stock basics for new investors

Easy Stock Basics to Master Before You Invest

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These stock basics will get you started investing and keep you from the worst investing mistakes

With more than a decade in investment analysis, it can be easy to lose sight of investing basics. Even newer investors can quickly lose focus on the real purpose of stock investing against the constant flow of tips and analysis on TV and online.

Sometimes it can be just as important to step back and relearn stock basics and how they fit in your overall financial plan.

It’s these same investing basics you learned to start investing that everyone needs to come back to every so often, the basics that will account for 90% of your success and help you avoid some of the worst mistakes.

For new investors, this article will be an introduction into stock basics and how to get started investing. For experienced investors, it could be a very important wake-up on the bad habits you’ve learned over the years.

What’s a Stock?

Since the first stock certificate was issued for the Dutch East India Company in 1606, stocks have been a favorite investment vehicle.

what is a stock certificate
What is a Stock Certificate

Stocks, also called equity investments, are an ownership share in a company. If a company issues 100 shares, then each share represents 1% of the present value and future cash flows in the enterprise.

If the company decides to return excess cash to investors, stockholders get a proportionate share of the dividends. If another company purchases the firm, investors get either stock in the acquiring company or a portion of the cash price paid.

A company can issue new stock at several points in its operational life.

  • When it incorporates, shares are issued to founders and other early investors
  • When the company begins trading on public markets like the New York Stock Exchange
  • Companies can also issue new shares of stock to fund projects or other costs

Conversely, a company can also repurchase its own shares from investors when it has cash that isn’t needed for dividends or growth projects.

What are the Advantages of Stock Investing over other Investments?

Stocks aren’t the only investments available for your hard-earned buck and, in fact, might not be the best depending on your investing needs. Stocks do hold several advantages against other investments.

Stocks versus bond investments

  • Bonds are debt issued by companies, a commitment to pay the money back plus interest. Investors don’t get the upside return potential that comes with stocks, only the fixed interest payment.
  • Stock investing is generally cheaper than bond investing with some online brokers charging just $5 a trade. You can buy bond funds as cheaply as stocks but fees are higher to buy individual bonds.
  • Stocks provide a hedge against inflation since companies can raise prices and the higher revenue flows through to the share price. Bond prices fall when inflation rises because investors have less purchasing power on their fixed bond payments.

Stocks versus real estate investing

  • Real estate prices generally come under pressure when interest rates rise. Higher rates might cool demand for real estate loans as well as make highly-leveraged properties more expensive to operate. Higher interest rates generally come during periods of economic growth, so stocks do well as companies grow.
  • Stocks are much more liquid than real estate, meaning you can buy and sell shares quickly when you need cash. It can take months to sell an investment property and selling costs easily reach into the thousands of dollars.
  • Buying stocks as an investment is accessible to nearly everyone with low minimums on most online accounts. This isn’t the case with real estate investing which can cost tens of thousands just for a down payment.

There are also risks to investing in stocks, which we’ll cover in the next section, but I don’t want you to get the impression that it is an either-or decision. You should absolutely buy stocks, bonds and real estate as a well-rounded investment strategy.

Investing in all three asset classes will mean benefiting from the advantages in each even as the disadvantages are smoothed out. When stocks tumble, your bond and real estate investments will keep your portfolio growing. When inflation increases and bond prices sink, your investments in stocks and real estate should do relatively well.

What are the Risks in Stock Investing?

Anyone investing over the last decade understands the risks to stock investing all too well.

Stocks in the S&P 500 fell in 2008 and 2015 with shares crumbling 40% in the former, and stocks still had three months to fall by the end of the year.

stock basics for new investorsStocks represent an ownership share in the future cash flow of a company. When it looks like those cash flows might slow or stop altogether, stock prices plunge and you could lose your entire investment.

While a bankruptcy will also hit bond investors, the company has an obligation to pay the bonds first from whatever money is left. Bond investors are also guaranteed a fixed payment during the life of the bonds while a stock return is never guaranteed.

One of the biggest risks in stock investing is the regular rise and fall of investor enthusiasm. As stock prices rise, more money flows into the markets and everyone expects the good times to last forever.

Investor expectations for higher prices push shares above a reasonable value for the company on which the stock’s value is based. It’s easy to get swept up in the frenzy, paying exorbitant prices for basically the same company compared to what investors were paying just a few months ago.

