Getting Started in Stocks

Historically, the returns delivered by stock investments have outperformed the returns from bonds, treasury bills, gold, cash, or real estate. In the short term, one or several other assets may outperform stocks but, overall, stock investing has been a winning strategy.

That’s especially important if you’re investing for the long term. However, there are so many ways to invest in stocks. When faced with individual stocks, mutual funds, index funds, and exchange traded funds (ETFs), investors may feel overwhelmed by the many different choices.

This guide is designed to help you learn about and navigate the ways that you can invest in stocks. So let’s get started.

Key Takeaways

• Stock investments have historically outperformed other types of investments, such as those in bonds, gold, cash, real estate, or treasury bills. 
• It is important to assess your tolerance for risk before deciding how to invest in stocks. 
• You should make sure that you have enough time to properly monitor and manage your stocks. 
• Diversification can be an excellent way to reduce risk associated with your stock investments. 
• If you need help with your investments, be sure to consult with a financial advisor or broker.

Consider the Risk

Though they’ve paid off over time, stocks are considered risky investments because they can be volatile. So begin by asking yourself some basic questions:

• What kind of investor are you, conservative or aggressive, hands-on or passive, someone constantly checking prices or able to wait for monthly statements?
• Are you a risk-taker, willing to invest money for a chance to make a lot more of it, or would you prefer an investment with a return that’s more of a sure thing? One that you can determine before you invest.
• What would be your response to a 10% drop in the price of a single stock in one day, or a 35% drop over the course of a few weeks?
• Would you sell your holding in a panic or would you keep your cool and your position?

The answers to these and similar questions can lead you to consider different types of equity investments, such as mutual or index funds rather than individual stocks (especially if you prefer to sleep at night when markets are turbulent).

Stock Funds vs. Individual Stocks

• If you’re not up for taking the higher risks associated with individual stocks, but still want to invest in them, your best bet might be mutual funds, ETFs, or index funds. All invest in a wide variety of stocks and as such are well-diversified.
• This diversification reduces the risk that any one stock dropping in price would affect your overall investment’s value to a serious degree.
• What’s more, these funds are convenient and easy to invest in. They don’t require you to research individual stocks and the companies that issue them, which is what you should do if investing in individual stocks.
• Typically, investing in funds is also less expensive than investing in a number of individual stocks.
• If you’ve done your due diligence and reviewed a fund’s prospectus, you like the historical performance of a fund and the investment approach of the fund managers, and the fees are acceptable to you, then your next step may be to invest.

Important

It is important to understand your risk tolerance and how it relates to the different types of stock investments available before making any major stock investment decisions. 

Understand the Commitment

Should you invest in funds, individual stocks, or both? The answer depends on how much time and effort you can devote to your investing efforts.

For Funds

Deciding to go with mutual funds, index funds, or ETFs, would allow you to invest your money and leave the hard, time-consuming work of picking individual stocks and managing the portfolio to fund managers.

Index funds are even simpler because they are not actively managed. They move up or down in value according to the benchmark index that they are designed to track.

For Individual Stocks

Responsible individual stock investing is time-consuming because it requires you to make judgments about a company’s management, its earnings, and its future prospects. You’ll also be judging the historical price performance of an individual stock.

As an investor, you’ll be trying to distinguish between money-making stocks and financial disasters. You need to know what companies do, how they make their money, their market share, any competitive edge, the risks they face, their potential for success, and much more.

Therefore, ask yourself how much of a commitment you want to make to investing. Are you willing to spend the necessary hours each week researching different companies, their industries, the broad economy? Do you want to manage a portfolio of individual stocks yourself?

Do you have that kind of interest? Or is your life too busy to carve out that time? Investing in and managing a portfolio of individual stocks takes time, effort, and discipline.

Diversify Your Portfolio

Diversification involves investing in a variety of assets. When you diversify your portfolio, you reduce the overall investment risk. That’s because you spread out your money across different assets and shouldn’t suffer greatly should a particular asset or area of your portfolio drop in value, while all others remain stable or move up in value.

For instance, don’t put all of your money in small biotech companies. Yes, the potential gain could be great. But what happens if these stocks plunge in price because the Food and Drug Administration (FDA) starts rejecting a higher percentage of new drugs? Your entire portfolio would be negatively impacted.

It’s better to diversify across several different sectors or industries, such as real estate (a real estate investment trust (REIT) is one possibility), consumer goods, commodities, insurance, etc., rather than to focus on just one or two.

Importantly, consider diversifying across asset classes as well by keeping some money in bonds and cash, rather than being 100% invested in stocks. How much you have in these different sectors and classes is up to you, but being invested more broadly lessens the risk of losing it all at any one time.

A Portfolio for Beginners

If you’re just starting out, without investing experience or expertise, think seriously about investing most of your money in a couple of stock index funds. Consider one that tracks the broad market, like the S&P 500, and one that gives you some exposure to international equities.

Adding another index fund that tracks small companies, like the Russell 2000, could boost returns, but would increase risk due to the nature of the companies and equities.  

A portfolio consisting of these index funds would offer diversification, providing the steadier performance of large companies and some upside with both international companies and small caps.

Note

This article focuses on helping you get started in stocks. But keep in mind that a smartly diversified portfolio should include investments in addition to equities, such as fixed-income securities and cash equivalents.

A Portfolio of Individual Stocks

If you wish to invest in individual stocks, a portfolio of 12 to 20 well-chosen ones should give you sufficient diversification while not overwhelming you with too many companies to follow and research.

