Your Investment Portfolio What You Need To Know About The Stock Market

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Contents

How to Invest in Stocks

You can buy individual stocks or stock mutual funds yourself, or get help investing by using a robo-advisor.

At NerdWallet, we strive to help you make financial decisions with confidence. To do this, many or all of the products featured here are from our partners. However, this doesn’t influence our evaluations. Our opinions are our own.

Steps

1. Decide how you want to invest in stocks

2. Open an investing account

3. Know the difference between stocks and stock mutual funds

4. Set a budget for your stock investment

5. Start investing

Investing in stocks is an excellent way to grow wealth. But how do you actually start? Follow the steps below to learn how to invest in the stock market.

1. Decide how you want to invest in stocks

There are several ways to approach stock investing. Choose the option below that best represents how you want to invest, and how hands-on you’d like to be in picking and choosing the stocks you invest in.

“I’m the DIY type and am interested in choosing stocks and stock funds for myself.” Keep reading; this article breaks down things hands-on investors need to know. Or, if you already know the stock-buying game and just need a brokerage, see our roundup of the best online brokers .

“I know stocks can be a great investment, but I’d like someone to manage the process for me.” You may be a good candidate for a robo-advisor, a service that offers low-cost investment management. Virtually all of the major brokerage firms offer these services, which invest your money for you based on your specific goals. See our top picks for robo-advisors .

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Once you have a preference in mind, you’re ready to shop for an account.

2. Open an investing account

Generally speaking, to invest in stocks, you need an investment account. For the hands-on types, this usually means a brokerage account. For those who would like a little help, opening an account through a robo-advisor is a sensible option. We break down both processes below.

An important point: Both brokers and robo-advisors allow you to open an account with very little money — we list several providers with low or no account minimum below.

THE DIY OPTION: OPENING A BROKERAGE ACCOUNT

An online brokerage account likely offers your quickest and least expensive path to buying stocks, funds and a variety of other investments. With a broker, you can open an individual retirement account, also known as an IRA — here are our top picks for IRA accounts — or you can open a taxable brokerage account if you’re already saving adequately for retirement elsewhere.

We have a guide to opening a brokerage account if you need a deep dive. You’ll want to evaluate brokers based on factors like costs (trading commissions, account fees), investment selection (look for a good selection of commission-free ETFs if you favor funds) and investor research and tools.

Below are strong options from our analysis of the best online stock brokers for stock trading: TD Ameritrade , E-Trade and Robinhood .

The passive option: Opening a robo-advisor account

A robo-advisor offers the benefits of stock investing, but doesn’t require its owner to do the legwork required to pick individual investments. Robo-advisor services provide complete investment management : These companies will ask you about your investing goals during the onboarding process and then build you a portfolio designed to achieve those aims.

This may sound expensive, but the management fees here are generally a fraction of the cost of what a human investment manager would charge: Most robo-advisors charge around 0.25% of your account balance. And yes — you can also get an IRA at a robo-advisor if you wish.

As a bonus, if you open an account at a robo-advisor, you probably needn’t read further in this article — the rest is just for those DIY types. Here are the top picks from NerdWallet’s latest robo-advisor comparison: Wealthfront , Betterment and Ellevest .

3. Know the difference between stocks and stock mutual funds

Going the DIY route? Don’t worry. Stock investing doesn’t have to be complicated. For most people, stock market investing means choosing among these two investment types:

Stock mutual funds or exchange-traded funds. These mutual funds let you purchase small pieces of many different stocks in a single transaction. Index funds and ETFs are a kind of mutual fund that track an index; for example, a Standard & Poor’s 500 fund replicates that index by buying the stock of the companies in it. When you invest in a fund, you also own small pieces of each of those companies. You can put several funds together to build a diversified portfolio. Note that stock mutual funds are also sometimes called equity mutual funds.

Individual stocks. If you’re after a specific company, you can buy a single share or a few shares as a way to dip your toe into the stock-trading waters. Building a diversified portfolio out of many individual stocks is possible, but it takes a significant investment.

The upside of stock mutual funds is that they are inherently diversified, which lessens your risk. But they’re unlikely to rise in meteoric fashion as some individual stocks might. The upside of individual stocks is that a wise pick can pay off handsomely, but the odds that any individual stock will make you rich are exceedingly slim.

For the vast majority of investors — particularly those who are investing their retirement savings — a portfolio comprised mostly of mutual funds is the clear choice.

