Stock Market for Beginners: An Overview
Let’s face it: investing in the stock market can be a little intimidating for beginners. It will be a true test of your patience, financial skill and decision making abilities.
Don’t be dismayed, though.
Today, more than half of all American households have some investments in the stock market. It’s one of the best ways to set yourself up for financial success, with potentially astronomical rewards if you play your cards right.
Keep reading to learn more about stock investing, how to pick a great stock, and other investment advice that can help guide your decisions.
First Up: What Exactly is the Stock Market, Anyway?
The first thing new investors need to understand is that there is no single stock market. Rather, there are many different stock exchanges where companies and institutions come together to buy and sell shares in a public sphere.
Here in the U.S., the three most widely followed stock exchanges include the S&P 500, the Dow Jones Industrial Average, and the Nasdaq Composite. There are 13 exchanges altogether, and each one is a little bit different.
How Stock Trading Works
When you open a trading account and buy a stock, you are purchasing a tiny piece of ownership in a publicly traded organization. The more the company grows and earns, the better your earning performs. And the more shares that you purchase, the more power you gain.
There are many different ways that you can approach buying and selling — or trading — stocks. From a high level, successfully trading stocks is all about buying shares and then watching them increase in value, and trying to make the best decisions that will set you up for success.
How to Get Started with Stock Trading
Buying stocks isn’t like going to the grocery store for milk and eggs. If you want to buy stocks, you have to go through a special type of firm called a brokerage.
That sounds intimidating, but you can start investing in the stock market with just 4 easy steps:
What is a Brokerage Account?
A brokerage is a company that trades stocks on your behalf. Some of the most popular brokers in the U.S. today are Charles Schwab, TD Ameritrade, E*Trade, and Fidelity. Most investors today use an online brokerage for their needs. Think of them as online stock brokers who make it possible to buy and sell stocks online.
Even though you are buying through a brokerage, you still retain full control over the stocks that you trade — if you want to. Some people, after all, will choose to pay an advisor to manage their accounts for them, and this is fine (as long as you have a trusted source who is doing it and not some average Joe off the street).
Tips for Choosing a Stock Broker
Some features to consider when shopping for a brokerage:
- Pricing – Select a broker that charges the lowest possible fees for the type of stocks that you are trading
- Overall service – Partner with a broker that offers easy online trading and access to charts and comparison tools. You should also have access to experts whenever they’re needed to help you make informed decisions.
- Dashboard – Make sure you’re comfortable with the user interface that you’ll be using. Some are easier and more intuitive than others.
Selecting the Right Type of Account
For the sake of this article, we’re not going to go into great detail about specific types of accounts. However, you will need to select the right option when setting up a brokerage account.
If you’re investing on your own, you’ll be using an individual brokerage account. If you’re working with someone else (like a spouse or partner), you’ll need a joint brokerage account.
You’ll also need to select the right type of model. Determine whether you want to set up a retirement account (like a traditional IRA or a Roth IRA). Retirement accounts will limit how much you can contribute annually. But they will come with specific tax benefits to aid in your retirement.
If you’re just looking to invest without a contribution limit or tax advantage, then move forward with a regular contributory account.
Funding Your Brokerage Account
This is (usually) the easy part. Funding a brokerage account is as simple as linking your online bank account with your brokerage firm.
Make sure to do a bit of research into this before you move forward with a brokerage provider. It should be a seamless process but this is not always the case.
It’s also important to be strategic about how much money you keep around in your brokerage account. Keeping less in your account may deter you from making rash investments without properly researching them. However, you also don’t want to miss out on great investment opportunities when they arise — or worse, borrow money to make an investment because you lack funds in your account. That’s an easy way to spiral into debt.
So, spend some time planning and determine how much you’re willing to risk at the onset and take it from there.
Different Types of Investments to Make with a Brokerage Account
This is where it gets a little bit complicated. Once you fund your brokerage account, you’re going to be presented with a full menu of options. So it’s a good idea to have a sense of what you’re looking at ahead of time.
1. Stock Investments
As previously mentioned, individual stocks are tiny ownership fractions issued by corporations. Individual shareholders become part owners in the company. With successful companies, shares typically become more valuable as profits grow. Some companies pay dividends, which can be accrued at various points in the year — some pay quarterly dividends, while others pay annually or semi-annually.
