Have you been interested in stocks, but have no idea where to start or what any of it even means? This beginner’s guide will go over the basics on understanding stocks, and hopefully by the end, you’ll be able to start on your own!
Investing in stocks is simple, but can’t be considered easy whatsoever.
To get started all you need is money and a platform to invest (preferably a free smartphone app such as Robinhood or WeBull). If you currently work and have a 401K, chances are you are already automatically investing in the stock market.
It’s a common misconception that if you just invest all your money into a stock that you’ll automatically make money. Unfortunately that’s quite far from the truth.
Picking a smart investment is difficult and it takes time to master your strategy. Let’s get over some questions that you may already have about stocks.
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Table of Contents
- 1 Why Even Invest In Stocks?
- 2 Investing Is Not Gambling
- 3 What Are Stocks?
- 4 How Much Money Do You Need to Buy Stocks?
- 5 Manage The Risks You’re Willing to Take
- 6 Learn About the Stock Market Trends
- 7 Choosing a Brokerage
- 8 Do Your Research Before Investing
- 9 How To Analyze a Stocks Value
- 10 Managing Your Portfolio
- 11 Bottom Line
Why Even Invest In Stocks?
Here’s a hard truth that some find hard to swallow:
No matter how smart you are about saving and spending, you’re not going to get really far unless you’re a super-rich CEO of a large company. It’s going to be hard to save everything for retirement.
To build long term wealth, you need to invest. Just dropping and leaving your money in a savings account or a CD account can earn you some interest, but it’s hardly enough to make a big difference.
Investing in stocks is the best way to get large returns and historically, it’s the best way to generate growth to reach financial goals.
Some of your goals may include:
- Buy a House
- Save for Retirement
- Save money for your children’s college education
A turn off to some people is that there’s a higher degree of risk when it comes to investing in stocks. However, it gives a much larger return than stuffing your money into a savings account.
Historically, stocks offer an average return of around 10%, which is substantially more than the 1% to 2% you might be able to get with a money market or high-yield savings account.
There’s always, and I repeat, always a risk when investing in stocks, which is why it’s crucial to educate yourself before you start throwing your money at stocks. And whatever you do, don’t put all your extra money in one stock.
Investing Is Not Gambling
Some people feel that investing in stocks is like gambling. That’s because you can never be 100% sure what is going to happen.
It’s true that a stock can take a hard-turn and hurt people’s wallet, but it’s important to understand the difference between gambling and investing.
It is gambling if you pick a random stock because it has an interesting sounding name and bet your dollars as if you would bet a running horse.
It’s called investing when you do your homework and take the time to make smart selections. You study the trends and feel relatively confident in your choice. You’re letting your wisdom – rather than chance – make your choices for you.
What Are Stocks?
A stock are companies selling small bits of themselves. When you buy a piece, you own a little bit of that company. If the value of the company increases, the pieces you’ve purchased will go up in value.
To put into perspective, stocks are ownership of a particular company.
The stocks we’re talking about are for shares of publicly traded companies, and can be bought and sold on an exchange. Stocks can also be referred to as equities or securities; for our purposes, the terms are interchangeable.
There are two basic ways to make money by investing in stocks:
- If you can sell stock for more than you purchased it
- If the stock you own pays out dividends to shareholders
For example, let’s say you buy 100 shares of a company’s stock at $20 each. That’s an initial investment of $2,000. After 5 years, the price per share has increased to $25. If you decide to sell all your shares, you’d sell for $2,500. You’d be making $500 in gains (not including any fees and commissions).
The price of a stock is operated on a supply-and-demand model. If the company is booming, lots of people will want to invest in the company, causing the price to increase.
If the company has more supply than demand, the prices of the company will fall.
How Much Money Do You Need to Buy Stocks?
You can invest in the stock market with little money. It’s best if new investors start off with little money to practice and master their strategy.
