Updated August 30, 2016

How to Invest in Stocks: Beginner's Guide

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When you want to invest in the stock market but you have no idea where to begin - or what any of it means - start with this beginner’s guide to stocks.

How to Invest in Stocks
How to Invest in Stocks © CreditDonkey

In this guide, you'll learn:

  1. Build Wealth by Investing Money
  2. Investing is Not Gambling
  3. Investing is Simple, But Not Easy
  4. What Are Stocks
  5. Why Invest Money in Stocks
  6. How Much Money Do You Need to Buy Stocks
  7. Assess Your Risk Comfort Level
  8. Choose a Brokerage
  9. Do Your Homework Before Deciding
  10. Don't Focus Solely on Price

Build Wealth by Investing Money

Here’s a hard truth: You can be smart about your spending budget and you can be smart about socking away some money into a savings account every month, but unless you’re a super-rich CEO with a huge income, you’re not going to get very far.

To make the most of your earnings and build up wealth, investing in stocks to some extent is usually the way to go.

Investing is Not Gambling (But Watch Out!)

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We say “usually” since sometimes stocks take a tumble and take people’s hard-earned money with them. Historically, stocks offer an average return of around 10%, which is substantially more than the 1% to 2% you might be able to get with a money market or high-yield savings account. There’s risk involved with stocks and that’s why it’s smart to educate yourself (as you’re doing now) and to not all put all your extra money in one place.

Tip: Don't put all your eggs in one basket. Diversify your portfolio by investing in mutual funds and ETFs. A mutual fund pools money from many investors and typically invest in a range of companies. This helps to lower your risk if one company fails.

It’s also smart to be cautious. Start small. As it is, more than a third of Americans say they're spooked of investing in the stock market. Some people feel like it's gambling. It is gambling if you pick a random stock because it has an interesting sounding name and bet your dollars as if you would bet a running horse.

It's called investing when you do your homework and let your wisdom - rather than chance - make your choices for you. Investors who use a mix of smart spending and investing are the ones who get to retire by the sunset while their hips and joints are still working.

"INVESTING IS SIMPLE, BUT NOT EASY"

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Warren Buffett, pretty much considered the smartest investor ever, made this summation. It’s pretty simple to get started: You could already be investing in stocks through your 401(K) as many employers enroll employees automatically. And you can easily sign up to start investing on your own through an online stock broker from the comfort of a smartphone app.

The hard part is what you do next. If you have time to let your wealth build up, will you be patient when times get rough, or will you panic, pull out all your money and stuff it into your pillowcase? Will you get sucked into the hot stock of today (any of Silicon Valley’s social media darlings?) and put all your funds there, or will you diversify and come up with a risk strategy?

JUST WHAT ARE STOCKS ANYWAY?

Simply put, stock represents ownership in a particular company. The stocks we're talking about are for shares of publicly traded companies, and can be bought and sold on an exchange. Stocks can also be referred to as equities or securities; for our purposes, the terms are interchangeable.

There are two basic ways to make money by investing in stocks:

  • If you can sell stock for more than you purchased it
  • If the stock you own pays out dividends to shareholders

Related:

WHY INVEST MONEY IN STOCKS ANYWAY?

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  • You want to buy a house
  • You want to save for retirement
  • You want to save for your children's college education

Will Rogers once said that the fastest way to double your money was to fold it in half and put it in your back pocket. Safe advice to be sure, but not necessarily the best move if you're trying to build long-term wealth. Investing your money in the stock market certainly means taking on a higher degree of risk than stuffing dollars in your pocket, but it also paves the way towards bigger returns.

Tip: Generally speaking, investing in bonds is safer than stocks. If you are more interested in preserving your wealth, you may want to consider investing in bonds. If you are young and want to build long-term wealth, you should focus on investing in stocks. As a long-term investment, stocks generally outperform bonds but also have more risk.

From a general perspective, investing is a must if you want to build long-term wealth. Parking your money in a savings account or CD allows you to earn some interest, but the amount is usually paltry, especially when compared to the kind of returns the market offers over the long-term. If you want to enjoy a comfortable retirement or help your kids get through college debt-free, investing money in stocks in some form has historically been the best way to generate the kind of growth needed to reach long-term financial goals.

Tip: Instead of investing in bank CDs, you may want to consider buying dividend paying stocks.

HOW MUCH MONEY DO YOU NEED TO BUY STOCK?

While prices can fluctuate wildly from one day to the next, the average per share price for an individual stock hovers around $70, according to The Wall Street Journal. If that seems a bit pricey, keep in mind that there are stocks currently being traded at well over $500 a share.

Knowing how much money you've got to play with going in ultimately shapes your investment choices.

You can invest in the stock market with little money. Many investors start small.

Fortunately, some brokers don't require you to put in a minimum amount of money before you can start trading while some will expect you to invest at least $500 or even thousands before they’ll let you do anything. On top of what you put into your account, each trade can set you back between $4.95 (with a broker like TradeKing and OptionsHouse) to $9.99 (with a broker like ETrade and TD Ameritrade).

Look at it this way: Nothing you’ll be doing is guaranteed, so limit your investment to an amount that you'll be comfortable losing if the stocks you choose turn out to be duds.

Basics: HOW TO MAKE YOUR FIRST STOCK INVESTMENT

The next step is to map out your investment strategy. Here's a step-by-step breakdown of what buying your first stock involves.

1. ASSESS YOUR RISK COMFORT LEVEL

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You have to decide upfront how much risk you're willing to take on. If you're relatively young and you have years ahead of you to invest, you may be more comfortable with an aggressive approach (remember, higher risk can result in higher returns). On the other hand, if you're nearing retirement or you're generally jittery when it comes to the possibility of losing your hard-earned dollars, playing it safe might make more sense. For retirees and those near retirement, preservation of capital is important.

