Starting to think about retirement? Wondering how you’ll be able to afford to spend your golden years in comfort? Investing in the stock market is one way to increase your wealth and security, but it is not without some serious risks. Follow these tips to get a solid start on your financial future.
Learning About Stocks
Understand the stock market. In order to invest properly, you need to understand what the stock market is and how it operates. Here’s a basic rundown of terms and processes:
- Stocks. Also referred to as “shares” or “equity,” a stock is a certificate that gives the holder part-ownership of a company. In order to raise money, a company releases shares that the public can buy. Each share represents a small percentage of ownership in that company.
- Shareholder. This is a person who owns shares in a company. A shareholder can hold as few as one share and as many as millions. Shareholders are given votes in the company and earn a percentage of the profits.
- Stock Market. This is where shares of companies are bought and sold. It can be a physical place or a virtual market. The three primary stock markets in the US are the New York Stock Exchange (NYSE), the American Stock Exchange (AMEX), and the National Association of Securities Dealers Automatic Quotation System (NASDAQ). All are accessible through stockbrokers, both by phone and online.
Familiarize yourself with different kinds of stocks. There are two main types of stocks: common and preferred.
- Common stock is the form of stock most recognizable to newcomers. It is a share in a company. Common stock can give some of the highest returns in investing but comes with the largest risk.
- Preferred stock gives ownership like common stock does, but does not bestow voting rights. The dividends paid out by preferred stock are fixed instead of variable like common stock. Preferred stock is a more secure source of dividend income than is common stock.
- Stocks can also be broken down into different classes if the company chooses. Typically, a company will make one class of share have more voting rights than the other, to make sure that certain groups maintain control of the company.
Learn about how stocks increase and decrease in value. Stocks operate according to the law of supply and demand. As the demand for a stock increases and more people are interested in buying than selling, the price of the stock goes up. This is because there is less supply of the stock and each share becomes more valuable. Stocks generally increase in demand as the company succeeds, and their demand lowers if the company performance suffers.
- Demand is often based on expectations of future performance. When investors feel that the company will be performing better in the near future, demand will increase.
- It is impossible to predict with any certainty how the overall stock market will behave. This is why there is so much risk associated with this form of investment.
Find out about dividends. Dividends are a benefit paid to shareholders at the discretion of the board of directors.
- Stable companies often pay dividends to keep investors happy when their stock price does not rise much.
- Dividends are a great way to earn “passive” (automatic) income over a long period of time.
Understand why you want to invest. Ask yourself why you want to invest and what you expect to gain from it. The stock market can be very volatile, and a bad day could see you lose a significant part of your investment.
- Good investors invest for the long term. If you are looking to cash in right away, the stock market might not be a good place to put your money.
- Don’t invest if you are trying to get out of debt. Make sure any high-interest debts are taken care of before investing in the stock market.
- Successful stock investing requires dedicated time from the investor. Ask yourself if you have the time to investigate companies for at least a few hours a week. Such research is extremely important. There are many research services available to do some of the leg work for you. Look online for websites like Scottrade, ShareBuilder, Motley Fool, E-trade, TDAmeritrade, TradeKing, Morningstar, and TheStreet, to name just a few. It is very dangerous to pick stocks without first investigating them thoroughly.
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Method 1 Quiz
Which stock is worth more money, a stock in high demand or a stock in low demand?
Choosing Stocks to Invest In
Determine your strengths. Since you will have to do some research when it comes to which company to invest in, focus at first on companies that you have some working knowledge of. This will make things a little more interesting and engaging as you get started.
- Check local companies, as you may have more of an opportunity to engage them and get a feel for how their business affects your area.
Consider the overall value of a stock. You’ll need to do some research and math to determine the value of a company. You’ll soon see that a one-dollar stock is not necessarily cheaper than a $40 one. A stock with a real value higher than the listed price is one that’s probably worth buying.
- Since buying stock means buying part-ownership of a company, determine if it would make financial sense to buy the entire company (assuming you had the money).
- Find out how long it would take to pay off your investment from profits if you bought the entire company. Use the results to determine if it is worthwhile to invest in shares.
- Keep in mind that profits can change wildly as markets change. Technologies can become obsolete, or regulations could change, rendering a company’s products less valuable or even useless.