» Still unsure which is right for you? Learn more about mutual funds

4. Set a budget for your stock investment

New investors often have two questions in this step of the process:

How much money do I need to start investing in stocks? The amount of money you need to buy an individual stock depends on how expensive the shares are. (Share prices can range from just a few dollars to a few thousand dollars.) If you want mutual funds and have a small budget, an exchange-traded fund (ETF) may be your best bet. Mutual funds often have minimums of $1,000 or more, but ETFs trade like a stock, which means you purchase them for a share price — in some cases, less than $100).

How much money should I invest in stocks? If you’re investing through funds — have we mentioned this is our preference? — you can allocate a fairly large portion of your portfolio toward stock funds, especially if you have a long time horizon. A 30-year-old investing for retirement might have 80% of his or her portfolio in stock funds; the rest would be in bond funds. Individual stocks are another story. We’d recommend keeping these to 10% or less of your investment portfolio.

» Got a small amount of cash to put to work? Here’s how to invest $500

5. Start investing

Stock investing is filled with intricate strategies and approaches, yet some of the most successful investors have done little more than stick with the basics. That generally means using funds for the bulk of your portfolio — Warren Buffett has famously said a low-cost S&P 500 index fund is the best investment most Americans can make — and choosing individual stocks only if you believe in the company’s potential for long-term growth.

If individual stocks appeal to you, learning to research stocks is worth your time. If you plan to stick primarily with funds, building a simple portfolio of broad-based, low-cost options should be your goal.

Nerd tip: If you’re tempted to open a brokerage account but need more advice on choosing the right one, see our 2020 roundup of the best brokers for stock investors. It compares today’s top online brokerages across all the metrics that matter most to investors: fees, investment selection, minimum balances to open and investor tools and resources. Read: Best online brokers for stock investors »

FAQs about how to invest in stocks

Do you have advice about investing for beginners?

All of the above guidance about investing in stocks is directed toward new investors. But if we had to pick one thing to tell every beginner investor, it would be this: Investing isn’t as hard — or complex — as it seems.

That’s because there are plenty of tools available to help you. One of the best is stock mutual funds, which are an easy and low-cost way for beginners to invest in the stock market. These funds are available within your 401(k), IRA or any taxable brokerage account. An S&P 500 fund, which effectively buys you small pieces of ownership in 500 of the largest U.S. companies, is a good place to start.

The other option, as referenced above, is a robo-advisor , which will build and manage a portfolio for you for a small fee.

Bottom line: There are plenty of beginner-friendly ways to invest, no advanced expertise required.

Can I invest if I don’t have much money?

There are two challenges to investing small amounts of money. The good news? They’re both easily conquered.

The first challenge is that many investments require a minimum. The second is that it’s hard to diversify small amounts of money. Diversification, by nature, involves spreading your money around. The less money you have, the harder it is to spread.

The solution to both is investing in stock index funds and ETFs. While mutual funds might require a $1,000 minimum or more, index fund minimums tend to be lower (and ETFs are purchased for a share price that could be lower still). Two brokers, Fidelity and Charles Schwab, offer index funds with no minimum at all. Index funds also cure the diversification issue because they hold many different stocks within a single fund.

The last thing we’ll say on this: Investing is a long-term game, so you shouldn’t invest money you might need in the short term. That includes a cash cushion for emergencies.

Are stocks a good investment for beginners?

Yes. In fact, everyone — including beginners — should be invested in stocks, as long as you’re comfortable leaving your money invested for at least five years. Why five years? That’s because it is relatively rare for the stock market to experience a downturn that lasts longer than that.

But rather than trading individual stocks, focus on stock mutual funds. With mutual funds, you can purchase a large selection of stocks within one fund.

Is it possible to build a diversified portfolio out of individual stocks instead? Sure. But doing so would be time-consuming — it takes a lot of research and know-how to manage a portfolio. Stock mutual funds — including index funds and ETFs — do that work for you.

» Which is the better investment? Stocks vs. real estate

What are the best stock market investments?

In our view, the best stock market investments are low-cost mutual funds, like index funds and ETFs. By purchasing these instead of individual stocks, you can buy a big chunk of the stock market in one transaction.

Index funds and ETFs track a benchmark — for example, the S&P 500 or the Dow Jones Industrial Average — which means your fund’s performance will mirror that benchmark’s performance. If you’re invested in an S&P 500 index fund and the S&P 500 is up, your investment will be, too.

That means you won’t beat the market — but it also means the market won’t beat you. Investors who trade individual stocks instead of funds often underperform the market over the long term.

How should I decide where to invest money?

The answer to where to invest really comes down to two things: the time horizon for your goals, and how much risk you’re willing to take.

Let’s tackle time horizon first: If you’re investing for a far-off goal, like retirement, you should be invested primarily in stocks (again, we recommend you do that through mutual funds).

Investing in stocks will allow your money to grow and outpace inflation over time. As your goal gets closer, you can slowly start to dial back your stock allocation and add in more bonds, which are generally safer investments.

