What is the stock market?
Stocks, which are also called equities, are securities that give shareholders an ownership interest in a public company. It’s a real stake in the business, and if you own all the shares of the business, you control how the business operates. The stock market refers to the collection of stocks that can be bought and sold by the general public on a variety of different exchanges.
Where does stock come from? Public companies issue stock so that they can fund their businesses. Investors who think the business will prosper in the future buy those stock issues. The shareholders get any dividends plus any appreciation in the price of the shares. They can also watch their investment shrink or disappear entirely if the company runs out of money.
The stock market is really a kind of aftermarket, where people who own shares in the company can sell them to investors who want to buy them. This trading takes place on a stock exchange, such as the New York Stock Exchange or the Nasdaq. In years past, traders used to go to a physical location — the exchange’s floor — to trade, but now virtually all trading takes place electronically.
When news people say, “the market was up today,” typically they are referring to the performance of the Standard & Poor’s 500 or the Dow Jones Industrial Average. The S&P 500 is made up of around 500 large publicly traded companies in the U.S, while the Dow includes 30 large companies. These track the performance of the collections of stock and show how they fared on that day of trading and over time.
However, even though people are referring to the Dow and the S&P 500 as “the market,” those are really indexes of stocks. These indexes represent some of the largest companies in the U.S., but they are not the total market, which includes thousands of publicly traded companies.
Of course, you’ll need a brokerage account before you start investing in stocks. As you’re getting started, here are eight more guidelines for investing in the stock market.
How to invest in the stock market: 8 tips for beginners
Buy the right investment
Avoid individual stocks if you’re a beginner
Create a diversified portfolio
Be prepared for a downturn
Try a simulator before investing real money
Stay committed to your long-term portfolio
Start now
Avoid short-term trading
. Buy the right investment
Buying the right stock is so much easier said than done. Anyone can see a stock that’s performed well in the past, but anticipating the performance of a stock in the future is much more difficult. If you want to succeed by investing in individual stocks, you have to be prepared to do a lot of work to analyze a company and manage the investment.
“When you start looking at statistics you’ve got to remember that the professionals are looking at each and every one of those companies with much more rigor than you can probably do as an individual, so it’s a very difficult game for the individual to win over time,” says Dan Keady, CFP, chief financial planning strategist at TIAA.
If you’re analyzing a company, you’ll want to look at a company’s fundamentals – earnings per share (EPS) or a price-earnings ratio (P/E ratio), for example. But you’ll have to do so much more: analyze the company’s management team, evaluate its competitive advantages, study its financials, including its balance sheet and income statement. Even these items are just the start.
Keady says going out and buying stock in your favorite product or company isn’t the right way to go about investing. Also, don’t put too much faith in past performance because it’s no guarantee of the future.
You’ll have to study the company and anticipate what’s coming next, a tough job in good times.
. Buy the right investment
Buying the right stock is so much easier said than done. Anyone can see a stock that’s performed well in the past, but anticipating the performance of a stock in the future is much more difficult. If you want to succeed by investing in individual stocks, you have to be prepared to do a lot of work to analyze a company and manage the investment.
“When you start looking at statistics you’ve got to remember that the professionals are looking at each and every one of those companies with much more rigor than you can probably do as an individual, so it’s a very difficult game for the individual to win over time,” says Dan Keady, CFP, chief financial planning strategist at TIAA.
If you’re analyzing a company, you’ll want to look at a company’s fundamentals – earnings per share (EPS) or a price-earnings ratio (P/E ratio), for example. But you’ll have to do so much more: analyze the company’s management team, evaluate its competitive advantages, study its financials, including its balance sheet and income statement. Even these items are just the start.
Keady says going out and buying stock in your favorite product or company isn’t the right way to go about investing. Also, don’t put too much faith in past performance because it’s no guarantee of the future.
You’ll have to study the company and anticipate what’s coming next, a tough job in good times.
Avoid individual stocks if you’re a beginner
Everyone has heard someone talk about a big stock win or a great stock pick.