Generally speaking, stocks are considered a high-risk investment because of the natural volatility of the stock market. However, stocks can vary significantly in their amount of risk, so it’s important to research and find companies that match your specific level of risk tolerance. This refers to your ability to weather something like an unexpected market downturn, or if a stock goes belly-up.
Your overall risk tolerance will depend entirely on your unique situation — like your age, your financial goals, and how much you’re looking to earn over time. If you’re having trouble determining your risk tolerance, consider working with a financial advisor. They’ll be able to set you up on the right path.
2. Bond Investments
In addition to stocks, brokers also provide access to bonds, which can be defined as debt instruments that have a promise to pay back a principal purchase, along with interest. Bonds are issued by government institutions, financial providers, and companies and payments are issued in the form of coupons.
When you purchase a bond, you are essentially making a loan to the organization that you purchase it from. Bonds come with a relatively low risk level compared to stocks, because bondholders are prioritized for repayments and liquidation. For many, bonds are a cornerstone of their personal finance plan.
3. Mutual Fund Investments
One of the best ways to accrue wealth over time is to invest in strong mutual funds. A mutual fund is a professionally managed investment that pools money from numerous investors to purchase securities.
Mutual funds offer many benefits, the primary one being market diversification. Since mutual funds track specific stocks, they can help you invest without putting all your eggs in one basket.
You can also look into index funds, which track specific market indexes.
One thing to watch out for when purchasing mutual and index funds are high fees, which can vary significantly.
Tip: Consider Vanguard Funds
Fees can be significantly lower for automated Vanguard index funds, which simply track individual markets without manual intervention. Vanguard has some great funds that can help you rack up money that would otherwise be passed along to fund managers.
You can also look into some of Vanguard’s competitors like Edward Jones, Merrill Lynch, and Franklin Templeton.
An exchange-traded fund (ETF) is a collection of securities that are sold on an exchange. ETF prices change throughout the day based on supply and demand.
ETFs are assembled by professional managers. There are also many different types, including diversified passive equity, niche passive equity and active equity.
There’s a lot more to say about ETFs — another post for another day — but many people see them as an easy and low-cost way for new investors to get into the market with a diversified portfolio and take some of the guesswork out of stock investing.
Building a Portfolio
All of this might seem overwhelming at first — and that’s perfectly fine. After all, you’re just getting your feet wet here. At this point, you now have a basic understanding of how the stock market works, some of the major exchanges to know about, and some of the individual types of investments that you can make through a brokerage firm.
Next, it’s time to start thinking about your first few investments. This is the point when most advisors will inform you that he or she can’t tell you which stocks to buy, but they can help you make the right choices.
For the sake of this example, let’s assume you have $3,000 to invest, and that you’ve already moved it into your brokerage account. Now, you’re locked and loaded and ready to find some growth stocks.
Now, this is where it pays to be patient and do some research before you throw all of your money into a sexy stock with a high share price, like Tesla or Apple. Before you do anything, you should spend some time thinking about building a robust investment strategy. Remember that you’re trying to build a foundation for success.
First, spend some time thinking about what that $3,000 means to you. Are you looking to potentially double your money in just a few months or years? Or do you want to use it as a foundation for long-term savings? This is important, as your entire strategy will bank on this decision.
You don’t have to go all-in on a particular strategy, either. For example, you could split the $3,000 in half and build a strategy that is both aggressive and conservative.
Diversity: A Critical Need
One important thing to consider if you’re just starting out in the stock market is to focus on building a diversified portfolio.
Simply put, a diverse stock portfolio is one where risk and opportunity are spread out among many different types of investments. For example, you may choose to buy a few conservative stocks, a few risky ones, and a mutual fund. Or, you could invest in a single fund that tracks many different companies in a particular index.
Spend some time exploring your options, and spread out your investments as much as you can. Take a look at any successful investor, and you will see that they do this. Very few people get rich banking on just a few different stocks.
Handling Market Volatility
If you’re gotten to this point in your investing journey, you’re probably familiar with Warren Buffett — the CEO of Berkshire Hathaway who is now worth more than $80 billion, and one of the most respected long-term investors in the world.
Warren Buffett once had a great quote, when he said “Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.” Of course, there are exceptions to this. For example, you may want to take a gamble on a small stock, and sell at a timely point. However, this is extremely risky. You’ll also have to pay taxes on stock gains, which is something that you’ll need to consider whenever you trade.