Eventually, investors start to question the value in stocks and enthusiasm takes a sharp drop lower. Suddenly nobody is willing to pay the same price for shares and you can only find a buyer for your stocks by taking a steep discount to the previous price.

That’s when stocks crash and the markets wonder where it all went wrong.

Because investing will always be prone to emotions of investors, this will always be one of the biggest risks in stocks.

How do You Make Money on Stocks?

If stocks are prone to frenzied buying and abrupt crashes, how do you make money?

It’s actually very simple to make money in stocks if you get back to the basics.

Publicly-traded stocks are listed on market exchanges like the NYSE or Nasdaq. Stock brokers pay to have access to the exchanges to make buy and sell orders for their clients, everyone from large institutional investors to individual investors.

When you place an order to buy shares of a company through an online investing account or with an advisor, that order is going through a broker who will find a seller for the shares.

In every stock trade, there is always a buyer and a seller.

That’s an important point and it goes to the very heart of how you make money in stocks. To make money selling a stock you own, someone else must be willing to pay a higher price.

Billions are spent every year trying to find strategies to predict if another investor will be willing to buy that stock from you. Most of these strategies are bunk but there is one guaranteed way to make money in stocks…

Hold the shares until the company is worth more than the price you paid!

It’s almost too simple. Stocks are ownership in a company’s value. Investor enthusiasm and expectations will rise and fall, taking stock prices higher and lower, but that intrinsic value of a company will eventually head higher.

Invest regularly and there will come a time when you are buying stocks at the very peak of a bull market. Stock prices will start to collapse and you’ll wonder if they will every rise again.

Just as the economy will eventually recover from a recession, companies will eventually start making higher profits. That means the company’s value will recover and stock prices will rise once again.

To make money in stocks, all you have to do is hold those stocks until the company’s value increases beyond what you paid for the shares.

It’s the only fool-proof, guaranteed way to make money in the stock market.

How to Invest in Stocks to Meet Your Financial Goals

Despite what you see on TV, investing isn’t about picking stocks. It’s about making your money work for you to meet your financial goals.

That means you can’t start investing until you know what those goals are and do an inventory of where your finances are right now.

Start with finding out how much you have and how much you need to meet your goals.

  • Visualize your goals, how much they will cost and how much you can invest on a regular basis
  • Use a risk tolerance worksheet to find how comfortable you are with the ups and downs of stocks and how much to invest in different assets
  • Develop a personal investment policy from your risk tolerance and the return needed to meet your financial goals

Your personal investment policy is going to show you what annual return you’ll need to meet your goals, given how much you can deposit on a regular basis.

For most investors, meeting your goals comes down to two simple ideas.

First, invest regularly. Investing is just as much about the money you put it as it is about earning money through returns. Investing even small amounts every month can grow to hundreds of thousands over several decades.

Investing just $100 a month grows to over $170,000 over 30 years versus a value of just $76,000 on an initial $10,000 investment.

how to invest in stocks

Second, reduce the risk in your portfolio with diversification. This means investing in different assets like stocks, bonds and real estate. It also means buying different types of investments within each asset, buying stocks of companies in different sectors and industries.

By diversifying into different stocks, you reduce the risk around any specific company or sector of the economy. If just a percent of your total portfolio is invested in a company, you don’t have to worry too much whether that company’s value will surge higher or plunge lower. Your total portfolio value will rise more gradually along with the general stock market.

How do I Buy a Stock?

The easiest way to buy stocks is to open an account with an online investment platform like Ally Invest or TD Ameritrade. These investing websites offer an all-in-one solution to understanding your investing needs, researching investments and buying stocks. Best yet, you can buy stocks on these discount investing websites for less than $10 a trade.

In fact, online investing sites almost make it too easy to buy stocks. The ability to buy or sell with the click of a mouse tricks many investors into bad investor behaviors and short-term trading. This isn’t investing rather gambling that you can make a quick buck on stocks.

We’ll cover how to buy a stock online but remember that long-term investing is about buying a piece of companies that will be around for decades. Resist the urge to sell for a quick profit, even if other investors reason the company or market may be in trouble, to benefit from that long-term upside to stocks.

Once you’ve decided to buy a stock, the process is fairly simple.

