News shows, Hollywood movies, and television assume you know what the stock market is and how it works. Everyone knows that you can make a lot of money in the stock market if you know what you’re doing, but beginners often don’t understand how the market works and exactly why stocks go up and down.
Here’s what you need to know about the stock market before you start investing.
Reading: Share market beginners
what is the stock market?
Stocks, also called equities, are securities that give shareholders an ownership interest in a public company. It’s a real stake in the business, and if you own all the shares in the business, you control how the business works. The stock market refers to the collection of shares that the general public can buy and sell on a variety of different exchanges.
Where do the shares come from? public companies issue shares so they can finance their businesses. Investors who believe the business will prosper in the future buy those stock issues. shareholders get any dividend plus any appreciation in the stock price. they can also see their investment shrink or disappear altogether if the company runs out of money.
The stock market is really a kind of secondary market, where people who own shares in the company can sell them to investors who want to buy them. This trading takes place on a stock exchange, such as the New York Stock Exchange or the Nasdaq. In years past, traders used to go to a physical location (the exchange floor) to trade, but now virtually all transactions are done electronically.
When news people say “the market is up today”, they are usually referring to the performance of the standard & 500 poor or the dow jones industrial average. The S&P 500 is made up of about 500 large publicly traded companies in the United States, while the Dow includes 30 large companies. these track the performance of stock collections and show how they fared on that trading day and over time.
however, even though people refer to the dow and s&p 500 as “the market”, they are actually stock indices. These indices represent some of the largest companies in the US. but they do not represent the total market, which includes thousands of publicly traded companies.
Of course, you’ll need a brokerage account before you start investing in stocks. To get you started, here are eight more guidelines for investing in the stock market.
how to invest in the stock market: 8 tips for beginners
- buy the right investment
- avoid individual stocks if you are a beginner
- build a diversified portfolio
- be prepared for a recession
- try a simulator before investing real money
- stay committed to your portfolio for the long term
- start now
- avoid short-term trading
1. buy the right investment
Buying the right stock is much easier said than done. Anyone can see a stock that has performed well in the past, but anticipating how a stock will perform in the future is much more difficult. If you want to be successful investing in individual stocks, you must be prepared to put in a lot of work to analyze a company and manage the investment.
“when you start looking at stats, you have to remember that professionals are looking at each and every one of those companies much more rigorously than you probably can as an individual, so it’s a very tough game for the individual to win over time,” says dan keady, cfp, chief financial planning strategist at tiaa.
If you’re analyzing a company, you’ll want to look at a company’s fundamentals: earnings per share (EPS) or a price-to-earnings ratio (P/E ratio), for example. But you will have to do much more: analyze the company’s management team, assess its competitive advantages, study its finances, including its balance sheet and income statement. even these articles are just the beginning.
keady says that going out and buying stock in your favorite product or company is not the right way to invest. Also, don’t rely too much on past performance because it’s no guarantee of the future.
You will have to study the company and anticipate what will come next, hard work in good times.
2. avoid individual actions if you are a beginner
everyone has heard of a big stock win or a big stock pick.
“What they forget is that they’re often not talking about those particular investments that they also own that have done very, very poorly over time,” Keady says. “So sometimes people have an unrealistic expectation about the kind of return they can get in the stock market. and sometimes they confuse luck with skill. sometimes you can get lucky choosing an individual stock. it’s hard to get lucky over time and also avoid those big recessions.”
Remember, to consistently make money on individual stocks, you need to know something that the prospective market is not yet pricing in the stock price. keep in mind that for every seller in the market, there is a buyer of those same shares who is equally sure to make a profit.
“There are tons of smart people doing this for a living, and if you’re a newbie, the chances of you making it through aren’t very good,” says Tony Madsen, CFP, founder of NewLeaf Financial Guidance in Redwood Falls. , Minnesota.
An alternative to individual stocks is an index fund, which can be a mutual fund or an exchange-traded fund (ETF). These funds hold dozens or even hundreds of shares. And every share you buy in a fund is owned by all the companies included in the index.
Unlike stocks, mutual funds and ETFs may have annual fees, although some funds are free.
