The stock market can be a daunting place. Investing in stock can be an effective way of building wealth. Investors have to make split-second decisions based on their gut, understanding, and knowledge of the market. This can be especially difficult for a beginner to navigate through. Stock investing starts with understanding the stock markets, and what makes it tick. It also starts with understanding who you are as an investor and how risk-averse you are. So to help out novice investors here’s a beginner’s guide to Stock Investing.
What is investing?
Before we dive into the contents of investing in stock, let’s familiarize ourselves with a few basic terms.
Let’s start off answering the question- what is investing?
An investment is the act of purchase or allocating resources such as money in the hopes of an income or profit generation. Investments do not depreciate i.e. things that lose their value with time and use cannot be considered as investments.
A portfolio is the collection of all your investments. Your portfolio usually contains 5 main types of investments including –
- Mutual Funds
- Money market funds
- Exchange-traded funds
Investment may also include definite investments or assets such as real estate, rare artifacts, etc- in other words, objects that appreciate in value over time.
What are stocks?
Since this is a beginner’s guide to stock investment it is only appropriate, we start with the definition and explanation of what stock is. Stock is sometimes referred to as equity. Stocks are a percentage of the company. If you own stock it means that you own a small percentage of the company. A share is a unit of stock. Stock ownership implies that the shareholder owns a portion of the company equal to the number of shares owned in proportion to the company’s total outstanding shares.
For example, suppose a company has 100,000 shares and you own 1000 of them- this means you own 1% of the company. stockholders are sometimes referred to as Shareholders.
There are two main types of stock- preferred and common stock. The main difference between preferred and common stockholders is that common stockholders have voting rights which can be used to influence certain business decisions for the company. This is not the case for preferred stockholders. But, as the name suggests, preferred stockholders are legally preferred over common stockholders and are the first ones to receive dividend payments before common stockholders.
Common stock can be further categorized into four subcategories-
- Growth stocks– earning is growing is a fast rate. Investors invest in hopes of capital appreciation. E.g a start-up tech company.
- Income stocks– these pay dividends consistently. People investment for the dividend return. E.g. a well-established utility company tends to have income stocks.
- Value stocks– They are relatively cheaper because they have a low price-to-earnings (PE) ratio.
- Blue-chip stocks– These are the shares offered by large well-established, well-known companies, and generally pay dividends.
How do stocks work?
People invest in stocks in hopes of some form of return. There are two main ways in which stocks generate a return-
- Price appreciation– The price of the stock goes up and the investors sell it for a profit.
- Stock dividend– the stock pays dividends which you collect at the end of a financial period.
Dividends are payments made to shareholders’ out of the company’s revenue.
Why do companies issue stock?
A company issues and sells its stock when it needs money. Issuing stock is therefore considered as a means of raising capital. Small startup companies don’t typically issue public stock, instead they offer equity in the form of preferred stock. This is because generally, small startups are not nearly big enough to have enough stocks which can be sold to the public. The process of issuing public stocks for sale is a long process and requires permission from the Securities and Exchange Commission. The initial process of issuing stocks is called an Initial Public Offering or IPO.
Why should we invest?
Before we get to how to invest in stock it is important to figure out why you should invest in stocks. So here are four reasons-
- Economic growth results in an increase in corporate earnings which means your returns on purchased stock also increases, which means you can successfully benefit from the growing economy.
- Return on shares is usually much higher than inflation or the market interest rate.
- The stock market is easy to navigate. Buying and selling of shares in very straightforward.
- Shares are very liquid which means you can sell them off whenever you want.
What is the stock market?
Since this is a beginner’s guide to stock investing, it is only appropriate that we start off by understanding what exactly the stock market is, and how it works.
According to Investopedia stock market refers to the collection of markets such as the New York Stock Exchange (NYSE), Nasdaq, and the London Stock Exchange (LSE) is where regular activities of buying selling of shares of publicly-held companies occur. The primary stock market is where companies float shares to the general public in an initial public offering (IPO) to raise capital. Simply put, the stock market is where the stock exchange occurs. All financial activities in the stock market occur through over-the-counter OTC marketplaces that operate under a defined set of strict regulations.
How does the stock market work?
The stock market works like any other market. There is a commodity- stocks and then there are buyers and sellers. These buyers and sellers come together and negotiate prices to buy and sell shares.
The stock market serves two main purposes. One is to provide the company with capital – which is why the company issues shares in the first place.
The other is to provide the people who purchase the stock -the investors – some form of monetary appreciation or profit for investing. The stock exchange acts as a facilitator for this capital raising process and receives a fee for its services from the company and its financial partners.
How can you invest in stocks?
Now that you are up to speed on what different parts of stock investing and the stock market is let us get to the actual investing part. Investing in stocks is a multi-step process.
The first step is choosing how you want to invest.
You can either go the DIY route and choose your own stocks to invest in. Or, you can opt for a less hands-on route- Robo-advisor. This is a service offered by most of the top brokerages. Through this service you can simply provide the brokerage with your specific goals and budget and they will invest in stocks accordingly. In this case, you can just sit back and enjoy the profits and return generated without having to intervene with the technical aspects or make any decisions.
