Investing is hard. The world of finance is best left to stock brokers and mutual fund managers. Regular people will never understand the incomprehensible jargon, obscure acronyms and complex math involved in making every investment decision.
At least, that's what they want you to think.
In reality, once you dig in to the world of stocks and bonds, you'll find it's not nearly as intimidating as investment pros would have you to think. A multi-billion dollar industry revolves around you making the decision to outsource your investment decisions instead of doing it yourself. And while there are certainly financial gurus out there who are fantastic traders, almost all their strategies boil down to just a few simple values: patience, discipline and passion for learning.
First, a little background. I started investing in 1990 and made my share of mistakes. It's the nature of the game. As time passed, I learned from those mistakes and have become a much improved investor. Anyone who's been in the stock market for a while will tell you that. We're all intelligent, but we lack wisdom at the start. Over time, you'll accumulate that wisdom and be on par with savviest investors.
Before you jump in, you need to know that investing takes a commitment of time. If you don't have the time to keep up with your investments, then mutual funds still remain the best choice for you. Some investors dedicate an hour or two every week to their "homework," while others like to spend some time every day checking up on current and future investments. It's up to you. As they say, "you reap what you sow."
There's never been a better time to take control of your investments. Information is abundant and the fees associated with trading and investing are so low that you can make thousand-dollar transactions for the price of a cheeseburger.
So without further adieu, for those new to the investing game, here's a quick overview of everything you need to know to start building your own portfolio.
Create a Game Plan
What are you looking for in an investment? A stable dividend-paying blue chip may offer more in income (great for an income investor) than it does in a rising stock price (bad for a growth investor). Maybe you have the stomach for stocks that have potential to rise sharply, but that could go to zero if the idea doesn’t pan out. Are you happy to stay stateside, or would you prefer some exposure to another part of the world?
You should probably have at least some exposure to all these types of investments, but establishing a game plan upfront is vital. The road map you create should stand the test of time, so really spend some time on it and be honest with yourself about your risk tolerance, your financial needs and your long-term goals.
After you create your plan, don't put it in the filing cabinet never to be seen again. As you trade, ask yourself if your portfolio still has the mix of investments you initially targeted.
Setting up a Brokerage Account
You can't simply buy and sell stocks through a traditional bank account. Instead, you'll need to open a brokerage account which is established solely for investments such as stocks, bonds and mutual funds. These accounts are subject to a great deal of oversight from securities regulators, and are generally insured in case the broker hosting the account runs into trouble. There are also some companies that sell shares of its stock directly to investors, allowing you to bypass your broker altogether. This is usually a low-cost route but can be quite cumbersome if you plan to own many stocks.
For many investors, online discount brokers are the way to go. These firms such as TD Ameritrade, E-Trade, thinkorswim, Charles Schwab and others charge rock-bottom fees and offer all of the bells and whistles you'll need. These include access to stock price quotes, news, and the ability to measure how your portfolio is performing.
If you've already got your money at a local trusted bank, ask them about their offerings, and compare them with the discount brokers listed above. If your local bank can match their fees and level of service, then they'll be a fine choice. Do the same for the companies that manage your retirement plan -- firms like T. Rowe Price, Fidelity Investments and Vanguard -- who may also be able to offer low-cost trading commissions connected to your 401K or IRA accounts.
If you go with a financial advisory firm like Merrill Lynch or Morgan Stanley, be prepared to pay fairly hefty fees. These firms are in the business of advice, and are best suited to investors that don't want to do their own research or make personal investment decisions. (The distinction is blurring a bit. For example, Merrill Lynch now offers Merrill Edge that is really just a glorified discount broker – and you get access to Merrill Lynch's research as well.)
Almost all brokers have an online application process that can get you trading within a few days. You'll need to provide personal information, employment information, your date of birth and your social security number. You'll also have to choose what kind of account you want. The most common –and best-suited for the beginner – is an individual brokerage account that allows you to simply buy and sell stocks.
More advanced investors can upgrade to margin accounts, which actually allows you to borrow money to buy stocks. Experienced investors can also sign up to trade stock options. Options are basically side bets on stocks, and are used by investors in a variety of ways to magnify returns, generate income, or provide diversification. They are a bit beyond the scope if this introductory tutorial, but you can learn more by reading more InvestingAnswers articles (including Options 101: A Primer for the Rookie Options Investor).
Required Materials: Investment Books
As you're setting up that brokerage account, you may want to hold off trading until you've polished your skills. I'd recommend buying three books.
1) One book that explains all the mechanics of investing (such as Stock Investing for Dummies or Jason Kelly's The Neatest Little Guide to Stock Market Investing)
2) One book that can be a handy reference for financial statement analysis so you can look up key terms and delve into key concepts as they arise (such as How to Use Financial Statements: A Guide to Understanding the Numbers)
Books alone aren't enough. I strongly suggest you make it a habit to read a daily business periodical such as The Wall Street Journal, Investor's Business Daily, The New York Times' business section, along with internet-based investment analysis, such as our own streetauthority.com.