On the other hand, if you’re investing for a short-term goal — less than five years — you likely don’t want to be invested in stocks at all. Consider these short-term investments instead.

Finally, the other factor: risk tolerance. The stock market goes up and down, and if you’re prone to panicking when it does the latter, you’re better off investing slightly more conservatively, with a lighter allocation to stocks. Not sure? We have a risk tolerance quiz — and more information about how to make this decision — in our article about what to invest in .

What stocks should I invest in?

Cue the broken record: Our recommendation is to invest in many stocks through a stock mutual fund, index fund or ETF — for example, an S&P 500 index fund that holds all the stocks in the S&P 500.

If you’re after the thrill of picking stocks, though, that likely won’t deliver. You can scratch that itch and keep your shirt by dedicating 10% or less of your portfolio to individual stocks. Which ones? Check out our list of the best stocks , based on year-to-date performance, for ideas.

Is stock trading for beginners?

While stocks are great for beginner investors, the “trading” part of this proposition is probably not. Maybe we’ve already gotten this point across, but to reiterate: We highly recommend a buy-and-hold strategy using stock mutual funds.

That’s precisely the opposite of stock trading, which involves dedication and a great deal of research. Stock traders attempt to time the market in search of opportunities to buy low and sell high.

Just to be clear: The goal of any investor is to buy low and sell high. But history tells us you’re likely to do that if you hold on to a diversified investment — like a mutual fund — over the long term. No active trading required.

Stock Market Basics: What Beginner Investors Should Know

If you’re not well-versed in the basics of the stock market, the stock trading information spewing from CNBC or the markets section of your favorite newspaper can border on gibberish.

Phrases like “earnings movers” and “intraday highs” don’t mean much to the average investor, and in many cases, they shouldn’t. If you’re in it for the long term — with, say, a portfolio of mutual funds geared toward retirement — you don’t need to worry about what these words mean, or about the flashes of red or green that cross the bottom of your TV screen. You can get by just fine without understanding the stock market much at all.

If, on the other hand, you want to learn how to trade stocks, you do need to understand the stock market, and at least some basic information about how stock trading works.

Stock market basics

The stock market is made up of exchanges, like the New York Stock Exchange and the Nasdaq. Stocks are listed on a specific exchange, which brings buyers and sellers together and acts as a market for the shares of those stocks. The exchange tracks the supply and demand — and directly related, the price — of each stock. (Need to back up a bit? Read our explainer about stocks.)

You place your stock trades through the broker, which then deals with the exchange on your behalf.

But this isn’t your typical market, and you can’t show up and pick your shares off a shelf the way you select produce at the grocery store. Individual traders are typically represented by brokers — these days, that’s often an online broker. You place your stock trades through the broker, which then deals with the exchange on your behalf. (Need a broker? See our analysis of the best stockbrokers for beginners.)

The NYSE and the Nasdaq are open from 9:30 a.m. to 4 p.m. Eastern, with premarket and after-hours trading sessions also available, depending on your broker.

Understanding the stock market

When people refer to the stock market being up or down, they’re generally referring to one of the major market indexes.

A market index tracks the performance of a group of stocks, which either represents the market as a whole or a specific sector of the market, like technology or retail companies. You’re likely to hear most about the S&P 500, the Nasdaq composite and the Dow Jones Industrial Average; they are often used as proxies for the performance of the overall market.

Investors use indexes to benchmark the performance of their own portfolios and, in some cases, to inform their stock trading decisions. You can also invest in an entire index through index funds and exchange-traded funds, or ETFs, which track a specific index or sector of the market. Read more about ETFs here.

Stock trading information

Most investors would be well-advised to build a diversified portfolio of stocks or stock index funds and hold on to it through good times and bad. But investors who like a little more action engage in stock trading. Stock trading involves buying and selling stocks frequently in an attempt to time the market.

The goal of stock traders is to capitalize on short-term market events to sell stocks for a profit, or buy stocks at a low. Some stock traders are day traders, which means they buy and sell several times throughout the day. Others are simply active traders, placing a dozen or more trades per month.

Investors who trade stocks do extensive research, often devoting hours a day to following the market. They rely on technical analysis, using tools to chart a stock’s movements in an attempt to find trading opportunities and trends. Many online brokers offer stock trading information, including analyst reports, stock research and charting tools.

Bull markets vs. bear markets

Neither is an animal you’d want to run into on a hike, but the market has picked the bear as the true symbol of fear: A bear market means stock prices are falling — thresholds vary, but generally to the tune of 20% or more — across several of the indexes referenced earlier.