  • Search for the company on your investing platform, most will display a ‘buy’ button to invest
  • Change your ‘order type’ to buy
  • Divide the amount you want to invest by the share price to find the quantity of shares you want to buy
  • Decide which price order you want to place.
    • A ‘market’ order will buy the stock immediately at the price available. For most stocks, this will be very close to the current price.
    • A ‘limit’ order requires you to put in a price at which you will pay for the shares. Your order isn’t guaranteed to be processed but you will only pay that price or less.
buy stocks online order screen
Example How to Buy Stocks Online

For most stocks, a market order is fine because there is enough buying and selling demand in the shares that orders are made quickly and at prices very close to the current price.

Stocks of smaller companies may not have as many willing investors so the price at which someone is willing to sell you the shares might be quite a bit higher than the last price paid. This is when a limit order might be necessary, to force sellers to come to your price rather than you paying more for the stock.

Most Common Questions about Stock Basics

I get a lot of questions about investing from the blog as well as clients. While some of these questions are about which stocks to buy or the direction of the markets, the most common are the basics about investing.

Is it better to pay off debt before starting investing?

It’s important to pay off high-interest debt before investing. It does no good to make 7% returns on stocks while paying 20% interest on your credit cards and personal loans.

But don’t wait to pay off all debt before you start investing. Too many people do this and find themselves heading into retirement never having started investing. Even if you can only invest $50 a month while you prioritize paying down debt, getting started will make sure you don’t procrastinate too long.

How do I start investing?

When someone asks, “How do I start Investing?” what they usually mean is, “What should I buy to get started?”

Getting started investing is easy. Opening an account with an online platform takes less than five minutes. In fact, most online sites will offer specials for new investors like this $600 cash bonus on TD Ameritrade.

In which stocks you should invest goes back to your asset allocation and investing needs. Most investors are best off buying exchange traded funds (ETFs) which hold hundreds of stocks in a group. ETFs give you the ability to instantly diversify your portfolio across sectors, themes and even whole asset classes with one investment.

Some ETFs to take a look at for your first portfolio:

  • SPDR S&P 500 (SPY) – This fund holds 500 of the largest companies in America and is the most popular measure of the overall stock market. If it’s true that you can’t beat the market then this is the best way to invest in the market.
  • iShares MSCI Emerging Markets (EEM) – This fund invests in 848 stocks of companies based in fast-growing countries like China, India, Brazil and Russia. The investments are riskier than the U.S. market but should provide a higher return over the long-run and really help lower your risk compared to a portfolio of just domestic stocks.
  • Vanguard REIT ETF (VNQ) – This fund invests in 150 companies that own real estate and pays a very high 4.2% dividend. Each company invests in hundreds of properties so the entire fund gives you diversification through a huge range of property types and across the United States.

Are stocks too risky?

Any single stock is too risky if that’s all you buy. Even the largest companies can fall on hard times and run the risk of bankruptcy.

A portfolio of more than 20 stocks are not risky at all if you diversify across different sectors of the economy. Some individual stocks may rise and fall but the entire group will see its value increase gradually over time.

How is retirement investing different?

Since retirement will be one of your biggest financial goals, most of your investing will probably revolve around that goal. This means investing in stocks according to that long-term goal and depending on how long you have to retirement.

Investors get a special tax break for investing in retirement plans and it’s the best decision you’ll ever make. Max out your retirement plan contributions every year for an instant tax deduction and tax-deferred growth.

How often should I check my stocks?

Checking your stocks too often is one of the biggest causes of bad investing behaviors. Investors fixate on short-term price moves and get worried that their investments won’t meet long-term goals.

In reality, there’s nothing wrong with just buying new shares of your stocks every few months and only really checking the performance maybe once a year. Check your stocks towards the end of the year to manage your taxes through tax-loss harvesting.

How do I know when to sell a stock?

The easy answer here is…never. Stock prices rise and fall almost immediately in response to news about the company’s prospects so it does no good to jump online to sell after new developments come out. Invest in companies that you can hold for decades.

There are two situations where you may want to decide to sell a stock

  • You need to start selling investments to meet your goals as in retirement or buying a home
  • Management has taken the company in a new direction that changes its business model and the reasons you invested in the shares

These stock basics may seem overly simplified for experienced investors but keeping to these simple ideas will help you avoid the worst investing mistakes. Too many investors overcomplicate stock investing when these basics are really all you’ll ever need to meet your goals. Keep these stock market ideas in mind whenever you change your investing approach and always remember your long-term goals.

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