“What they forget about is that often they’re not talking about those particular investments that they also own that did very, very poorly over time,” Keady says. “So sometimes people have an unrealistic expectation about the kind of returns that they can make in the stock market. And sometimes they confuse luck with skill. You can get lucky sometimes picking an individual stock. It’s hard to be lucky over time and avoid those big downturns also.”
Remember, to make money consistently in individual stocks, you need to know something that the forward-looking market isn’t already pricing into the stock price. Keep in mind that for every seller in the market, there’s a buyer for those same shares who’s equally sure they will profit.
“There are tons of smart people doing this for a living, and if you’re a novice, the likelihood of you outperforming that is not very good,” says Tony Madsen, CFP, founder of NewLeaf Financial Guidance in Redwood Falls, Minnesota.
An alternative to individual stocks is an index fund, which can be either a mutual fund or an exchange traded fund (ETF). These funds hold dozens or even hundreds of stocks. And each share you purchase of a fund owns all the companies included in the index.
Unlike stock, mutual funds and ETFs may have annual fees, though some funds are free.
Try a stock market simulator before investing real money
One way to enter the world of investing without taking risk is to use a stock simulator. Using an online trading account with virtual dollars won’t put your real money at risk. You’ll also be able to determine how you would react if this really were your money that you gained or lost.
“That can be really helpful because it can help people overcome the belief that they’re smarter than the market,” Keady says. “That they can always pick the best stocks, always buy and sell in the market at the right time.”
Asking yourself why you’re investing can help determine if investing in stocks is for you.
“If their thought is that they’re going to somehow outperform the market, pick all the best stocks, maybe it’s a good idea to try some type of simulator or watch some stocks and see if you could actually do it,” Keady says. “Then if you’re more serious about investing over time, then I think you’re much better off – almost all of us, including myself – to have a diversified portfolio such as provided by mutual funds or exchange traded funds.”
(Bankrate reviewed some of the best investing apps, including a few fun stock simulators.)
Stay committed to your long-term portfolio
Keady says investing should be a long-term activity. He also says you should divorce yourself from the daily news cycle.
By skipping the daily financial news, you’ll be able to develop patience, which you’ll need if you want to stay in the investing game for the long term. It’s also useful to look at your portfolio infrequently, so that you don’t become too unnerved or too elated. These are great tips for beginners who have yet to manage their emotions when investing.
“Some of the news cycle, at times it becomes 100 percent negative and it can become overwhelming for people,” Keady says.
One strategy for beginners is to set up a calendar and predetermine when you’ll be evaluating your portfolio. Sticking to this guideline will prevent you from selling out of a stock during some volatility – or not getting the full benefit of a investment, Keady says.
Start now
Choosing the perfect opportunity to jump in and invest in the stock market typically doesn’t work well. Nobody knows with 100 percent certainty the best time to get in. And investing is meant to be a long-term activity. There is no perfect time to start.
“One of the core points with investing is not just to think about it, but to get started,” Keady says. “And start now. Because if you invest now, and often over time, that compounding is the thing that can really drive your results. If you want to invest, it’s very important to actually get started and have … an ongoing savings program, so that we can reach our goals over time.”
Avoid short-term trading
Understanding whether you’re investing for the long-term future or the short term can also help determine your strategy – and whether you should be investing at all. Sometimes short-term investors can have unrealistic expectations about growing their money. And research shows that most short-term investors, such as day traders, lose money. You’re competing against high-powered investors and well-programmed computers that may better understand the market.
New investors need to be aware that buying and selling stocks frequently can get expensive. It can create taxes and other fees, even if a broker’s headline trading commission is zero.
If you’re investing for the short term, you risk not having your money when you need it.
“When I’m advising clients … anything under a couple of years, even sometimes three years out, I’m hesitant to take too much market risk with those dollars,” Madsen says.
Depending on your financial goals, a savings account, money market account or a short-term CD may be better options for short-term money. Experts often advise investors that they should invest in the stock market only if they can keep the money invested for at least three to five years. Money that you need for a specific purpose in the next couple years should probably be invested in low-risk investments, such as a high-yield savings account or a high-yield CD.
Bottom line
Investing in the stock market can be very rewarding, especially if you avoid some of the pitfalls that most new investors experience when starting out. Beginners should find an investing plan that works for them and stick to it through the good times and bad.
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