How to Invest in Stocks: A Beginner’s Guide
Investing is a way to set aside money while you are busy with life and have that money work for you so that you can fully reap the rewards of your labor in the future. Investing is a means to a happier ending. Legendary investor Warren Buffett defines investing as “the process of laying out money now in the expectation of receiving more money in the future.” The goal of investing is to put your money to work in one or more types of investment vehicles in the hopes of growing your money over time.
Let’s say that you have $1,000 set aside and are ready to enter the world of investing. Or maybe you only have an extra $10 a week and you’d like to get into investing. In this article, we’ll walk you through getting started as an investor and show you how to maximize your returns while minimizing your costs.
- Investing is defined as the act of committing money or capital to an endeavor with the expectation of obtaining an additional income or profit.
- Unlike consuming, investing earmarks money for the future, hoping that it will grow over time.
- However, investing also comes with the risk of losses.
- Investing in the stock market is the most common way for beginners to gain investment experience.
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What Kind of Investor Are You?
Before you commit your money, you need to answer this question: What kind of investor am I? When opening a brokerage account, an online broker such as Charles Schwab or Fidelity will ask you about your investment goals and what level of risk you’re willing to take.
Some investors want to take an active hand in managing their money’s growth, while others prefer to “set it and forget it.” More traditional online brokers, like the two mentioned above, allow you to invest in stocks, bonds, exchange-traded funds (ETFs), index funds, and mutual funds.
Brokers are either full-service or discount. Full-service brokers, as the name implies, give the full range of traditional brokerage services, including financial advice for retirement, healthcare, and everything related to money. They usually only deal with higher-net-worth clients and can charge substantial fees, including a percentage of your transactions, a percentage of your assets that they manage, and sometimes, a yearly membership fee. It’s common to see minimum account sizes of $25,000 and up at full-service brokerages. Still, traditional brokers justify their high fees by giving advice detailed to your needs.
Discount brokers used to be the exception but are now the norm. Discount online brokers give you tools to select and place your own transactions, and many of them also offer a set-it-and-forget-it robo-advisory service. As the space of financial services has progressed in the 21st century, online brokers have added more features, including educational materials on their sites and mobile apps.
In addition, although there are a number of discount brokers with no (or very low) minimum deposit restrictions, you may be faced with other restrictions, and certain fees are charged to accounts that don’t have a minimum deposit. This is something that an investor should take into account if they want to invest in stocks.
After the 2008 financial crisis, a new breed of investment advisor was born: the robo-advisor. Jon Stein and Eli Broverman of Betterment are often credited as the first in the space. Their mission was to use technology to lower costs for investors and streamline investment advice.
Since Betterment launched, other robo-first companies have been founded, and even established online brokers like Charles Schwab have added robo-like advisory services. According to a report by Charles Schwab, 58% of Americans say they will use some sort of robo advice by 2025. If you want an algorithm to make investment decisions for you, including tax-loss harvesting and rebalancing, then a robo-advisor may be for you. Also, as the success of index investing has shown, you might do better with a robo-advisor if your goal is long-term wealth building.
Investing Through Your Employer
If you’re on a tight budget, try to invest just 1% of your salary into the retirement plan available to you at work. The truth is you probably won’t even miss a contribution that small.
Work-based retirement plans deduct your contributions from your paycheck before taxes are calculated, which will make the contribution even less painful. When you’re comfortable with a 1% contribution, maybe you can increase it as you get annual raises. You’re unlikely to miss the additional contributions. If you have a 401(k) retirement account at work, then you may be investing in your future already with allocations to mutual funds and even your own company’s stock.
Minimums to Open an Account
Many financial institutions have minimum deposit requirements. In other words, they won’t accept your account application unless you deposit a certain amount of money. Some firms won’t even allow you to open an account with a sum as small as $1,000.
It pays to shop around some and check out our broker reviews before deciding where you want to open an account. We list minimum deposits at the top of each review. Some firms do not require minimum deposits. Others may often reduce costs, such as trading fees and account management fees if you have a balance above a certain threshold. Still others may offer a certain number of commission-free trades for opening an account.
