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The stock market can feel like an overwhelming and foreign topic for many people. You know that the stock market can be a valuable tool for building wealth, but you might have no idea where to start or how to invest. This is a guide to the stock market for beginners. We’ll take you through the relevant terminology, the risks and rewards of the stock market and some tips for investing.
By the end of this blog, you’ll feel confident you have the foundational building blocks to become a player in the stock market yourself.
What Are Stocks?
A stock, also known as an equity, is a unit of ownership of a corporation. When a company “goes public,” they allow investors to purchase a part of the organization. This entitles the stock’s owner to a proportion of the organization’s assets and profits, in direct proportion to how much stock they own. Units of stocks are called shares.
In addition to receiving a portion of profits, certain shareholders have the right to vote in the elections for the board of directors.
Lastly, shareholders also benefit from “limited liability.” This means that if the company goes bankrupt or loses a lawsuit, your stock might become worthless, but no one will ever come after you to garnish your assets.
Types of Stocks
There are two types of stocks: common and preferred. Common stock comes with voting rights, while preferred stock does not. However, preferred shareholders have priority in payouts. This means preferred shareholders are paid out dividends before common shareholders. Common stockholders are paid last after creditors, bondholders and preferred shareholders.
There are three standard classes of stock: Class A, Class B and Class C. An organization will issue different share classes as a way of assigning various rights to different types of stockholders. There can be different rights for voting, dividends and the rights to the company’s assets and capital.
For example, an organization might release Class A shares where each share holds one vote. Then, executive Class B shares are released where one share owns 100 votes.
Depending on what priorities you have, you’ll want to carefully consider if you want common or preferred stocks and if you’re interested in different stock class levels.
What Is the Stock Market?
The term “stock market” encompasses the collection of exchanges and markets where regular buying, selling and issuance of stocks of publicly held companies occur. The stock market refers to the stocks that are publicly traded and available for anyone to purchase.
“Stock market” and “stock exchange” are often used interchangeably but aren’t exactly the same thing. The stock market is made up of all the stock exchanges in the world. Some of the world’s major stock exchanges are the New York Stock Exchange, the Tokyo Stock Exchange and the London Stock Exchange.
The stock market comprises investors and traders, who usually have different perceptions about the value of a specific stock. A stock exchange provides these individuals with a platform where they can trade these stocks.
The Risks and Rewards of Investing in Stocks
Investing in stocks can be very lucrative as it can get you more money (and get it faster) than if your money sits in a savings account. For example, the average interest on a high-interest savings account (HISA) right now is between 0.6 and 0.8 percent APY (annual percentage yield). In comparison, the average return on investments in the stock market is 10.83 percent. That is quite a difference!
However, as with anything that offers the potential for significant financial gain, there are risks involved. You could lose the money you’re investing, so you need to be smart about your investment choices.
Generally speaking, you want to invest for the long term. Investments for the short term have a higher risk. When the stock market dips, typically, if you wait long enough, it will “correct” itself. However, when you’re investing for the short term, you may not have the luxury of waiting, and you may need to pull your stocks out when you’re at a loss.
Investing Tips for Beginners
DIY or Open a Robo-Advisor Account
The first thing you’ll want to consider is whether to take a DIY investing approach and manage everything yourself or outsource some of the work to a robo-advisor account. Robo-advisors are automated investment accounts that use an algorithm to make investment decisions. They charge you a small fee but do all the work for you.
Usually, you pick what kind of investor you are (risk-averse, balanced or risk-tolerant) and let the account do everything else. The robo-advisor will adjust the portfolio based on data and stock market trends, report on results and automatically take deposits from your account.
On the other hand, a DIY approach will be free but will cost you time. You’ll need to take the time to educate yourself on which stocks to buy, learn how to buy and sell stocks, analyze your returns and balance your portfolio as needed.
With either of these options, you’ll probably need an investment account with a brokerage.
Make Use of Index Funds
Mutual funds and exchange-traded funds (ETFs) are safer for beginners than individual stocks because they have more diversity. Mutual funds and ETFs are made up of groups of stocks rather than an individual stock. This tends to balance the risk as when one stock dips, others in the group hold steady or increase.
An index fund is a type of ETF that matches a financial market index, such as the S&P500. Rather than buying into a single company, it’s like buying into how the entire stock market will perform.
Every investment portfolio should be diverse to balance the total risk to the individual. You want some risk, as that is where the big wins usually come from, but you should also be smart about the risk.
Typically, your portfolio’s diversification should directly correlate to your age. When you’re younger, you’ll likely have more time in the stock market, so you can ride its highs and lows. Therefore, you have a higher tolerance for risk.
The general rule is to subtract your age from 100 to get the portfolio percentage that you should keep in stocks. For example, if you’re 25, you should keep 75 percent of your portfolio in stocks and 25 percent in mutual funds.
Stick to a Budget
If you see an uptick in your investments, it can be tempting to throw everything you have into your portfolio. However, remember that investing is about the long term and you don’t want to have to take that money out early for an emergency. Set a budget and don’t let yourself invest past a certain amount.
Every time you get a raise, consider increasing your investment contributions. Additionally, if you’re paid out dividends, try to put this money back into more investments.
Don’t Let Fluctuations in the Market Scare You
Remember that investing in stocks is a long-term strategy; the market will be better at some times and worse at others. You just need to stick it out through these fluctuations.
For example, the United States has seen four major market crashes: 1929, 1987, 1999 – 2000 and 2008. A market return eventually followed all of these stock market crashes.
You want to check in on your stocks regularly, but there’s also a danger in checking too often. If you see stock prices falling temporarily, you may panic and try to pull out. Decide ahead of time how often you want to check on your portfolio and don’t exceed that amount.
Invest in Your Financial Health
Your financial health is based on you feeling secure about your financial future and making smart monetary decisions. Most experts agree that to be financially secure, you need minimal (or no) debt, a six-month emergency fund saved up, a healthy credit score and credit report, retirement savings and a diversified portfolio.
You can’t achieve these goals without taking control of your finances. Now that you’ve tackled the stock market for beginners, consider also looking through your credit report, your outstanding debts and any other financial factors that may be holding you back from exceptional financial health.