Younger investors may be familiar with the term bear market but unfamiliar with the experience: We’ve been in a bull market — with rising prices, the opposite of a bear market — since March 2009 . That makes it the longest bull run in history.

It came out of the Great Recession, however, and that’s how bulls and bears tend to go: Bull markets are followed by bear markets, and vice versa, with both often signaling the start of larger economic patterns. In other words, a bull market typically means investors are confident, which indicates economic growth. A bear market shows investors are pulling back, indicating the economy may do so as well.

Bull markets are followed by bear markets, and vice versa, with both often signaling the start of larger economic patterns.

The good news is that the average bull market far outlasts the average bear market, which is why over the long term you can grow your money by investing in stocks.

The S&P 500, which holds around 500 of the largest stocks in the U.S., has historically returned an average of around 7% annually, when you factor in reinvested dividends and adjust for inflation. That means if you invested $1,000 30 years ago, you could have around $7,600 today.

Stock market crash vs. correction

A stock market correction happens when the stock market drops by 10% or more. A stock market crash is a sudden, very sharp drop in stock prices, like in October 1987 when stocks plunged 23% in a single day.

While crashes can herald a bear market, remember what we mentioned above: Most bull markets last longer than bear markets — which means stock markets tend to rise in value over time.

Worried about a crash? Focus on the long term

When the stock market declines, it can be difficult to watch your portfolio’s value shrink in real time and do nothing about it. However, if you’re investing for the long term, doing nothing is often the best course.

Thirty-two percent of Americans who were invested in the stock market during at least one of the last five financial downturns pulled some or all of their money out of the market. That’s according to a NerdWallet-commissioned survey, which was conducted online by The Harris Poll of more than 2,000 U.S. adults, among whom over 700 were invested in the stock market during at least one of the past five financial downturns, in June 2020. The survey also found that 28% of Americans would not keep their money in the stock market if there were a crash today.

It’s likely some of these Americans might rethink pulling their money if they knew how quickly a portfolio can rebound from the bottom: The market took just 13 months to recover its losses after the most recent major sell-off in 2020. Even the Great Recession — a devastating downturn of historic proportions — posted a complete market recovery in just over five years. The S&P 500 then posted a compound annual growth rate of 16% from 2020 to 2020 (including dividends).

If you’re wondering why you should wait years for your portfolio to get back to zero, remember what happens when you sell investments in a downturn: You lock in your losses. If you plan to re-enter the market at a sunnier time, you’ll almost certainly pay more for the privilege and sacrifice part (if not all) of the gains from the rebound.

Curious how long it would have taken to recover your losses after some of the stock market’s major downturns? Use our calculator to find out.

The importance of diversification

You can’t avoid bear markets as an investor. What you can avoid is the risk that comes from an undiversified portfolio.

Diversification helps protect your portfolio from inevitable market setbacks. If you throw all of your money into one company, you’re banking on success that can quickly be halted by regulatory issues, poor leadership or an E. coli outbreak.

To smooth out that company-specific risk, investors diversify by pooling multiple types of stocks together, balancing out the inevitable losers and eliminating the risk that one company’s contaminated beef will wipe out your entire portfolio.

But building a diversified portfolio of individual stocks takes a lot of time, patience and research. The alternative is a mutual fund, the aforementioned ETF or an index fund. These hold a basket of investments, so you’re automatically diversified. An S&P 500 ETF, for example, would aim to mirror the performance of the S&P 500 by investing in the 500 companies in that index.

The good news is you can combine individual stocks and funds in a single portfolio. One suggestion: Dedicate 10% or less of your portfolio to selecting a few stocks you believe in, and put the rest into index funds.

Ready to get started? The brokers below offer access to both individual stocks and funds.

How to Buy Stock for Your Investment Portfolio

Over the past couple of centuries, business ownership, including ownership of publicly traded companies in the form of common stock, has been the most lucrative asset class for those wanting to build wealth. Despite the higher-than-average volatility, when you buy stock and earn the legal right to participate in the profits and losses of the enterprise, your money can grow in a way that simply isn’t possible with bonds, certificates of deposit, or in some cases, even real estate. For new investors and would-be investors, one of the more common questions asked involves how to buy stock; the mechanics of actually getting your hands on that piece of ownership entitling you to dividends that are direct deposited or mailed to your family so you can enjoy the stream of passive income.

There are several different ways to buy stock, each with its own advantages and disadvantages, including tax and liquidity considerations. Some popular options can help you gain a general layout of the land, and be better informed to make decisions of equity acquisition.