Right now the stock market is full of people who are buying and selling on whim, based on how they feel the pandemic is going. If you’re buying based on which company just announced the latest vaccine, you better believe that the experts knew about the development long before you did. Using that approach, some are getting rich, but many are losing money left and right because they simply don’t know what they’re doing.
So, be aware of the “hold on for dear life” strategy. Stick to investing in sound companies that pay strong dividends, are in high demand, and which aren’t going anywhere and focus on making money over time and you will be in good shape in the long haul.
People often run into trouble when they put too much into the stock market, and become overly reliant on it. Best practices call for building a well-rounded portfolio and building a life that operates outside of the scope of the market.
For example, you could open a high yield savings account (HYSA) with a high interest rate to store quick cash, and park some money in real estate or life insurance. This way, you will have options to draw on cash when you need it, allowing you to keep your money in the market longer and avoid shorting investments.
FAQs About the Stock Market
What are penny stocks?
If you’ve watched The Wolf of Wall Street, then you’re probably wondering about penny stocks which is what the real life Wolf, Jordan Belfort, got rich on.
Penny stocks are micro-cap or small-cap stocks. These are common shares of public corporations that trade for what you might be able to find in your couch cushions.
Are penny stocks worth it?
Penny stocks are considered a very risky investment, largely because they come with limited information and because they are unregulated by the SEC. As a result, there are many scams — known as pump-and-dump schemes — out there in which con artists take advantage of unsuspecting investors by building up the hype around a little-known company and then selling their shares once they’ve driven up the share price. So penny stocks are probably not one of the best stocks to consider if you’re just starting out.
As with most investments, there’s a chance you can get rich with penny stocks. But you are more likely to lose a lot of money if you don’t know what you’re doing.
Is it a good idea to sell stocks?
It can be a good idea to sell a stock, especially if you see a better opportunity for your money elsewhere or if the reason you bought in the first place has changed. But timing the market is a risky game, especially for newer investors. Many investors are trying to do this right now during COVID-19, buying stocks low in certain industries like oil and hospitality, with the plan to sell them strategically when they reach certain thresholds.
As with most investments, the answer is that decision whether to sell stocks depends on a lot of factors — and most investors have nowhere near enough data on present or past performance to make a truly informed decision about selling stocks. So, seller beware.
What is a stock price?
A stock price is the price of a single share of a number of stocks within a company. The stock price is the largest amount that someone is willing to pay for a particular stock.
As an example, a technology company could hypothetically have a stock price of $50 per share. So if you were to buy $50 worth of stock, you would have one share. If you were to spend $200, at that price you would have four shares.
The way you make or lose money on a purchase is when the stock changes in value after you buy it. Going back to our technology company example, suppose that stock rises to $100 per share. If you buy four shares at $50 each, your investment would rise to a value of $400.
This is where it gets tempting to sell high. If you think that a stock is overperforming in the short-term, then you might be tempted to sell quickly and collect your profits. If you think the stock will perform well in the long term, then it makes sense to ride out your investment and weather the storm regardless of what happens.
Many early investors in Amazon sold their shares when they jumped from $5 per share to $100, and they probably felt pretty smart about their gains at the time. But with Amazon higher than $3,000 per share today, those same sellers are probably feeling a lot of regret right about now.
Are Robo Advisors a good idea?
Robo investors are generally for people who are new to the stock market. The best robo advisors will first ask you questions to understand your unique situation, and then make investments depending on your goals.
Robo investments can be a good idea if you’re new to the market and want a little bit of help getting started. But in the long term, they can make you lazy and can prevent you from making strategic investments.
They can also come with high fees, which is something to watch out for. Every dollar you spend on fees is a dollar that you’re not investing.
The Bottom Line
This may be a lot to take in, but you’ll get the hang of it sooner or later. The best investors never stop learning — they are continuously ingesting information and using it to try new things and make better decisions. But all of them started where you are, by learning about how the market works and building a basic strategy.
In fact, just by reading this, you’re one step closer to sipping a mojito on a private island (or building your own money pool, like Uncle Scrooge). And the best part is, you don’t have to be a Wall Street pro in New York to do it. Anyone can become a great investor.
Keep learning, keep investing, and you’re bound to retire rich.