Luckily some brokers don’t have a minimum amount required to start trading. And some brokers will expect you to invest around $500 to a couple thousands before they’ll even let you do anything.
To top it off, some brokers charge a fee for every trade you make. It can either be a flat rate or a percent rate. Each trade can usually set you back between $4.95 to $6.95.
Then you have the price of stocks themselves. Prices can fluctuate wildly in minutes for some stocks, dropping or gaining 5%-10% while others barely move 1% per day.
Prices for stocks range from just a couple dollars to as much as $1,000 per share.
Manage The Risks You’re Willing to Take
When investing it’s smart to understand how the stock moves. Slow moving stocks with low volatility (small movements per day) are good for those who are fine with waiting a couple months or years to see your returns and generally have lower risks.
It’s easy to catch and sell your stocks if you start seeing a downward trend.
High moving stocks with high volatility (big movements per day) offer big returns in a short amount of time, but have come at a much higher risk.
If you want an aggressive approach to investing and want to see those big returns in a short amount of time, learn and master a strategy that’s suites those needs.
If you’ve got a stable career, then you can afford to take more risk with stocks. After all, you’ll have your steady paychecks in case anything goes wrong.
ut if your income is more unpredictable (such as if you’re self-employed), you may not want the high risk of stocks. In this case, it may be better if more of your portfolio is allocated to mutual funds and bonds.
Learn About the Stock Market Trends
Next on the list is knowing when to invest. You need to have the proper investing strategy for the current trends in the market. Learn about when stocks tend to rise and what type of stocks are currently performing well.
Here are some general things to know:
- Stock Prices Rise When Interest Rates are Low:
- When interest rates are low, people tend to borrow more money. In turn, companies can get more money and grow which can result in the increase of stock market prices.
- On the other hand, high interest rates mean that people find it harder to borrow money and will therefore spend less. This can hurt companies an cause their stock prices to drop.
- Understand bear and bull markets:
- You may have heard the terms “bear” and “bull” markets. Bull market is when the market is performing well. Stocks on are the rise and people are confident about the economy.
- Bear market is when the economy is bad (such as in a recession). This leads to drops in stock prices. You’ll want to adjust your portfolio to ride out this period or to take advantage of the opportunity. This may be a scary time and cause people to panic, but remember that historically, the market always has a positive return in the long run.
- Knowing what industries do well in strong economies:
- Companies that perform the best during a strong economy are retailers, airliners, automobiles, etc. Be sure to invest in companies that perform the best during these times.
- Knowing what industries do well in weak economies:
- On the other hand, during a weak economy, the companies and industries listed above won’t be doing so well. However there are those that thrive during these times like utilities and discount retail.
Choosing a Brokerage
Before you can actually start investing, you’ll need to decide on a brokerage. These accounts companies hold onto your money that you’ve invested.
- Full Service Firm: These firms do all the work and research for you. They consist of a single person or an entire team that works to understand the market and make the right decisions. This is perfect for those who are not sure what stocks to choose or don’t have the time to do the research themselves. However, all this services comes at quite the price or rate.
- A Discount Brokerage: These have low fees, but you’ll be doing all the investing yourself. This is the best option if you are confident in your decisions. This ensures that more of your investment seed money is going towards the purchase of your stocks.
- Robo-advisors: These have recently become more popular among investors. It uses computer based algorithms to make decisions for the investor based on your goal and risk tolerance. Since there are no actually people, the fees are considerably lower.
If you’re interested in choosing a robo-advisor, read up on our reviews about Acorns, a leader in the robo-advisor industry.
Each online broker offers the same general features, but it’s good to check out each and every brokerage in depth to make sure it’s perfect for you.
Be aware of how much each trade will cost as well. Fees and rates will generally cost between $5 – $10 per trade, depending on what brokerage you choose.
If you plan on trading long term, the fees may not make a big difference for you, but if you plan on trading on a regular basis, choosing a cheaper option may be suitable for you.