How to Buy Stock in a Regular, Taxable Brokerage Account

If you want to buy stock with no restrictions, no tax advantages, and no contribution limits, the easiest way is to open a brokerage account. Choosing a specific brokerage house involves several considerations, such as whether you want a full-service broker or a discount broker that does nothing more than executing your stock trades at rock-bottom prices, but these days it is as easy as taking five minutes to fill out a series of questions online.

Imagine you wanted to open an account at Charles Schwab & Company, one of the biggest brokers in the United States. You would fill out the online application, providing your name, address, social security number, employment information, and more depending upon whether or not you wanted to add margin debt capability or stock option trading privileges. You would then send in the minimum account balance of $1,000 or, alternatively, sign up for $100 per month direct deposits or electronic sweeps from a Schwab checking account.

Once your brokerage account had been opened, you would see the cash deposited and parked, waiting for you to do something with it. You would log on to the website, enter the ticker symbol of the company you wanted to buy, enter the number of shares you wanted to purchase and submit the trade in a few clicks once you had verified the details. In most cases, within a second or two, you’d see the stock deposited into your account and the cash withdrawn. A few days later, you’d receive a trade confirmation document. Whenever the company paid a dividend, you’d see it direct deposited into your brokerage account. If the company ever had a tax-free spin-off or split-off, you’d see those shares deposited into your brokerage account, as well (e.g., Chipotle Mexican Grill was split off from McDonald’s while Allstate Insurance was spun-off from Sears).

How to Buy Stock in a Roth IRA, Traditional IRA, SIMPLE IRA, SEP-IRA or Other Similar Retirement Account

From a nuts-and-bolts perspective, the process of buying stock in a Roth IRA or any of its related cousins is practically identical to buying stock in a regular, taxable brokerage account. If your IRA is held at a brokerage firm, you follow the exact same procedure. The difference has to do with how the taxes are treated and the amount of new cash you can contribute each year.

For example, you can only contribute $5,500 to a Traditional IRA if you are 49 years old or younger, and $6,500 if you are 50 years of age or older. As long as you fall below the income limits in effect for the year based upon your marital status, you can write off these contributions as if you never made the money. Meanwhile, the dividends and capital gains your money earns while invested in stock within the Traditional IRA are completely tax-free with only a handful of exceptions. When you go to pull the money out of the account, you pay regular income tax on the amount withdrawn. If you try to withdraw the cash too early, you’ll be subject to a 10% penalty fee unless you meet one of the eight exemptions.

How to Buy Stock Through a Direct Stock Purchase Plan or Dividend Reinvestment Plan (aka DRIP)

What if you don’t want to open a brokerage account? You’re in luck. Many companies, especially large blue chip shares, sponsor programs that allow you to buy stock directly from the firm’s transfer agent for free, or at a heavily subsidized price. Consider the modern day descendant of John D. Rockefeller’s oil empire, Exxon Mobil. It sponsors a direct stock purchase plan through a business called Computershare. Would-be owners who open an account with either $250 or agree to have $50 per month withdrawn from a checking or savings account can buy the stock at no commission. Even better, the plan allows fractional stock purchases so every single penny gets put to work for you, the investor, even if you don’t have exactly the right amount to acquire a full share at any given time.

When you apply online, you can tell the transfer agent whether you want your dividends direct deposited into your checking or savings account or reinvested in additional shares of stock. Decide carefully. While there is no right or wrong answer — it all depends on your personal financial situation and the subsequent performance of the stock itself — there is a big difference between reinvesting and not reinvesting your dividends over long periods of time if you’re fortunate enough to find yourself in possession of a truly outstanding enterprise.

How to Buy Stock Through an Employee Stock Purchase Plan

One of the biggest overlooked benefits in corporate America, a lot of huge companies allow employees to become an owner of the firm at attractive discounts, often as high as 15% off the stock market price, through programs known as Employee Stock Purchase Plans. In fact, some academic research shows the typical employee gives up between $4,000 and $5,000 in free money a year by not taking advantage of ESPPs they are entitled to join.

In most situations, you need to go down to the human resources department and ask for an enrollment form. You tell the company how much of your paycheck you want withheld to buy shares. Each pay period, part of the money you would have earned is, instead, used to buy stock at a cheaper price than you could have paid through a brokerage firm (e.g., for a company with a 15% discount, a $100 stock would be sold to you for $85, giving you an instant $15 profit).

How to Buy Stock Through a Mutual Fund

If you don’t want to pick individual stocks, but want to own stocks regardless, your best bet is a mutual fund; most likely a low-cost index fund. In short, you write a check or have the initial amount taken out of your bank account so your money is pooled with other investors. The fund managers then use the cash to go out and buy stocks on your behalf, holding them in a centralized, consolidated portfolio that is, itself, divided into shares that you own. In addition to a commission, which you might have to pay, you indirectly pay your share of the fund’s cost, which is expressed as the mutual fund expense ratio.