In case you go for the more hands-on approach the next step would be to open a brokerage account.
An online brokerage account is a cheap and hassle-free option for you to invest in stocks and other forms of investments. You can either open an individual retirement account (IRA) or a taxable brokerage account. Your broker needs to be chosen after careful consideration. Therefore, assess available brokers based on account fees, trading commissions, investment selection, investor research, and tools. Make sure your broker is a well-reputed and trustworthy one.
Many financial institutions have minimum deposit requirements. In other words, they won't accept your account application unless you deposit a certain amount of money. Some firms won't even allow you to open an account with a sum as small as $1,000.
The Robo-advisor service performs all the technical aspects of stock investing for you including opening the broker account. Now I know it seems slightly unorthodox but trust me the Robo-advisor charges a fraction of in-person advisors but gets the same job done.
Now that you have set up your brokerage account you need to –
Decide what kind of stock you want to invest in.
There are two main types of stocks available for you to invest in.
- Stock mutual funds or exchange-traded funds- These mutual funds also sometimes known as equity mutual funds allow you to purchase small portions of various stocks in one transaction. When you invest in a fund you own small fractions of the companies. You can also diversify your portfolio by putting together various funds. These possess a lower risk when compared to individual stocks as they tend to be very diversified and do not have fluctuating prices.
- Individual stocks– You can also purchase a few shares from a specified company as a beginner. Building a diversified portfolio is possible with individual stocks but it will take a large amount of time with significant investment. Prices of individual stocks may skyrocket or plummet depending on factors we will be looking at further down this article. Therefore, individual stocks pose a higher risk compare to mutual funds.
Set a budget.
Contrary to popular belief you don’t have to dive in headfirst with a large startup investment to make money on the stock market. If you are a novice who simply wants to dip their toes and see how stock investment works, you can start with a purchase of as small as $50 dollars.
However, if you want to start small it is suggested that you go for individual stocks because mutual funds tend to have a minimum of $1000 and higher. There are other fees associated with mutual funds such as the management expense ratio (MER) which is charged by the management team each year, based on the number of assets in the fund. Putting all of these factors into account the price of
How to decide which stocks to invest in?
There are many online platforms such as Udemy, Coursera, Skillshare offer insightful and detailed courses for beginners who want to invest in the stock market. If you want a thorough idea of how the stock market works, which stocks to invest in, etc- it is strongly suggested that you take a beginner’s course.
Nevertheless, to help you along here are a few basic tips and tricks you can apply while choosing which stock to invest in.
Do your homework and research before you invest in stocks.
This is a beginner’s guide to stock investing, so, as a beginner, it is crucial that you make educated decisions that are only possible through research. The best way to research stocks is to keep up with the market news. Stock charts are the best way to understand trends in the stock market. Read financial news, blogs, financial analysis articles to keep up with various activities of different companies. Also, trust your gut and observational skills to notice trends and predict whether the price of a certain stock is about to go up or down. You can also research a company by going through its financial statements to see how it performed in the past and how that quality of performance affected their stock prices.
Besides keeping up with overall market trends, news, and financial activities of various companies it is imperative that you keep up and research the relative growth of the industry. Does the industry have the potential for growth? Will the amount of return being generated an increase in the future? Also for specific companies, you can look into the relative positioning of the company in the industry. If it stands out it may have growth and profit potential.
You can also use a screener to filter stocks based on specific criteria such as sectors and industry. You can also sort companies based on market capital, dividend yield and other useful investment metrics.
Another metric that can be used to measure the potential for growth in a company is its dividends. If a company pays dividends it is automatically more stable compared to a company that does not. However, a company paying high amounts of dividends may indicate that it is not reinvesting enough for itself which is not necessarily a good thing.
Figure out what type of investor you are
Are you a risk lover or risk-averse? If you are a risk-taker, then how much risk can you afford to take? These are some of the basic questions you need to ask and answer before you pick which stocks to invest in.
The idea is to create a stock-picking strategy that is a good balance of both risk and return. Start out with minimal risk then as you gain more experience about how the stock market works and learn more about the companies you are investing in, you can increase the level of risk-taking.
The most important point is to take calculated well thought out risks. Don’t just start investing because “just dipping your toes” or “figuring out how everything works”. Whatever decision you make, whichever stock you pick make sure it is well researched.
Forces that drive stock prices
The stock market works the same way any typical market does. As in, stock prices are driven by supply and demand. If there is a surplus of buyers and not enough shares available for them to purchase, the price of that particular stock goes up and vice versa. Other than these two other fundamental factors play a role in determining the price of stock-
- An earnings base, such as earnings per share (EPS)
- A valuation multiple, such as a P/E ratio
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To summarize the entire process of investing in stocks- do your research, be wary of hidden charges and most importantly trust your gut. Always be vigilant and constantly monitor the stock market to make the most educated possible decisions.
I hope this beginner’s guide to stock investing will help kickstart your journey as a stock investor.