Do Your Research Before Investing
As stated above, investing is not gambling. You’ll need to put time and research into understanding the market before you can begin.
You’ll want to know who are the top rising companies in the market. Established brand (also known as blue chip stocks) are usually safer bets, because they are mature and established companies.
However the trade off is that these companies will grow at a slower pace than a rising new company.
Learn which companies to invest in. When researching individual companies, you need to understand the company’s goals and how likely it is to make a profit based on its structure and operations.
If you buy stock in a startup, for example, but the people running it don’t have a solid plan for turning a profit, odds are you’re not going to make any money either.
Some things to look for include:
- The profit margin (in %): This shows much profit the company gains for every dollar in sales. The higher number the better.
- The return on equity (in %): This shows how much profit the company generates with each $1 of the shareholders’ money. The higher number the better.
- The company’s debt: Look at how much debt the company is carrying. The more that a company borrows, the more it has to pay back with interest, which can affect the stability of its per-share stock prices.
- The annual report: This is a report detailing the company’s activities, financial performance, and future insights. Most companies will have this for free on their website to download.
- The balance sheet: This snapshot tells the company’s assets (what they own) and liabilities (what they owe).
- The income statement: This statement tells investors the company’s total earnings over a period of time.
- The cash flow statement: This is a breakdown of cash coming in and leaving the company. It’s broken down into business operations, investing, and financing.
How To Analyze a Stocks Value
Another way to look at a stock is to analyze it’s value. The most widely used way to do this look at the price to earnings (P/E) ratio. It’s a quick and simple way to gauge a stocks worth with a minimal amount of work.
The P/E ratio is the ratio of the company stock’s current share price to the company’s average earnings per share (EPS) over the past year. Simply put, it’s how much investors are currently paying for $1 of the company’s profit.
- The EPS is the total earnings divided by the number of shares held by all investors. So for example, let’s say a particular company in the past year has a profit of $1,000,000, and there are 500,000 shares out there held by the public. This would mean that the earnings per share is $2.
- Now, let’s say the current price per share of the stock is $40. The P/E ratio would be $40/$2, or 20. This means investors are paying $20 for $1 of the company’s profit.
This method is a great way to compare how the company you’re looking at is doing compared to other companies in the same field.
A high P/E ratio means that the company is expected to have some growth in the future. Investors are paying more for the stock than the earnings. However, if the ratio is way above average, that means that people are paying more than what the company is actually worth. The stock can have an instant drop in value if the growth stops.
Many investors swear to buy shares of stocks from a company with a low P/E. This means that the company is doing well and growing, but nobody has noticed yet. In that case, it would be a smart buy.
However, it could also mean that investors predict future problems with the company and aren’t buying. Take any option into consideration before purchasing your stock.
The P/E ratio is a quick way to gauge value and compare against other companies. It’s a great tool to use, but it shouldn’t be your only factor.
Managing Your Portfolio
Whenever your start investing, be sure to always diversify your portfolio. Purchase stocks across all industries to ensure constant growth.
Assess your investments. If the stock you’ve purchased is growing slower than other companies in the same field, maybe you should sell and reconsider which company to invest your money into. Maybe the stock is way to volatile and it’s making you uncomfortable. If any of these apply, maybe it’s time for change.
If your stocks aren’t growing as much as you’d expect, don’t be too impatient. Be sure to also consider long term wealth preservation – think years ahead!
It’s common for people to want to invest and make a quick buck, but be sure to always be patient and consider all your options before making a decision.
Every year you should review the companies you’ve invested in and see whether or not there is still potential growth. Evaluate and make a decision based on what you discover and predict will happen with the company.
As previously stated, investing is simple, but no where near easy. It’s easy for newcomers to just start throwing their money at a company without doing their homework and research first.
Take your time, we don’t want you to waste your hard earned money on quick decisions.
Hopefully after reading this article, you’ll begin your journey as a stock investor. It’s not an easy one, but with time and practice, results will show. Take your time and do your research for the best results!
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