Let’s imagine you wanted to buy an S&P 500 index fund. You would open an account directly with the mutual fund company or you could have your stockbroker buy shares through your brokerage account, the latter of whom may charge you a commission on the shares whereas the mutual fund company doesn’t for in-house funds. The fund allocates shareholder money to stocks based upon something known as market capitalization. The top 10 stocks, as a group, receive 17.8% of your money.

Whenever you buy additional shares of your mutual fund by sending a new check or having an electronic transfer made from your bank account, as well as when you have mutual fund distributions (made up of capital gains and dividends in most cases) automatically reinvested into the fund, you are indirectly buying stocks. The shares you own of big corporations are every bit as real as if you held them directly in your brokerage account, there is just a legal intermediary between you that offers economies of scale and diversification.

How to Buy Stock Through a 401(k) Plan

Unless you have a self-directed 401(k) at a brokerage firm, you are almost assuredly going to have to choose from a slate of mutual funds chosen by your employer to get exposure to stocks, buying indirectly as if you were purchasing a mutual fund on your own. The human resource department can help you set up your account, get your share of the free matching money that may or may not be offered, and make sure contributions are allocated to the funds you think best fit your needs.

Most decent 401(k) plans will offer at least a large capitalization stock fund, a small capitalization stock fund, and an international stock fund for those who want to own international (non-U.S. companies) that pay dividends in multiple currencies. If your 401(k) plan offered the Vanguard Total International Stock Index Fund, by way of illustration, the top 10 holdings would represent 8.3% of your assets and include Nestle in Switzerland, Royal Dutch Shell in the United Kingdom, Novartis in Switzerland, Roche Holding in Switzerland, HSBC in the United Kingdom, Toyota Motor in Japan, Samsung Electronics in South Korea, BHP Billiton in Australia, BP in the United Kingdom, and Bayer in Germany. When you opted for this fund on your 401(k) allocation instructions, you are buying stocks in all of these businesses and then some.

How to Buy Stock in an International Company

What if you are an investor in the United States who wants to buy shares of a company headquartered somewhere outside of the country? There are a few different ways for you to do this, almost all of which are going to go through your brokerage account.

  • If the foreign stock has a listing on an American stock exchange such as the New York Stock Exchange, you can buy shares by entering the ticker symbol just as you would any other domestic business. British alcohol giant Diageo PLC, for example, trades under ticker symbol DEO in the United States.
  • If the foreign stock has American Depository Receipts and American Depository Shares that have been created, you can buy these in the United States through the ADS ticker symbol. This is a complex topic that would require its own in-depth explanation and is probably not appropriate for most new investors given the currency risks involved and foreign withholding taxes that might be due. An example would be Nestle, which trades in the pink sheets in the United States under the symbol NSRGY. Those are really a sort of trust fund that holds the actual Nestle shares over in Zurich, Switzerland, conveniently put together by Citibank for American investors.
  • You can open a special type of brokerage account that offers global trading capabilities. Many major brokers have this service. The global trading account will hold multiple currency balances as well as shares of stock purchased directly on foreign stock markets but will cost a lot more with commissions sometimes running as high as several hundred dollars and minimum purchases often being set at tens of thousands of American equivalent dollars per trade.
  • You can opt to buy a domestic mutual fund that focuses on international stocks like the one previously described in the 401(k) section of this article.

A Few Closing Thoughts on How to Buy Stock

There are a handful of other ways to buy stock, including setting up a family partnership through something like a limited liability company or even finding someone who owns shares, negotiating directly, and transferring the stock between yourselves, bypassing the stock exchanges entirely (though there is almost no circumstance under which an ordinary, non-control investor would ever find it necessary to do such a thing unless he or she were transferring shares of stock to a child, grandchild, or heir at a discounted price for various tax and inheritance reasons that are far beyond the scope of this discussion). Suffice it to say, how you buy your stock can have huge consequences for your bottom-line profits, but in most situations, you’re going to be doing almost all of your purchases through a stockbroker, a mutual fund company, or an employer-sponsored retirement plan such as 401(k) or 403(b).

The big key to success is to find good, quality companies, pay a reasonable price (or if you don’t know how to do that, dollar cost average), and then do what wealthy families do by eschewing portfolio turnover. This will allow you to not only avoid frictional expenses but take advantage of deferred tax assets in some cases, which can add several percentage points to your compounding rate. That means a whole lot of extra money over decades.

How to Invest in Stocks

We tell you everything you need to know to get started investing in stocks.

