Beginners Guide to Investing in the Stock Market
Anyone new to investing in the stock market can become quickly intimidated by the hype and vocabulary surrounding it. Options, calls, yields, dividends, small-cap, large-cap, we’ll explain everything you need to know to start investing in the stock market. Perhaps the vocabulary used is meant to scare individuals away, leaving financial advisors raking in commissions, typically ranging from 3-6%. This is money that is thrown away, instead of being invested. Whether you have a few hundred dollars or a few hundred million dollars, the principals around investing in the stock market stay the same. There are certain things you should always be on the lookout for. Keep reading to understand the principles and strategies some of the top financial advisors use to maximize their clients' returns in the market.
Before you start investing in the stock market, you’ll need to understand your financial situation, your goals, and your risk tolerance.
Decide your initial investment amount
First, you’ll need to decide how much to invest. Keep in mind that when investing, you should be prepared to lose your money as no return is 100% guaranteed. Returns are typically calculated as a percentage on your investment. For example, if you invested $100 and one year later your investment is worth $110, you would have a 10% return on investment (ROI). Depending on the brokerage you chose, there might be minimums to open an account. However, some newer brokerages targeted towards millennials offer lower fees with no minimums.
After deciding how much you want to invest initially, you’ll need to define your investment goals. Is your goal to save for retirement and build wealth? Or is your goal to simply hold money and match the inflation rate? Defining what you want from your money will decide what strategies you use in your investment portfolio.
Determine risk tolerance
Are you financially prepared to lose 100% of your investment? If not, you’ll certainly want to choose a conservative investment strategy. If you’re prepared to lose it all, we’d recommend a more aggressive investment strategy to maximize your returns.
Open an account
In order to purchase stocks, you must sign up for a trading account. First, you’ll need to decide what kind of account you’ll need. A traditional brokerage account is acceptable for this case. There are no tax advantages for this type of account. Next, compare brokerage pricing and incentives with the goal of lowering fees. Minimizing fees can become a large part of your investment strategy so it’s important to start out this way. Once you’ve weighed the cost and benefits of the brokerage, it’s time to make your decision and fill out all of the paperwork to open your account.
How does the Stock Market Work?
The stock market is defined as the aggregation of buyers and sellers of stocks, which represent ownership claims on businesses. Each Monday through Friday at 9:30am ET (excluding holidays), the stock market opens where people can buy or sells stocks. There are many different markets when people refer to the stock market. In the United States, the most popular securities markets are the New York Stock Exchange (NYSE), the National Association of Securities Dealers Automated Quotation (Nasdaq), and the American Stock Exchange (AMEX). When the markets open, people buy and sell stocks for the prices they believe the company is worth. Computer algorithms determine the price at which you can buy or sell a stock based on supply and demand.
What are the most common investment strategies?
People use many different things to determine what a stock is worth. Some people don’t use anything at all. There is a wide variety of investment strategies, we’ll cover some of the most common below. On average, the stock market has returned 10% annually over the past 90+ years. Many will use this as a guide to determine how their strategy is performing. If you can consistently obtain 15% returns while the market is returning 10%, you’re on the right track!
Diversification is an extremely common investment strategy that lowers your overall risk compared to other strategies. This investment strategy encourages you to invest in different companies in many different sectors. This way, if one company underperforms, you can still achieve a positive return with the help of your other investments. Diversification is not just an investment strategy for stocks. It is recommended that you invest in other areas such as real estate and bonds to achieve true diversification.
Some people like to invest their money in specific sectors they believe will outperform the market, like technology or healthcare. There are both positives and negatives to this strategy. If the sector is doing well, you’ll be doing great. However, if the sector underperforms, you’ll be hurting. While we don’t recommend this strategy to new investors, those with more experience might be able to succeed with this one.
How do stocks make money?
There are two main ways stocks produce income. Appreciation and dividends. We’ll cover each in more detail below!
Whenever your stock increases in value, you obtain capital appreciation. This is simply, the increase of value in your stock. Whenever you decide to sell your stock, the difference between what you originally paid and the selling price is your capital appreciation. Stocks that are considered “growth stocks” typically focus on this type of return to its’ shareholders. To do this they oftentimes pay very low, to zero in dividends and instead reinvest any profits back into the company in hopes of producing even higher profits in the years to come.
A dividend is a sum of money paid by a company to its shareholders out of its profits. Certain companies offer higher dividends than others, and some offer no dividend at all. AT&T (T) for example, offers an annual dividend yielding 6.3% (2019). Add that plus slight capital appreciation and it’s a pretty good return! It’s important to note that dividends are not guaranteed. If a company has a low performing quarter or year, the dividend might decrease or cease to exist for that time period.
How is a dividend paid?
Whenever a dividend is announced, you will receive the amount prorated to the number of shares that you own. These funds will become available to you in your brokerage account or by a check in the mail depending on the type of account. You can choose to withdraw these funds or reinvest them.
How do stocks affect my taxes?
As the saying goes, “nothing is certain in life except for death and taxes”. The IRS treats your gains on your investments either one of two ways depending on how long you have owned them. For stocks that have assumed capital appreciation (increase in value), you will have to pay taxes on the difference of what you paid and how much you sell them for. If you have held the stock for more than one year, you will need to pay long term capital gains tax. If it has been held for less than one year, it is taxed at your normal income tax rate. It’s worth noting that the long term capital gain tax rate is less than your normal income tax rate, so it’s advantageous to hold your investments for more than one year.
What happens if I lose money on my investments?
While no one aims to have negative returns, it happens. Maybe you don’t like the outlook of the economy and you decide to sell some of your investments at a loss. There’s good news, you can deduct up to $3,000 in capital losses per year. Anything over $3,000 can be carried forward to deduct on your next years tax return.
For example, if you were to lose $5,000 this year, you may deduct $3,000 in capital losses with $2,000 being carried forward to the next year. If next year you were to sell investments for a positive return of $8,000, you will subtract the $2,000 that was carried forward, leaving you with $6,000 in taxes owed.
Taxes are dependent on your own financial situations. Always consult a tax professional before making any decisions.
How long does it take to make money in the stock market?
The stock market is NOT a get rich quick scheme. While you can get rich overnight, this is not normal. It is recommended that you plan to hold stocks for a year or more to avoid short term volatility and for tax advantages mentioned above. If you will need access to your money within a year, perhaps a high-interest savings account it a better option for you.
When you first decide to invest in the stock market, don’t get intimidated by the verbiage and jargon surrounding it. Do your research first and stay the course to maximize returns and avoid short term market volatility. Have questions? Comment below! Want to learn more about stocks and the stock market? You can read all of our posts here!