To determine the value of a company, you will have to look at several variables. These include Future Performance, Cash Flow, and Revenue, among many others.
- Future Performance. A company’s worth is based largely on projections of future performance. Past performance is important only as an indication of how the company will perform in the future.
- Cash Flow. In general, a company that has a lot of assets and high operating costs has less cash flow than a similar business with less assets and a lower operating cost. Cash flow is cash on hand that can be used to pay debt.
- Revenue. Revenue is one of the major factors when valuing a company. If two companies have the same cash flow, but one has a higher revenue, that company will most likely be worth more.
Create a diverse portfolio. While it is important to invest in what you know, you don’t want all your eggs in one basket. If something happens to the industry that you are invested in, you could lose much of your investment in short order. Invest broadly to minimize risk of sudden loss.
- Invest in a broad range of economic sectors. If you are heavily focused in technology, consider investing in consumer goods, real estate or any number of other industries.
- Most investment experts recommend against putting all of your investable funds into the stock market. Also consider bonds, currencies, and commodities.
- Try to create a portfolio of around 20 different stocks that aren’t related. This should be a manageable number to keep track of while still providing a wide array of earning opportunities.
Know when to buy. Buying at the right time is essential to successful investing.
- Don’t buy everything at once. If the market takes a downturn right after you buy, you could lose most of your investment. Instead, spread out your initial investment over several months to minimize the risk each time you buy.
- Consult a stock chart when considering stock purchases. Google and Yahoo both provide comprehensive online stock charts, and there are many other similar services to choose from.
- Check to see if the stock trend is rising. This means that the price has been increasing steadily. Look for stocks that are increasing but not necessarily rapidly. Stocks will only go so high, so if a price is climbing rapidly, there’s a good chance that it will level off or drop soon.
- Check the volume of trades. If a stock is finding steadily more buyers, that’s a good indicator of the stock’s health. A rising price with a declining volume could mean that the price will drop soon due to lack of interest.
- Find the moving average of the stock. The moving average is the average price of a stock over time. Ideally this average would be increasing and the listed price would be above this average.
- Avoid volatile stocks. If the price jumps too much, and there are a lot of spikes in the chart, the stock is probably too unstable to safely invest in.
Contact a broker when ready. In order to buy stocks, you must go through a licensed stockbroker. There are many options to choose from, but they boil down to four main choices. Determine which one will suit your needs best.
- Online/Discount Broker. Online brokers are essentially order-takers. They provide no personal assistance, and leave the decisions of what to buy and sell up to you. Fees are usually per-transaction, and they typically require very little initial investment to open an account. The research will be up to you.
- Discount Broker with Assistance. This is essentially the same as the category above, except the broker may provide a bit more basic research, such as newsletters and in-house research reports. The fee is often higher than online-only because of these extra services.
- Full-Service Broker. These are the traditional stock brokers who will meet with you and discuss your full financial situation, as well as risk analysis. They will help develop financial plans and give advice in other financial areas such as taxes. Full-service brokers will be quite a bit more expensive than a discount broker, but many offer significant benefits.
- Money Manager. A money manager takes full control of your personal finances. Their clients are typically those with a significant amount of income, and the usual minimum account is $100,000 or more.
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Method 2 Quiz
True or False: A company with a strong past performance will have a strong future performance.
After You Invest
Buy and hold good stocks. Selling stocks as soon as they rise in price is a sure way to move nowhere fast. Practice self control and hold on to solid stocks unless you’re desperate to raise cash. Good stocks can result in big payoffs over the long run.
- If you buy and sell repeatedly, much of your profit will go to commissions for brokers, and your gains will suffer.
- “Day trading” is stacked against newcomers, because they trade against seasoned professionals and computer programs designed to buy and sell at optimum moments.
- Instead, hold on to stocks of companies that are solid and growing. If your stocks pay dividends, reinvest them to increase your earning potential.
Add to your portfolio as you go. Once your portfolio is established, revisit it every so often and make appropriate changes.
- Move money out of sectors that aren’t performing well and invest more in areas that are seeing greater returns.
- Add more investments with additional funds as they become available in order to continue diversifying.