First of all, congratulations! Investing in the stock market is the most reliable way to create wealth over long time periods. It might surprise you to learn that a $10,000 investment in the S&P 500 index 50 years ago would be worth nearly $1.2 million today.

With that in mind, there’s quite a bit you should know before you dive in. Here’s a step-by-step guide to investing money in the stock market to help ensure you’re doing it the right way.

Image source: The Motley Fool.

Investing checklist

  1. Determine your investing approach
  2. Decide how much you will invest in stocks
  3. Open an investment account
  4. Diversify your stocks
  5. Continue investing

1. Determine your investing approach

You can invest in individual stocks if — and only if — you have the time and desire to thoroughly research and evaluate stocks on an ongoing basis. If this is the case, we 100% encourage you to do so — it is entirely possible for a smart and patient investor to beat the market over time.

In addition to buying individual stocks, you can choose to invest in index funds which will track a stock index like the S&P 500. Or, you can invest in actively managed funds that aim to beat an index.

On the other hand, if things like quarterly earnings reports and some moderate mathematical calculations don’t sound appealing, there’s absolutely nothing wrong with taking a more passive approach.

When it comes to actively managed mutual funds versus passive index funds, we generally prefer the latter (although there are certainly exceptions). Index funds typically have significantly lower costs and are virtually guaranteed to match the long-term performance of their underlying index. Over time, the S&P 500 has produced total returns of about 10% annualized, and performance like this can build substantial wealth over time.

2. Decide how much you will invest in stocks

First, let’s talk about the money you shouldn’t invest in stocks. The stock market is no place for money that you might need within the next five years, at a minimum. While the stock market will almost certainly rise over the long run, there’s simply too much uncertainty in stock prices in the short term — in fact, statistically speaking, a drop of 20% in any given year wouldn’t even be considered an unusual occurrence.

Here are some examples of money that would be much better off in a high-yield savings account than the stock market:

  • Your emergency fund
  • Money you’ll need to make your child’s next tuition payment
  • Next year’s vacation fund
  • Money you’re socking away for a down payment, even if you will not be prepared to buy a home for several years

Asset Allocation

Now let’s talk about what to do with your investable money — that is, the money you won’t likely need within the next five years. This is a concept known as asset allocation, and there are a few factors that come into play here. Your age is a major consideration, and so are your particular risk tolerance and investment objectives.

Let’s start with your age. The general idea is that as you get older, stocks gradually become a less desirable place to keep your money. If you’re young, you have decades ahead of you to ride out any ups and downs in the market, but this isn’t the case if you’re retired and reliant on your investment income.

Here’s a quick rule of thumb that can help you establish a ballpark asset allocation. Take your age and subtract it from 110. This is the approximate percentage of your investable money that should be in stocks (this includes mutual funds and ETFs that are stock-based). The remainder should be in fixed-income investments like bonds or high-yield CDs. You can then adjust this ratio up or down depending on your particular risk tolerance.

For example, let’s say that you are 40 years old. This rule implies that 70% of your investable money should be in stocks, with the other 30% in fixed income. If you’re more of a risk-taker or are planning to work past a typical retirement age, you may want to shift this in favor of stocks. On the other hand, if you don’t like big fluctuations in your portfolio, you might want to modify it in the other direction.

3. Open an investment account

To invest in stocks, you’ll need a specialized type of account called a brokerage account.

These accounts are offered by companies such as TD Ameritrade, E*Trade, Schwab, and many others. And opening a brokerage account is typically a quick and painless process that you can do in a matter of minutes. You can easily fund your brokerage account via EFT transfer, by mailing a check, or by wiring money.

The brokerage account opening process is generally quick and painless, but there are a few things you should consider before choosing a particular broker:

Type of account

First, determine the type of brokerage account you need. For most people who are starting out in the stock , this means choosing between a standard brokerage account or an individual retirement account (IRA). The main considerations here are why you’re investing in stocks and how easily you want to be able to access your money.

If you want easy access to your money, are just investing for a rainy day, or want to invest more than the annual IRA limit, you’ll probably want a standard brokerage account. Both account types will allow you to buy stocks, mutual funds, and ETFs.

On the other hand, if your goal is to build up a retirement nest egg, an IRA is a great way to go. These accounts come in two varieties — traditional or Roth. IRAs are very tax-advantaged places to buy stocks, but the downside is that it can be difficult to withdraw your money until you get older.

Compare costs and features

The majority of online stock brokers have eliminated trading commissions, so most (but not all) are on a level playing field as far as costs are concerned.

However, there are several other big differences. For example, some brokers offer customers a variety of educational tools, access to investment research, and other features that are especially useful for newer investors. Others offer the ability to trade on foreign stock exchanges. And some have physical branch networks, which can be nice if you want face-to-face investment guidance.

