How to Invest in Stocks for Beginners
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The U.S. equity markets are the largest in the world, representing 42% of the $125 trillion global equity market cap, according to the Securities Industry and Financial Markets Association (SIFMA).
Stock market investing is not rocket science, and being the Wolf of Wall Street or possessing vast swathes of capital are not prerequisites to begin investing (for the record, Jordan Belfort spent about two years in prison for stock-market manipulation). Investing in stocks has become more accessible thanks to technology, and with a little bit of effort and homework, anyone can start buying stocks.
Stocks are considered a safe investment if you have a long investment horizon. Still, there are a few things to consider before purchasing your first stock, like your risk tolerance (how much money you're willing to potentially lose), how much capital you can commit (spoiler: you don't need a lot) and your goal, to name a few.
Related: Best Stocks to Buy for Beginners
Jump To
What is a stock
A stock is a small piece of a company that is usually referred to as a share. Think of buying a stock as owning a part (or a "share") in a company. The more shares you purchase, the higher your ownership in that company goes. Companies issue shares all the time to raise money to fund their expansion or to function efficiently. Stocks are mostly bought and sold on exchanges like the New York Stock Exchange and the Nasdaq and comprise a large part of most individuals' investment portfolios.
Common stock and preferred stock are the two most common types of stock. The former entitles the holder to vote at meetings and receive dividends. While the latter does not have voting rights, preferred shareholders take precedence when it comes to dividend payments and is prioritized if a company is liquidated.
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How to start investing
Goals
The first order of business is figuring out the why. Why are you going to start investing? Is it to finance a big purchase like a house or a car? Or perhaps it's meant to be your nest egg for retirement? Answering these questions will dictate how much money you'll invest and how much of an aggressive approach you'll take to meet your investment goals. For example, if you're looking to retire early, you will skew your investment to stocks that deliver high returns.
Budget
Now that you know the why, it's time to decide how much money you can commit. As a rule of thumb, don't invest money you'll need in the short term. Take into consideration include your current after-tax income, your monthly expenses, overall debt, your investment horizon, and risk tolerance. A longer investment horizon allows you to ride market volatility.
Contrary to widely held belief, you do not need much money to begin investing in stocks, and costs are at an all-time low. and Fidelity, for example, offer zero-commission accounts. Don't have money for a full share? Robinhood allows you to invest in fractional shares and requires no minimum investment.
What to invest in
Before buying, you should research a stock to ensure it will be a sound investment. The regulatory filings companies make with the Securities and Exchange Commission are a good place to start. You should be on the lookout for the company's profitability, its earnings growth potential, and industry performance versus peers, to name a few.
Anyone new to the market should stick to blue-chips, well-established and stable corporations, and dividend-yielding companies. Dividends are essentially a company sharing its wealth with investors, providing a consistent source of income on top of any appreciation in the share price.
Choosing your broker
There are several ways you can go about investing in stocks. Are you a DIY investor or would you like an independent portfolio manager?
In the do-it-yourself approach, you can utilize the services of robo-advisers, which use algorithms to make trades depending on your input. Robo-advisers like Betterment and Wealthfront have exploded in popularity recently, thanks to low costs and consistent returns. This is a very inexpensive way to invest, but there will not be a live human to answer any queries or provide guidance.
Alternatively, you could open an online brokerage account. This puts you in the driver's seat as you will be responsible for all aspects of your trades like researching the stocks and executing trades. This option is best suited to individuals who know how the markets operate.
A human money manager not only executes trades on your behalf but also provides investment advice. And because they don't have sale quotas, the advice will likely be in your best interests. However, some money managers only accept high-net-worth individuals, while others will also take on beginners.
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Investing methods
Growth stocks
This stock investing method involves buying shares in young or small companies offering above-average profit potential. These companies exhibit continuous and robust bottom-line growth, outpacing competitors with innovative products and price offerings. Growth stocks generally tend to have a higher price-to-earnings ratio, but given their future trajectory, investors are often willing to pick them up at a premium.
Dividend stocks
This investment strategy entails buying shares of companies that pay dividends, providing an income stream on top of any increase in the stock price. Dividend stocks provide steady returns and are a good choice if you're saving for retirement. A word of caution: dividends are never guaranteed, and companies can decide to stop paying dividends at will.