Commissions and Fees
As economists like to say, there ain’t no such thing as a free lunch. Though many brokers have been racing recently to lower or eliminate commissions on trades, and ETFs offer index investing to everyone who can trade with a bare-bones brokerage account, all brokers have to make money from their customers one way or another.
In most cases, your broker will charge a commission every time you trade stock, either through buying or selling. Trading fees range from the low end of $2 per trade but can be as high as $10 for some discount brokers. Some brokers charge no trade commissions at all, but they make up for it in other ways. There are no charitable organizations running brokerage services.
Depending on how often you trade, these fees can add up and affect your profitability. Investing in stocks can be very costly if you hop into and out of positions frequently, especially with a small amount of money available to invest.
Remember, a trade is an order to purchase or sell shares in one company. If you want to purchase five different stocks at the same time, this is seen as five separate trades, and you will be charged for each one.
Now, imagine that you decide to buy the stocks of those five companies with your $1,000. To do this, you will incur $50 in trading costs—assuming the fee is $10—which is equivalent to 5% of your $1,000. If you were to fully invest the $1,000, your account would be reduced to $950 after trading costs. This represents a 5% loss before your investments even have a chance to earn.
Should you sell these five stocks, you would once again incur the costs of the trades, which would be another $50. To make the round trip (buying and selling) on these five stocks would cost you $100, or 10% of your initial deposit amount of $1,000. If your investments do not earn enough to cover this, you have lost money just by entering and exiting positions.
Mutual Fund Loads
Besides the trading fee to purchase a mutual fund, there are other costs associated with this type of investment. Mutual funds are professionally managed pools of investor funds that invest in a focused manner, such as large-cap U.S. stocks.
An investor will incur many fees when investing in mutual funds. One of the most important fees to consider is the management expense ratio (MER), which is charged by the management team each year based on the number of assets in the fund. The MER ranges from 0.05% to 0.7% annually and varies depending on the type of fund. But the higher the MER, the more it affects the fund’s overall returns.
You may see a number of sales charges called loads when you buy mutual funds. Some are front-end loads, but you will also see no-load and back-end load funds. Be sure that you understand whether a fund that you are considering carries a sales load prior to buying it. Check out your broker’s list of no-load funds and no-transaction-fee funds if you want to avoid these extra charges.
For the beginning investor, mutual fund fees are actually an advantage compared to commissions on stocks. This is because the fees are the same regardless of the amount that you invest. Therefore, as long as you meet the minimum requirement to open an account, you can invest as little as $50 or $100 per month in a mutual fund. The term for this is called dollar-cost averaging (DCA), and it can be a great way to start investing.
Diversify and Reduce Risks
Diversification is considered to be the only free lunch in investing. In a nutshell, by investing in a range of assets, you reduce the risk of one investment’s performance severely hurting the return of your overall investment. You could think of it as financial jargon for “Don’t put all of your eggs in one basket.”
In terms of diversification, the greatest difficulty in doing this will come from investments in stocks. As mentioned earlier, the costs of investing in a large number of stocks could be detrimental to the portfolio. With a $1,000 deposit, it is nearly impossible to have a well-diversified portfolio, so be aware that you may need to invest in one or two companies (at the most) in the first place. This will increase your risk.
This is where the major benefit of mutual funds or ETFs comes into focus. Both types of securities tend to have a large number of stocks and other investments within their funds, which makes them more diversified than a single stock.
The Bottom Line
It is possible to invest if you are just starting out with a small amount of money. It’s more complicated than just selecting the right investment (a feat that is difficult enough in itself), and you have to be aware of the restrictions that you face as a new investor.
You’ll have to do your homework to find the minimum deposit requirements and then compare the commissions to those of other brokers. Chances are that you won’t be able to cost-effectively buy individual stocks and still diversify with a small amount of money. You will also need to choose the broker with which you would like to open an account.
For additional useful views and observations, please consider also reading our articles on learning how to trade the market in five steps and on how to buy and sell stocks for your account.