However, you will need to ensure that you fully understand each company, from its business and its risks to its historical performance and prospects for the future.

If you plan to invest in stocks alone, spread your purchases across different sectors such as health care, technology, insurance and banking, energy, real estate, and more.

Also spread your money across companies with different market capitalizations, such as small-cap and large-cap stocks.

Invest in Individual Stocks and Funds

If you don’t have the time or desire to do the research required to pick and manage a number of stocks, consider investing in a mixture of index funds and individual stocks.

Another consideration, especially if you’re just starting out and have limited funds, is that investing in 12 to 20 stocks may not be feasible financially.

Putting the majority of your money in funds and using a small part of it to invest in individual stocks could provide the potential returns you seek from equities and simplify your efforts to build and manage a portfolio. 

Find a Broker

Once you’ve determined the shape of your portfolio, it’s time to invest. Find a broker with whom you’re comfortable, either online or by visiting a local office of a brokerage. Call and talk with a broker, if necessary. Learn what’s needed to open an account. Then fill out the paperwork and deposit your money.

Most brokers operate online. That means that once your account is open, you can place your orders using a mobile app on your phone, your laptop, or other device.

If buying individual stocks, don’t buy all at once. Enter the market slowly via dollar-cost averaging (DCA). What if you invested all your money just before a market downturn? Being in the red that quickly wouldn’t do much for your confidence.

Plan to take several months to invest all of your money to minimize any market timing risk. Finally, remember to set aside time each week to review or catch up on news concerning your investments.

About Robo-Advisors

Robo-advisors are digital platforms that automate portfolio and trade decisions for users via a mobile app or web interface.

Instant Portfolio

By following well-established formulae, like Modern Portfolio Theory (MPT), robo-advisors’ algorithms optimize portfolio allocation based on time horizon and risk tolerance, and simplify the entire investment process for investors

This automation offers not only an optimal investment strategy, but also cost savings. Many robo-advisors charge far less than a human advisor and often require very low minimum investment amounts to get started.

Less Control

Of course, automation also means giving up control of the portfolio decisions. It also eliminates the personal touch you get when a person helps you manage your money.

Furthermore, if you want to buy shares of a hot stock or IPO, short a stock, or sell call options against some holding, a robo-advisor will not allow you to do this.

Still, for most new investors, these speculative or higher-risk strategies may not be appropriate. So a robo-advisor that adheres to, for example, an index fund investing strategy could be the better choice.

Pros

• Low cost and low minimums to get started

• Typically follows indexing strategies suitable for many long-term investors

• Automation eliminates human error and can continuously monitor portfolios

• Expanding set of choices, such as ESG-focused portfolios

Cons

• Reduced personal touch or human interaction

• Very little control over portfolio or trading decisions

• Limited investment options; cannot trade whatever you want

Review and Rebalance Your Portfolio

As your experience grows, your risk profile changes, or the value of assets in your portfolio increases, your asset allocation needs may change. That means you will need to rebalance that allocation to minimize portfolio risk.

Rebalancing puts asset weightings back to their original states. Or it can adjust the balance of holdings in a portfolio to fit a new investment strategy. Additionally, you may have more money to invest. That would involve adding assets. In turn, that could require a rebalancing.

Plan to review your investments’ performance when each monthly statement arrives. Consider rebalancing your portfolio at least once every year.

How Much Money Do I Need To Start Investing?

Today, most individual investors can start with very little. Many financial experts advise beginning early, especially for long-term investments for goals like college or retirement. Adding weekly or monthly contributions to your portfolio can help grow a small seed planted early into a mighty tree.

How Do You Start Investing in Stocks With Little Money?

Today, ordinary individuals can get started with literally $1 to invest. Online brokerages like Robinhood or E-Trade offer commission-free trading and fractional shares, meaning that the unit price of a share is no longer a limiting factor. Similarly, robo-advisors, which automate long-term investment portfolios, are low cost and many require as little as $5-$100 to get started. Both options entail opening an account online and transferring money from your bank, which can be accomplished with just a few clicks.

How Can I Get Started in Penny Stocks?

Penny stocks are highly risky shares of sometimes questionable companies with share prices below $5 and often below $1. Generally, penny stocks trade on the so-called Pink Sheets or the OTC Bulletin Board (OTCBB). Penny stocks should be approached with extreme caution. That’s especially true for the Pink Sheets since the companies traded on it aren’t required to file with the SEC, unlike OTCBB stocks. Some online brokers will restrict trading in penny stocks.

What Is the CAN SLIM Method for Investing in Stocks?

CAN SLIM, created by Investor’s Business Daily’s William J. O’Neil, is an aggressive system for selecting growth stocks using a combination of fundamental and technical analysis techniques. It is intended for investors with high risk tolerance and relatively short time horizons.

The Bottom Line

Before you jump into the stock market, spend some time thinking about what you want to accomplish and how your tolerance for risk may affect what you buy.

In addition, consider your level of stock investing expertise and how much time you have to devote to stock investing. Then, consider the types of stock investments that might fit your investor profile.

For beginning investors, mutual funds, index funds, and ETFs may be an ideal way to get involved in stocks. For more experienced investors, individual stocks may fit the bill.

When you invest in stocks over a long period of time, you can build a substantial portfolio that could help fund your retirement, pay for a second home, or meet whatever financial goals you set when you started your stock investing journey.