An easy guide for how to start investing and reach your financial goals with stock market basics
Beyond the stock market basics we’ll cover below, one of the most important ideas in investing is just to start early! I know it’s not always easy to put money aside after all the bills are paid. I’ve been there, living paycheck-to-paycheck. That only makes it even more important to start investing now.
The reason is called compound interest but it’s just an investing term for making money off your money. Even if you’re only able to invest $50 a month, you’ll be earning dividends on that money and then dividends off your dividends for decades if you start early enough. Invest just $50 a month starting in your 20s and you’ll have over $180,000 by the time you get ready to retire. Wait until you’re 30 years old to start investing and you’ll have less than half the amount on which to retire.
Stock Market Basics #1: Start Investing NOW…like right now, I’ll wait.
I am a big believer of paying off debt, especially high-interest cards, but please don’t wait until you are totally debt-free to start investing. This is one of the most frequent questions I receive, whether someone should wait to start investing until after they pay off all their debt.
The problem is that shopping is way too much fun! With a little control, you can pay off the bad debt and high-interest stuff but you might never be completely debt free. And that’s not necessarily a bad thing. With interest rates on home mortgages as low as 4%, there’s nothing wrong with holding some mortgage debt and using the rest of your money to invest and make returns of 6% or higher.
I’ve seen too many people focus solely on paying off debt. By the time they reach retirement, they still have some debt and absolutely no investments on which to retire.
Stock Market Basics #2: Investing is about YOUR goals not about picking stocks
Understand that 90% of the investing advice you’re going to hear on TV and the internet is not there to make you money. The entertainment industry has perverted investing into something that does more harm than good for most people.
Most investing advice is now about getting you to come back, day after day, to the television program or internet site. Why? Your attention is worth billions in advertising and content producers will do anything to keep you coming back. If that means pitching high-flying stocks and get-rich dreams, then that’s what they’ll do…even if it loses you money over the long-run.
Real stock market basics and real investing begins with making investing about you. Successful investing is about understanding your financial goals, your risk tolerance and which types of investments are best for your plan.
This all starts with creating a personal investment plan, laying out your goals and what it’s going to take to get there. Your personal investment plan will map out your path to your goals by understanding the amount of risk you need to take along with the necessary amount of stocks, bonds and other investing assets.
Stock Market Basics #3: Play the Stock Market Game by Your Rules
This is one of my favorite rules to stock market basics because it goes against so much of what we learn from the media and from other investors. ‘Beat the market’ is the mantra from Wall Street to Main Street. From professional advisors and money managers all the way down to kitchen-table investors, the goal is to beat the stock market by trading in and out of investments.
This sets investing up as a professional’s game, where everyone is chasing higher returns through the riskiest investments. You have to continuously bet big and find stocks poised for big moves.
Turns out that most people end up losing this professional’s game. The average investor earned just 2.6% annually in the decade to 2013, well under the stock market return over 7% and returns of almost 5% in the bond market. Investors end up jumping into stocks with the rest of the bandwagon and then panic-selling for a loss when everyone starts selling at once.
The only way to win the stock market game is to play by your rules and to play like an amateur. Think of investing like a game of tennis. You can try for the ace and return the ball as hard as you can but if you aren’t Roger Federer or Serena Williams, you’re likely just going to be chasing the ball as it goes out of bounds. The way to win the amateur game in tennis is to make fewer mistakes, carefully returning the ball and letting your opponent foul.
Winning the stock market game is about not making mistakes. It isn’t about taking big risks but about making calculated decisions to grow your money over time. This means not investing on margin, diversifying your portfolio across different assets and stocks and investing for the long-term.
Stock Market Basics #4: Don’t just talk about diversification
Diversification is something everyone talks about in investing but something that few people actually do correctly. It’s the biggest factor in poor investor returns and is your best chance at meeting your long-term goals.