Know when to sell. Ideally, you want to sell a stock when it reaches the value you determined when investigating the company and when the value is not expected to rise much more.
- If your stock has not met the target value and doesn’t look like it’s going to, sell it, especially if the price falls below the moving average. This is typically seen as the “last chance” to get rid of a stock before it dips too low.
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Method 3 Quiz
True or False: Sell your stocks as soon as their prices rise.
What To Expect Using a Professional Broker
Expect to pay a fee for every transaction you make. Brokers make their money charging you for each time you buy or sell a stock. You need to know this fee going in, but you also need to make it clear to your broker your acceptable level of trading. Some brokers will try to sucker in novice investors with high-commission stocks and multiple trades to make more money.
- If you have a large account and plan on frequent or aggressive trades, you might look for a commission-based account, where the broker gets a percentage of your portfolio instead of a fee per trade.
- If your broker is making frequent changes and trades, known as “churning,” they may be trying to raise their commission. Any trading that eats into your principal should be red-flagged.
Expect your broker to ask your acceptable level of risk. Your risk tolerance determines how bold of an investment the broker will take. Stocks are, in some way, gambling, and there are both safe bets and long-shots. Your broker will want guidance on where to steer the portfolio, based on your financial needs:
- Younger investors should aim for high-risk investments. Stocks are a long game, and any busts now will more than likely be rectified with later booms. You have the time to afford the risk.
- Middle-aged investors should strike a balance between safe and risky stocks.
- Low-risk accounts will make safe bets with lower profits. These are great for older investments who could not deal with a sudden loss of money near retirement, or those who only want slow, reliable growth.
Expect most professional investors to choose margin accounts, not cash accounts. There are two basic investment account options — cash and cash/margin accounts. Cash accounts must have a deposit available to make a trade– the money must be on hand. Margin accounts allow you to borrow money from the brokerage firm to purchase stocks. This loan is based on the expected profit from the stock.
- Cash accounts are safer, but yield far less profit. You know exactly where all your money is, and whose money it is.
- Margin accounts technically put you into debt, though interest rates are far lower than that at a bank. Because they make more money available to you, you stand to earn more money. Some higher-risk trades are only available on margin accounts.
Expect the broker to determine your tax status based on your financial needs. Are you in the stock game to make a profit right now, or for retirement? Depending on how you classify your portfolio, your broker can get you potentially lower tax rates.
- Standard brokerage accounts can be swapped, taken out, and edited on the fly. They can be short or long-term investments or a bit of both. They are fully taxed.
- Retirement accounts, like IRAs, pay much lower taxes. However, you can only take the money out of them at a certain age, or risk losing much of your profit.
- A professional trader would usually have both types of accounts, though this requires a lot of upfront cash.
Expect the meeting to end with a request for your investment money. Most brokers will give you up to two weeks to give them money. You can cut a check, which will take about a week to get cleared. If you’re in a hurry, expect to get a routing number and instructions to wire transfer your money over.
- Professional investors always set aside specific accounts for investments. They don’t link their investment money to a savings or checking account.
Expect a professional broker often uses algorithm-based trading. The stock market is not what it used to be. Professionals now have mines of data, and computer programs to sift through them, making split-second trading decisions for your investment that you could rarely make alone. This is why, if you have the money, full-scale brokers often turn the highest profits.
- That said, the financial crash of 2007 was partially due a broken algorithm that investors used but didn’t understand.
Expect a professional to invest in things other than stock. While investing in the stock market may be the goal, a professional investor knows better than to put all of their money in one basket. All of these, including stocks, fall under the blanket definition of a “security.”
- CDs, or Certificates of Deposit, are savings accounts that mature at a certain date, at which point you receive a small profit. They can range from one month to five years.
- Bonds are loans that your grant, usually to the government, that must be paid back with interest. They are safe, consistent investments that generally outpace inflation.
Expect a broker to invest in “funds,” or pre-made collections of stocks. Funds are created either by a brokerage firm or an outside agency. Basically, they allow multiple investors to take risks together by all paying together for a larger portfolio, and thus more profit as there is usually a manager of the funds who buys and sells stocks inside of it. While they are usually profitable, you have to be comfortable with someone else handling your money with little control on your end.