3. create a diversified portfolio
One of the main advantages of an index fund is that you immediately have a variety of stocks in the fund. For example, if you own a broadly diversified fund based on the S&P 500, you will have shares in hundreds of companies in many different industries. but you could also buy a narrowly diversified fund focused on one or two industries.
Diversification is important because it reduces the risk that any stock in the portfolio will greatly detract from overall performance and actually improves your overall returns. conversely, if you’re buying just a single stock, you really have all your eggs in one basket.
The easiest way to build a broad portfolio is to buy an ETF or mutual fund. the products have diversification built in and you don’t need to do any analysis of the companies that are in the index fund.
“It may not be the most exciting, but it’s a great way to start,” says Keady. “And again, it gets you out of thinking that you’re going to be so smart, that you’re going to be able to pick which stocks are going to go up, which ones aren’t going to go down, and know when to get in and out of them.”
When it comes to diversification, that doesn’t just mean a lot of different stocks. it also means investments that are spread across different asset classes, since stocks in similar sectors can move in a similar direction for the same reason.
4. prepare for a recession
The most difficult problem for most investors is sustaining a loss on their investments. And because the stock market can fluctuate, you will have losses from time to time. you’ll have to steel yourself to handle these losses, or you’ll be prone to buying high and selling low during a panic.
As long as you diversify your portfolio, any single stock you own shouldn’t have much of an impact on your overall performance. If so, buying individual stocks might not be the best option for you. even index funds will fluctuate, so you can’t get rid of all your risk, try how you could.
“Whenever the market changes, we have this propensity to try to push back or question our willingness to participate,” says the crazy newleaf.
That’s why it’s important to prepare for recessions that could come out of nowhere, as happened in 2020. You need to overcome short-term volatility to earn attractive long-term returns.
When investing, you should know that it is possible to lose money, since stocks do not have capital guarantees. if you’re looking for guaranteed performance, maybe a high performance cd is better.
keady cautions that the concept of market volatility can be difficult for new and even seasoned investors to grasp.
“one of the interesting things is that people will see that the market is volatile because it is going down,” says keady. “Of course, when it goes up, it’s also volatile, at least from a statistical point of view, it moves all over the place. so it’s important for people to say that the volatility they see going up, they’ll also see it going down.”
5. try a stock simulator before investing real money
A risk-free way to enter the world of investing is to use a stock simulator. using an online trading account with virtual dollars will not put your real money at risk. you will also be able to determine how you would react if it was really your money that you won or lost.
“That can be very useful because it can help people get past the belief that they’re smarter than the market,” Keady says. “That they can always pick the best stocks, always buy and sell the market at the right time.”
Asking yourself why you’re investing can help you determine if investing in stocks is for you.
“if your idea is that you’re going to somehow outperform the market, pick the best stocks, maybe it’s a good idea to try some kind of simulator or look at some stocks and see if you can really do it.” Keady says. “so if you’re more serious about investing over time, then I think you’re much better off, almost all of us, myself included, if you have a diversified portfolio, such as that provided by mutual funds or exchange-traded funds bag”.
(bankrate reviewed some of the best investing apps, including some fun stock simulators).
6. stay committed to your portfolio for the long term
keady says that investing should be a long-term activity. it also says you should divorce yourself from the daily news cycle.
By skipping the daily financial news, you’ll develop the patience you’ll need if you want to stay in the investing game for the long haul. It’s also helpful to look at your portfolio infrequently, so you don’t get too nervous or too elated. These are great tips for beginners who have yet to control their emotions when investing.
“Some of the news cycle, sometimes it gets 100 percent negative and it can get overwhelming for people,” Keady says.
A strategy for beginners is to set up a calendar and predetermine when you will evaluate your portfolio. Following this guideline will prevent stocks from selling out during some volatility, or not getting the full benefit of a well-performing investment, Keady says.
7. start now
picking the perfect opportunity to jump in and invest in the stock market usually doesn’t work out well. No one knows with 100 percent certainty the best time to enter, and investing is meant to be a long-term pursuit. there is no perfect time to start.
“One of the main points of investing is not just thinking about it, but getting started,” says Keady. “and start now. Because if you invest now, and often over time, that compounding is what can really drive your bottom line. if you want to invest, it’s very important to start and have… an ongoing savings program, so that we can achieve our goals over time.”