Diversification is about holding a mix of different asset classes and a mix of different investments within each asset classes. Asset classes are the broadest definition of investments, groups that share economic drivers. All bonds are affected similarly by interest rates and inflation. Stocks as a group are affected by economic growth and investor enthusiasm.
The idea is that; if you hold a good mix of stocks, bonds and other asset classes, then your overall wealth won’t take a nosedive when one particular asset class crashes. Holding bonds means your portfolio won’t be destroyed in the next stock market crash. Holding stocks means you’ll be able to benefit from long-term economic growth and won’t see your returns crushed by inflation.
We’ll spend most of our time on three asset classes; stocks, bonds and real estate. These are the must-have investments and a critical part of investing basics. We’ll also cover some of the alternative assets like private equity and hedge funds along with a few up-and-comers like peer loans and crowdfunding investments.
One of the newest online investing sites, Motif Investing, offers a new twist on diversification. The site lets you group up to 30 stocks and funds together and then buy them all with just one commission. I’ve created four funds from my favorite stocks and bonds on Motif. I get instant diversification and save hundreds each time I want to invest.
Stocks are the growth asset in your investing strategy. As an ownership claim on the company, you benefit from long-term profit growth. Within stocks, the return potential ranges from stable growth on utility companies to big gambles on start-up tech companies.
Stocks also offer good protection against inflation, since most companies can increase their prices along with general increases in prices. This isn’t the case with bond investments where inflation constantly eats away at your return until that semi-annual payment just doesn’t buy as much as it did ten years ago.
Is there any question about the risk in stocks as an asset class? Ask any investor what comes to mind when you say 1987, 2000 and 2008 then offer them a tissue for their tears. A decade of stock returns can be wiped out in an instant and you absolutely must have some bonds and real estate in your portfolio when the market crashes.
Bonds are debt issued by a government or company and generally paid off over one year to 30 years. You receive equal payments twice a year and then the face value of the bonds when the debt comes due. This makes for very stable returns and cash flow on which many retirees depend on for living expenses.
That stable stream of cash flow is also the problem for bonds. If inflation heats up, those regular payments start buying less stuff. When interest rates on other investments and stock returns increase, the fixed-return on bonds starts looking less attractive and prices fall.
Real estate got a bad name with many investors during the 2008 crash but it’s one of the safest long-term investments you can make. Real estate offers the benefit of strong cash flow on rents as well as price returns on the property value. Since it’s a ‘real’ asset, as opposed to a financial asset like stocks and bonds, real estate prices generally increase at least with the rate of inflation.
The downside to real estate investing is that it can be difficult to get the diversification you need in direct ownership. It’s expensive to buy property yourself and you’d have to buy real estate in many property types and locations to guard against a crash in any particular market. Investing in real estate investment trusts (REITs) is a great way to get indirect exposure to real estate but prices tend to be more volatile than direct ownership.
Stock Market Basics #5: Don’t supersize your stock portfolio
Just about any broker or online stock investing platform will allow you to borrow money to invest. This is called investing on margin. There are rules set by the Securities & Exchange Commission that allow investors to borrow up to 50% of the money to buy a stock. That means you can invest $15,000 even if you only have $10,000 in your account.
If you buy that $15,000 in stock and the price goes up 10% then you’ve made $1,500 on the investment. That amounts to a 15% gain on your $10,000 in actual money in your account!
Sounds like a great idea but so many investors have been bankrupted because they didn’t understand the downside
What happens when that stock falls 10% instead of increasing? You just lost $1,500 for a 15% loss on your money. What happens when the stock price tumbles in a stock market selloff? The Dow Jones fell nearly 23% on a single day in 1987 but someone playing with margin would have lost more than 34% of their investments.
Not only does margin amplify your losses but the money isn’t free either. Your online stock platform is going to be charging an interest rate as high as 10% on the borrowed money, making it extremely difficult to earn anything extra after fees are paid.
Investing with margin is just a losing game, pure and simple. You’ll be tempted to borrow more and buy more stock as market enthusiasm builds only to see your losses pile up when investors rush for the exits.