The stock market reflects all manner of companies, good or bad. If you can focus on high-quality companies that have bright prospects, then you're bound to do better than an index fund that must buy all of the companies in a particular category. Experts vary on what kind of return you should expect. And short-term moves can distort the picture. The 1990's were a great time for investing. This last decade stunk. The upcoming decade? Nobody can say for sure. But it is clear than over an extended period of time, stocks represent the best growth vehicle for your hard-earned dollars. Over the long haul (think decades, not years), stocks should appreciate anywhere from +5% to +8% annually. That compares favorably to bonds and CDs.
One of the most frustrating things about investments is that they tend to rise slowly and drop quickly. So you're much more likely to see a -25% loser in a day than a +25% winner. Even though I just counseled to cut your losses, you need not do so immediately. Many times, a stock overshoots the mark on the downside, and ends up rebounding a bit in subsequent days. I tend to wait for that possible modest rebound before finally cutting my losses.
What to Buy?
Now, the number one goal for your portfolio is to see it grow. But as you'll soon discover, it only happens in fits and starts. I've had many years where my investments treaded water or even sank, and other years where they zoomed ahead. Early on in my investing career, my spirits would soar when a carefully-researched investment rose to new heights. But I also became despondent when investments turned sour. (And if there's one lesson I very belatedly learned, it was the importance of cutting ties with a losing investment in a timely fashion.)
Speaking of lessons, I just completed a list of 11 Things Every Trader Should Know. I've boiled down over 20 years of investing experience into 11 pieces of advice applicable to both beginners and grizzled veterans, and explain each in depth in the article. It's the perfect companion piece to this article, so make sure you go back and check it out. (But not until you're done with this one!)
Digging Deeper with Stocks
As you search for stocks to buy, you'll hear of "great ideas" from various financial media outlets. That's not an invitation to blindly follow their advice. Instead, it's simply a chance to do more research yourself.
Learn more about the company, its recent past, its competitive environment, and most important, figure out if the stock appears inexpensive in relation to its profits or assets.
Know that stock tips always start somewhere and by the time they've been passed on to you, they've already become stale. So take all stock tips with the view of a skeptic. For every stock you end up buying, you should be passing on several other ideas.
Also, be sure to add companies to your portfolio that bring exposure to disparate parts of the economy. Owning both Ford and GM isn't really wise, as both companies are subject to the same economic factors, and are likely to trade in a similar fashion. Instead, focus on Ford or GM and then look for companies in banking, high-tech, retail, energy, etc. An ideal portfolio has exposure to all of these areas.
Adding Shares the Hassle-Free Way
Once you hold shares in a brokerage account, there is a low-cost way to keep adding more investment dollars and acquiring more shares without incurring annoying transaction costs.
It's called a dividend reinvestment plan (DRIP) and it allows you to receive additional shares in lieu of cash dividend payments. The beauty of DRIPs is that they help a portfolio grow faster through compounding -- additional shares lead to more dividend payments which then purchase more shares which lead to even more dividend payments, and so on.
DRIPs are offered directly through the company, so you don't have to deal with expensive transaction fees from your brokerage account. You can go to any company's website and see if it offers a DRIP (not every company does). For example, this link takes you to Coca-Cola's (NYSE: KO) DRIP page where you can download forms to get started.
If you're looking to open DRIP accounts with several companies, the process can start to get cumbersome. To ease the paperwork, check out sharebuilder.com, which offers a wide range of options to mimic the best features of a DRIP without so much paperwork. (If you transfer an account to Sharebuilder, they'll even toss in an additional $100 to your account).
Discipline and Persistence
Now that you've got $100 invested, it's time to start planning ahead. It will be hard to turn that $100 into real dough, so you'll need to keep adding funds to the portfolio. Many investors stick with a fixed plan, i.e. $25 a week or $150 a month. The amount of funds to invest will rise in tandem with your expanding knowledge base.
By now, you'll be tracking your first investment while starting to research the next one. But there's no hurry. Watching and waiting before jumping into a stock can be more fruitful then the "shoot first, ask questions later" approach to investing.
A number of websites such as Yahoo Finance and Google Finance allow you to create hypothetical portfolios that you can track. As these stocks move up or down, click on the news to see what's driving them.
In time, you'll notice clear patterns emerging. For example, if a stock rises on good news and then falls right back, and this happens repeatedly, it may be a sign that some investors know that all is not as rosy as it seems. This is the kind of stock you want to sell when it surges, since a subsequent pullback has been the pattern in place.
The Investing Answer: Many first-time investors like to wait until they have amassed a few thousand dollars before wading into the daunting world of investing. That's a mistake. You can get going for as little as $100, and the earlier you start, the faster your skills will build.