So you have saved up a bit of money and are interested in starting to invest in stocks. You have heard that you can get greater returns by investing – which is true – but you aren’t sure where to start. In this article we’ll go over a strategy of where to start and then how to continue to invest and grow wealth.
First of all, before starting to invest it is important to have your finances in order. This means that you should:
1) Have a bank account with enough cash to cover 3-6 months worth of expenses. This money is to only be used for emergencies such as if you lose your job, your car breaks down, the air conditioner breaks, you suffer a serious medical problem, etc… (Going on vacation or buying some toy that you want is not an emergency.) This account is very important since it ensures that you have the cash you need for the various misfortunes that occur. Instead of going into credit card debt when the car breaks down you will have the cash on hand. Whenever you need to use money from this account you must replenish it as fast as possible.
2) Pay off all credit cards. Credit cards charge 15-30% interest or more. No matter how good an investor you are it is unlikely that you will do better than 15% over long periods of time, so paying off the credit cards is a much better investment.
3) Fund you retirement accounts such as an IRA or 401K plan. Retirement is going to require a lot of money, but time is on your side while you are young. Make sure you are putting 10-15% of your income away in your retirement funds consistently. Note that you can (and should) invest these accounts in stocks – mainly mutual funds and Exchange Traded Funds (ETFs) – while you are young, slowly converting about half of the account to cash and fixed-income securities as you approach retirement age, so these accounts are part of your stock investing as well.
Once you have your financial house in order, you are ready to start stock investing.
The first thing you need to decide is your risk tolerance. If you are willing to undergo movements of 50% or more up and down within a month or less with individual investments, you may be suited to invest in individual stocks. Note that the mindset here is that you may get a few stocks that fall and don’t work out, but you will also get a few winners that will make up for the losers (think Microsoft or Walmart). Because the winners will far exceed the losers, you’ll come out far ahead – it will just be a bumpy ride.
Serious stock investing does not involve a lot of trading. While it is fun to try to guess the next moves of the market and move in and out of positions, if you want to make real money you should pick stocks that have prospects for steady growth over a long period of time and buy these stocks and hold onto them. Actually, once you have made your purchase it is normally sufficient to just check them once in a while, perhaps every few months or so or with each statement, and read over the annual report when it comes.
Because you are investing for the long-term you should only sell if 1)the company changes their business such that they no longer have the long-term steady growth behavior you want or 2)the position has become so large that it becomes too risky and you need to sell some shares and spread out the funds a bit. Note that just because the share price has declines is not a reason to sell. Sometimes good companies get dragged down because of a correction in the overall market or the company’s sector.
If you have $1500 to $2000 you can by shares of one individual stock. You are looking for a stock that has had earnings growing consistently for a number of years and still has room to expand, such that earnings can continue to grow. This is also typically reflected in the price, which will have a long, steady, gradual upward slope. A good source of information when choosing stocks is the Value Line Investment Survey (most libraries carry this). There are also a few websites that list earnings dating back a year or so, but the number of sites that give out a long earnings history for free is very low. The brokerage houses also have varying amounts of information. A full service broker such as Merrill Lynch or UBS would have far more information than the discount brokers (in general), but large account balances are typically required, so this option may not be available for beginning investors.
If you cannot handle the types of fluctuations experienced by owning individual stocks you can do just fine investing in Exchange Traded Funds (ETFs) and index mutual funds. These each invest in a large number of stocks so the movements of any one stock are balanced by the others. This means that in a really bad year they may drop by 30%, but most of the time movements will be between 5 and 20% up or down per year, and over the long term there will be more up years than down. The long-term average return on the stock markets has been between 10 and 15%, which has far exceeded bonds, savings accounts, and other investments.
With $1000-$2000 you can start investing in ETFs or mutual funds. ETFs trade on the stock exchanges and are purchased through a broker. Online brokers such as ETrade are options here. Mutual funds are sold through the various fund companies which must be contacted directly. Vanguard is a leader in index funds, but many other fund companies also sell their own index funds. Because index funds have been shown to outperform the majority of managed funds over a long period of time (because the fees are much lower), index funds are typically the best investment.
Whether buying index funds or ETFs, the first investment should be in one of the major investment categories. Good choices would be a small cap or a mid cap fund or ETF (growth, value, or mixed). The Russell 2000 is a common small-cap index. Large caps could also be purchased, such as an S&P 500 or Dow Jones Industrials tracking fund or ETF. These are indexes that contain large, well established companies, which means that there share prices will be more stable, but their total return will likely lag that of the small and mid caps (because they have already grown so large there is little room left for more growth).