Stock Market Basics #6: Don’t be afraid to leave home
As I write this towards the end of 2015, stocks of international and emerging market companies have been blasted. The iShares MSCI Emerging Markets Fund (NYSE: EEM) has lost a third of its value since July 2014 as the price of oil crumbles and the surging U.S. dollar causes problems for developing countries.
But it’s a scenario that has happened many times before over the last two decades. Investors have a home-bias to stocks of U.S. companies and freak out at the first sign of trouble in emerging markets. Everyone sells out at the same time and foreign stock prices crash.
But just as the last of the near-sighted investors are selling out of their emerging market stocks, the prices start to rebound. Companies in developing countries benefit from faster economic growth and long-term trends compared to their U.S. and European peers. Adding emerging market stocks to your portfolio, especially when everyone else is selling, gives you the long-term advantage in one of the most neglected stock market basics.
The days of parking your money in American companies and enjoying a stable long-term return are over. The national debt of the U.S. is now larger than the economy and some would wonder if the financial system ever fully recovered from the 2008 collapse of the banking system. Not only will stocks of foreign companies offer extra growth over the long-term, differing economic cycles means your portfolio won’t tumble during the next U.S. recession.
Stock Market Basics #7: Investing is about what you put in
Think of your investments as a savings account, one with a really great interest rate on your deposits. While most people fixate on getting the highest return possible, investing is just as much about what you put in the account.
In fact, it’s not until after about 20 years that your investing gains will be more than your regular deposits. You’ll end up making good money on your investments if you follow the stock market basics but you’ll only make money on the money that you deposit into the account.
Related to the savings account idea is the investing rule that you should never take money out of your account except to meet your long-term financial goals. I see constantly posts on social media asking if someone should take money out of their investments to pay off debt or for a new car.
While it’s important to manage your debt and you should enjoy your money, withdrawing from your investments sets yourself up to miss your longer-term goals. Do it once and you’ll make a habit of withdrawing money from investments whenever something comes up. You’ll never get the chance to make money off your money.
Make debt payments a part of your path to financial freedom but don’t wait to start investing and don’t withdraw your investments unless it’s an emergency or to meet your financial goals.
Stock Market Basics #8: Get the free money
The easiest money you’ll ever make in investments is the free money you get from your employer and from the government.
If your employer offers a company match on a 401k program, contribute at least to the maximum amount for the match. It’s free money and you’ll be earning a return off it immediately! Even if your employer is only offering a 25% match on your contributions, that’s a 25% return on your money. The long-term return on stocks is around 7% a year so that 25% immediate return is something you do not want to pass up.
Another source of free money is just maxing out your 401K or IRA contributions every year. The money you invest in these retirement accounts comes off your income so you don’t pay income taxes. That’s an immediate return of 10% to 40% depending on your tax bracket. You also won’t have to pay taxes on your investing gains in retirement accounts until you withdraw the money. Both those benefits add up to huge savings.
Most online investing platforms like will even give you free money to open an IRA account. For example, Click through the link here and you can get a $150 cash bonus from Motif Investing.
Those savings could add up to more than $400,000 over 30 years with a modest return and contributing just 6% of your income.
Yeah it sucks that you can’t withdraw money from your retirement accounts until you’re almost 60 years old but you need to save for retirement anyway. The fact that you can’t withdraw money from retirement accounts without a harsh penalty is actually a great thing for many investors. It keeps them from making bad decisions and spending their investment money before it has the chance to grow.
Think that’s all the free money the government is offering on your retirement investments? Think again! If your income is below a certain point, you’ll qualify for what’s called the Saver’s Credit. You’ll get an additional tax credit for money you put into a retirement account.
There’s more to the blog than just these eight stock market basics but these are the rules that I invest by and a lot of what we’ll talk about will come back to these basic ideas. If you remember just one thing from the blog, remember these stock market basics each time you buy or consider selling an investment.