Related: What is Dividend Growth Investing
Small-cap investing
A company whose market capitalization is between $300 million and $2 billion is considered a small-cap stock. These companies offer high-growth potential and are best suited for investors willing to take risks for higher gains. Small-cap companies experience higher volatility and are likelier to fail in an economic recession.
ESG investing
Environmental, social and governance (ESG) factors have focused over the past few years, and many investors consider these trends before investing in a company. There are several ESG research companies, and each has its methodology of assessing a company. These companies are then assigned a score, which many investors factor into their decision-making process.
Fractional investing
This investment method allows you to start investing with limited capital. Fractional investing means buying partial shares of a company's stock. So instead of one full share, you own a portion of it. This allows you to invest in stocks you couldn't otherwise afford. For example, one Amazon share is about $3,000 right now, but you can buy $1,000 worth of shares by utilizing companies like Robinhood and Fidelity.
Value investing
Buying stocks trading at a significant discount to their intrinsic value is called value investing; it's basically purchasing stocks flying under the market's radar. This method requires a lot of research into a particular stock and is best suited for investors with a long-term investment horizon. Value investors are always on the hunt for these stocks over beliefs that movement in a company's stock price does not reflect its long-term fundamentals.
Things to avoid
Panic selling
Market volatility is a certainty in the stock market, and many investors offload stocks during a downturn. Looking at stock markets flashing red without context can lead to bad decisions, but stocks always bounce back in the long run.
Following the herd
Remember the GameStop saga in 2021? Chasing the herd and buying hot stocks without a fundamental value is a common mistake. Always conduct due diligence before buying a stock. It's best to keep emotions out of investing, and investment decisions should not be rushed. In addition, social media is also flush with misinformation about investing.
Not diversifying
Putting all your eggs in one basket can lead to disastrous consequences. A diversified portfolio of multiple stocks protects you against volatility and wild price fluctuations. Having a basket of different stocks is a way to avoid exposure to any one investment when it goes sour.
Buying the dip
This may sound like bad investment advice. "Be fearful when others are greedy, and greedy when others are fearful," attributed to Warren Buffett. A stock seeing price decline is considered a good entry point, but before you put money to work, do some digging on what's causing the price to slide. Is it something temporary, or is the company facing long-term challenges? These questions will help you make sound decisions.
Using borrowed money
Trading using margin i.e., money borrowed from a brokerage, can result in high rewards and significantly amplify your losses. It carries hefty costs, and you'll have to put up collateral. In case the value of the collateral falls, you'll be immediately required to bring it back up to the required level. Failure to do so may cause the broker to liquidate your position.
Lacking a goal
Having an endgame in sight dictates your strategy. Investing in stocks shouldn't be the goal, but it should serve as a means to meet your goal. Know why you're investing and what you plan to get out of it. This allows you to deploy the best tools to meet your objectives.
Pros and cons
Pros
- You can start investing with very little money.
- You don't need to be a pro at investing thanks to robo advisers that do all the heavy lifting.
- Dividends can provide a steady stream of income.
Cons
- It's easy to get caught up in market volatility.
- Building wealth through stocks takes years which may not suit everyone.
- Researching a stock is time consuming.
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FAQs
Do I need a lot of money to begin buying stocks?
Even if you have a few hundred dollars to spare, there are services that allow you to begin buying stocks at zero commissions.
I'm not very experienced, who should I choose as a broker?
It's best to choose a robo-adviser. These are computer algorithms that make trades automatically based on your inputs. They're also cheap compared to human advisers. You can't turn to a robo adviser for investment advice, however.
Do I have to buy a company's whole share?
No, there are platforms that allow you to buy fractional shares in a company, such as Robinhood.
The bottom line
If you're looking to break into stock investing, it may come off as a daunting task, especially for new investors, and there's a general belief that it requires a large amount of capital. However, the rise of robo-advisers and zero-commission online brokerage accounts have changed the investing landscape, allowing anyone with a few hundred dollars to vie for a slice of the $52 trillion U.S. equities markets.
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Writer
Jasir Jawaid is Joy Wallet's Assistant Editor. He has more than 13 years of experience as a journalist covering Wall Street, equities, financial policy and regulation, and cryptocurrency and blockchain.
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