P 500 historically has produced about a 10% annual return which is a fantastic way to build your investment portfolio over time, hence why it’s such a sought after index to be invested in.
Individual stocks are another protocol for investing in the stock market.
Do you believe Apple (Nasdaq: AAPL) will remain a dominant player in the computing/phone/wearable device industry for years to come? You can buy a piece of that company by buying shares, thus profiting if they grow in value over time.
Do you think Amazon (Nasdaq: AMZN) will for years to come be the dominant player in the retail e-commerce space? Again, you can buy individual shares of Amazon and partake in the stocks increase in value over time.
Investing in individual stocks allows you more nuance in what you want to invest in, when you want to invest in, and how much to invest in them. Again, this takes a bit more time as you are ‘actively’ deciding which stocks to invest in. But if you feel you can learn the skills of investing in stocks, and think specific companies will do well over time, you will want to consider investing in individual stocks.
Regardless of whether you are in the active or passive investing camp, we recommend having investments in both individual stocks and index funds.
4 – How much to invest into the stock market?
When it comes to how much money you may want to consider investing in the stock market, we only recommend investing money which meets the following requirements:
- It’s not needed to pay off bad debt (i.e. any debt with a 10% interest rate or higher), and
- You won’t need this money in the next three to five years.
If you have funds available that meet the above criteria, then we recommend at least investing some of those funds into the stock market.
It’s important to note the stock market has a directional bias of going up over time. If you look at the prices of the US stock markets over years, you’ll see they have a natural incentive to go up because the goal of a company is to increase its value over time.
It’s also important to note the stock market can and often does lose 20+% of its value (what we call a bear market) over time. This has occurred over five times in the last twenty years, so it’s something that’s not uncommon, and to be expected. Thus, it’s important you understand the risks of investing in the stock market.
Now as to how much should you invest with your investable funds, we recommend the rule of 110. This simple rule states that you take your age and subtract it from the number 110. Whatever that number is, that is the % of your investable funds you should put at risk into stocks and index funds. The remainder we suggest putting into fixed-income investments like higher grade bonds (AA or AAA rated).
So now you know how much to invest in the stock market with your investable funds.
5 – Open an investment account
Once you’ve decided upon your investment goals, how you want to invest (active vs passive) and how much to invest, its time to open a brokerage account. This is simply an account that allows you to buy stocks and index funds.
There are many companies which offer brokerage accounts, and its possible your bank offers this as well.
For those who are more active investors, especially those with (or looking to build their investing skills), we recommend TD Ameritrade.
For those who are more passive investors, we recommend Public or Robinhood as they offer easy mobile apps which allow you to open the account via your phone and can be done so within a matter of minutes.
Generally opening a brokerage account is pretty easy, but it’s important to consider what type of investor you will be, and what account you may need to invest your funds.
For those just looking to invest funds from your normal bank account, you’ll want to choose a standard brokerage account. This will give you easy access to your funds and allow you more flexibility.
For those of you wanting to invest from your IRA account, note you’ll have limitations as to how much and will have less access to your funds.
It’s important to note the costs and fees associated with stock investing so make sure you understand the fees and commissions for buying and selling stocks and index funds with your chosen broker.
We always recommend your broker have the following qualities:
- Be regulated (by your regulating agency in your country)
- Have customer support you can contact via phone
- Has a user-friendly app or software that allows you to easily make decisions about how to buy and sell stocks or stock indices.
6 – Choosing your stocks
Now that you’ve gotten your brokerage account all setup, it’s time to choose which stocks to invest in. Below are several points to consider which stocks to invest in:
- Invest only in stocks where you understand their business
- Avoid stocks that have high volatility (i.e. massive changes in their stock price) in the beginning
- Avoid penny stocks (most penny stock companies go broke and lose value over time)
- Learn the basics of how to evaluate stocks (through both fundamental and technical analysis)
- Diversify your holdings to mitigate risk
Based on the above key points, here are a few things to consider or avoid doing:
- Avoid meme stocks as they have high volatility and rarely will accumulate value over time
- Invest in companies you understand their product, market position and future developments
- Invest in a base of stocks that will have lesser price volatility, but stable growth over time
- Choose a few stocks that have strong dividends (4% and above) with lower price volatility
- Invest in a few index funds to provide lesser risk and greater stability over time
- Always pick a few stocks that focus on growth so you can capture more upside in your portfolio.
7 – Keep Investing
Virtually every successful investor in the last 50 years didn’t just put money in the stock market one time. They all kept investing and adding to their portfolios over time. We recommend the same approach, and often suggest simplifying this process by choosing a small amount you can put aside each month towards your investment portfolio.
As we’ve said before, the stock markets have a directional bias of going up, thus by continually investing your money over long periods of time, you increase your probabilities of maximizing your returns and increasing your wealth.
Investing in the stock market is a potential method for increasing your financial wealth over time. It’s important to understand there are risks and to never risk more than you can afford to lose.
But for those who are prudent with risk and invest their funds well, you can produce additional returns on your capital over time while building your financial means to buy a new home, pay for college, or fund your retirement.
Whatever your goals are, we recommend following the step by step guide above for investing in the stock market to improve your chances of success.