Young investors have time on their side. They can reinvest their dividends and survive the ups and downs of the stock market.

There’s always the chance that the stock you've chosen will lose value over time. That’s why it’s a good idea to balance things out by mixing up your portfolio to include less volatile investments like mutual funds or bonds.

Tip: Build an investment portfolio that matches your financial situation and tolerance for risk. Be mindful of your age, what your goals are, and your investment horizon. Revisit your portfolio on a regular basis.

2. CHOOSE A BROKERAGE

Before you can actually begin buying stocks, you'll need to enlist the help of a brokerage to seal the deal. Going with a full-service firm means you'll have expert advice on tap at all times, but that comes at a premium since the fees tend to be higher. Opting to use a discount brokerage instead ensures that more of your investment seed money is going towards the purchase of your stocks.

 TradeKingScottradeFidelity
Stock Trading
Options Trading
Mobile App
Commissions and Fees
Ease of Use
Online Community
Research
Trading Platform
Banking
Customer Service
Mutual Fund Trading

How to Make Your Choice:
There are a number of online brokers to choose from. You’ll need to take a look at their features, fees and convenience. Will you want to set up a retirement account like an IRA (you can get tax advantages with such an account) or a general brokerage account (which will result in you having to pay taxes on your earnings if you sell)?

Also be sure to pay attention to how much it will cost you to buy and sell stocks. Fees can run $5 to $10 per trade, depending on which brokerage you choose. If your strategy is to hold on to your investments over the long-term, paying the higher fee may not make much of a difference, but you'll want to look into cheaper options if you plan to trade stocks on a regular basis.

Learn which stockbroker is right for you. In some cases, paying a lower commission for trades means sacrificing some of the variety you'd get with a more expensive brokerage. E*TRADE, for example, charges $9.99 per trade plus an extra $45 for broker-assisted trades, but it also offers one of the broadest investment selections. By comparison, Scottrade charges slightly less, at $7 per trade, but feature-wise is less comprehensive.

Tip: You also want to choose a broker that's beginner friendly with a lot of educational resources. Some brokers such as Ameritrade and OptionsHouse allows you to dip your toe in the water first before taking that plunge with a virtual trading platform. Using a virtual trading platform, you can do paper trades to practice strategies and ideas. That way, you can ease into this new world by making mock trades before doing the real thing with your hard-earn dollars

3. DO YOUR HOMEWORK BEFORE DECIDING ON AN INVESTMENT

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There’s an art to investing, and you'll need to put in the time researching what's out there before settling on your choices. You’ll want to know who the rising stars in an industry are and where they seem to be headed. You could stick with only established brands, which are usually safer bets, but you’ll pay more for them. The value of a mature enterprise will tend to grow at a slower pace than a rising (i.e., riskier) newly public company.

Learn which companies to invest in. When researching individual companies, you need to understand the company's goals and how likely it is to make a profit based on its structure and operations. If you buy stock in a startup, for example, but the people running it don't have a solid plan for turning a profit, odds are you're not going to make any money either.

Also take a look at how much debt a particular company is carrying. The more that a company borrows, the more it has to pay back with interest, which can affect the stability of its per-share stock prices.

Tip: If you don’t have time to focus on any one company, you could put your money toward a mutual fund or ETF (exchange-traded fund). Index ETFs are very popular choices. Whatever you do, do not put all your money in one place. Diversifying where you park your money will help you avoid losing your shirt if one industry falters suddenly.

Popular places to keep tabs on stock news:

Tip: Investment magazines are a great way to keep up to date with the latest market news and trends. Kiplinger wins our title of Best All Around Magazine; each issue contains a lot of tips and recommendations for making wise investments, as well as for basic personal finance. Our other top picks include Bloomberg BusinessWeek, which is a must-read for staying on top of breaking financial news, and Barron's, which is entirely focused on financial markets analysis.

DON'T FOCUS SOLELY ON PRICE

There's a lot more to a stock than its price.

Tip: There are two common approaches to selecting stocks. Growth investors want stocks that offer earnings growth potential. Growth stocks are generally more expensive. While value investors want stocks that are undervalued. Both growth investing and value investing have their pros and cons. You may want to consider having both growth and value stocks in your portfolio.

For some, checking out the price to earnings ratio is might be better way of gauging a stock's worth. This is the price of a stock divided by its average earnings per share over the past year. The P/E ratio is used to measure a stock's projected growth; the higher it is, the more earnings the company is expected to realize. Looking at the company's previous rate of growth and the stock's pricing history can give you an idea of whether it's priced fairly based on the P/E ratio. You can also take it a step further by comparing ratios for different companies within the same industry. The key is to weigh a specific stock's potential for growth against its per share price to determine whether the investment is really worth it.

FINAL WORD

Buying your first stock can be hit-or-miss if you haven't done your research beforehand.

Understand how the market works before making your first trade, and you'll be setting the tone for success.

Rebecca Lake is a journalist at CreditDonkey, a stock broker comparison and financial education website. Write to Rebecca Lake at rebecca@creditdonkey.com. Our data-driven analysis has been recognized by major news outlets across the country and has helped investors make savvy financial and lifestyle decisions. (read more)

Disclaimer: Opinions expressed here are those of the author's alone. Please support CreditDonkey on our mission to help you make savvy financial decisions. Our free online service is made possible through financial relationships with some of the products and services mentioned on this site. We may receive compensation if you shop through links in our content.

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How to Build Wealth in Your 20s


Why You Should Invest in Stocks


10 Smart Ways to Save $1,000 a Month

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