8. avoid short-term trading
Understanding whether you’re investing for the long-term or short-term future can also help determine your strategy, and whether you should invest at all. Sometimes short-term investors can have unrealistic expectations about the growth of their money. And research shows that most short-term investors, like day traders, lose money. you are competing against powerful investors and well-programmed computers that can better understand the market.
New investors should be aware that frequently buying and selling stocks can be costly. may create taxes and other fees, even if a broker’s primary trading commission is zero.
If you’re investing short-term, you run the risk of not having your money when you need it.
“When I advise clients…anything in a couple of years, sometimes even three years, I’m hesitant to take too much market risk with those dollars,” says Madsen.
Depending on your financial goals, a savings account, money market account, or short-term certificate of deposit may be better options for getting money in the short term. Experts often advise investors that they should invest in the stock market only if they can keep the money invested for at least three to five years. The money you need for a specific purpose in the next two years should probably be invested in low-risk investments, like a high-yield savings account or a high-yield CD.
how the stock market works
The stock market is really a way for investors or brokers to exchange stocks for money, or vice versa. Anyone who wants to buy shares can go there and buy whatever the owners of the shares offer. buyers expect their stocks to rise, while sellers may expect their stocks to go down or at least not go up much more.
so the stock market allows investors to bet on the future of a company. Collectively, investors establish the value of the company based on the price at which they are willing to buy and sell.
While stock prices in the market on any given day may fluctuate based on the number of shares being demanded or offered, over time the market evaluates a company based on its business results and future prospects. A company that increases its sales and profits will likely see its shares rise, while a shrinking company will likely see its shares fall, at least over time. In the short term, however, a stock’s performance has a lot to do with just supply and demand in the market.
When private companies see which stocks investors favor, they may decide to finance their business by selling stock and raising cash. They will hold an initial public offering, or IPO, using an investment bank, which sells shares to investors. investors can then sell their shares later in the stock market if they wish, or they can buy even more any time the shares are publicly traded.
The key point is this: Investors price stocks based on their expectations of how the company’s business will perform in the future. therefore, the market looks to the future, with some experts saying the market anticipates events six to nine months from now.
risks and benefits of investing in stocks
The stock market allows individual investors to own stakes in some of the best companies in the world, and that can be tremendously lucrative. On the whole, stocks are a good long-term investment as long as they are purchased at reasonable prices. For example, over time, the S&P 500 has generated about a 10 percent annual return, including a nice cash dividend as well.
Investing in stocks also offers another nice tax advantage for long-term investors. As long as you don’t sell your shares, you won’t owe any income tax. only the money you receive, as dividends, will be taxed. so you can keep your shares forever and never have to pay taxes on your earnings.
However, if you make a profit on selling the stock, you will have to pay capital gains tax. how long you held the shares will determine how they are taxed. If you buy and sell the asset within a year, it will be included in short-term capital gains and taxed at your regular income tax rate. If you sell after you’ve owned the asset for a year, you’ll pay the typically lower long-term capital gains rate. If you record an investment loss, you can deduct it on your taxes or against your earnings.
While the market as a whole has performed well, many stocks in the market are underperforming and may even go bust. these shares are ultimately worth zero and are a total loss. On the other hand, some stocks like Amazon and Apple have continued to rise for years, earning investors hundreds of times their initial investment.
so investors have two great ways to win in the stock market:
- Buy an index-based stock fund, such as the s&p 500, and hold it to capture the long-term performance of the index. however, their performance can vary markedly, from 30 percent less in one year to 30 percent more in another. When you buy an index fund, you’ll get the weighted average return of the stocks in the index.
- Buy individual stocks and try to find stocks that will outperform the average. however, this approach requires a great deal of skill and knowledge, and is riskier than simply buying an index fund. however, if you can find an apple or amazon on the way up, your returns are likely to be much higher than in an index fund.
Investing in the stock market can be very rewarding, especially if you avoid some of the pitfalls most new investors experience when starting out. beginners should find an investment plan that works for them and stick with it through good times and bad.
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Editorial Disclaimer: All investors are advised to conduct their own independent research on investment strategies before making an investment decision. furthermore, investors are cautioned that past performance of the investment product is not a guarantee of future price appreciation.
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