There’s also the user-friendliness and functionality of the broker’s trading platform. I’ve used quite a few of them and can tell you firsthand that some are far more “clunky” than others. Many will let you try a demo version before committing any money, and if that’s the case, I highly recommend it.

4. Choose your stocks

First off, if you’re looking for some great beginner-friendly investment ideas, here are five great stock ideas to help get you started.

Of course, we can’t go over everything you should consider when selecting and analyzing stocks in a few paragraphs, but here are the important concepts to master before you get started.

  • Diversify your portfolio
  • Only invest in businesses you understand
  • Avoid high-volatility stocks until you get the hang of investing and always avoid penny stocks
  • Learn the basic metrics and concepts used to evaluate stocks

It’s a good idea to learn the concept of diversification, meaning that you should have a variety of different types of companies in your portfolio. However, I’d caution against too much diversification. Stick with businesses you understand — and if it turns out that you’re good at (or comfortable with) evaluating a particular type of stock, there’s nothing wrong with one industry making a relatively large proportion of your portfolio.

Flashy high-growth stocks may seem like great ways to build wealth (and they certainly can be), but I’d caution you to hold off on these until you’re a little more experienced. It’s wiser to create a “base” to your portfolio with rock-solid, established businesses.

If you want to invest in individual stocks, you should familiarize yourself with some of the basic ways to evaluate them. Our guide to value investing is a great place to start. There, we help you find stocks trading for attractive valuations. And if you want to add some exciting long-term growth prospects to your portfolio, our guide to growth investing is a great place to begin.

5. Continue investing

Here’s one of the biggest secrets of investing, courtesy of the Oracle of Omaha himself, Warren Buffett. You do not need to do extraordinary things to get extraordinary results. (Note: Warren Buffett is not only the most successful long-term investor of all time, but he is also one of the best sources of wisdom that you can apply to your investment strategy.)

The most surefire way to make money in the stock market is to buy shares of great businesses at reasonable prices and hold on to them for as long as they remain great businesses (or until you need the money). If you do this, you’ll experience some volatility along the way, but over time you’ll produce excellent investment returns.

Four Steps to Building a Profitable Portfolio

In today’s financial marketplace, a well-maintained portfolio is vital to any investor’s success. As an individual investor, you need to know how to determine an asset allocation that best conforms to your personal investment goals and risk tolerance. In other words, your portfolio should meet your future capital requirements and give you peace of mind while doing so. Investors can construct portfolios aligned to investment strategies by following a systematic approach. Here are some essential steps for taking such an approach.

Key Takeaways

  • Overall, a well-diversified portfolio is your best bet for the consistent long-term growth of your investments.
  • First, determine the appropriate asset allocation for your investment goals and risk tolerance.
  • Second, pick the individual assets for your portfolio.
  • Third, monitor the diversification of your portfolio, checking to see how weightings have changed.
  • Make adjustments when necessary, deciding which underweighted securities to buy with the proceeds from selling the overweighted securities.

Step 1: Determining Your Appropriate Asset Allocation

Ascertaining your individual financial situation and goals is the first task in constructing a portfolio. Important items to consider are age and how much time you have to grow your investments, as well as the amount of capital to invest and future income needs. An unmarried, 22-year-old college graduate just beginning his or her career needs a different investment strategy than a 55-year-old married person expecting to help pay for a child’s college education and retire in the next decade.

A second factor to consider is your personality and risk tolerance. Are you willing to hazard the potential loss of some money for the possibility of greater returns? Everyone would like to reap high returns year after year, but if you can’t sleep at night when your investments take a short-term drop, chances are the high returns from those kinds of assets are not worth the stress.

Clarifying your current situation, your future needs for capital, and your risk tolerance will determine how your investments should be allocated among different asset classes. The possibility of greater returns comes at the expense of greater risk of losses (a principle known as the risk/return tradeoff). You don’t want to eliminate risk so much as optimize it for your individual situation and lifestyle. For example, the young person who won’t have to depend on his or her investments for income can afford to take greater risks in the quest for high returns. On the other hand, the person nearing retirement needs to focus on protecting his or her assets and drawing income from these assets in a tax-efficient manner.

Conservative vs. Aggressive Investors

Generally, the more risk you can bear, the more aggressive your portfolio will be, devoting a larger portion to equities and less to bonds and other fixed-income securities. Conversely, the less risk you can assume, the more conservative your portfolio will be. Here are two examples, one for a conservative investor and one for the moderately aggressive investor.

The main goal of a conservative portfolio is to protect its value. The allocation shown above would yield current income from the bonds, and would also provide some long-term capital growth potential from the investment in high-quality equities.

Step 2: Achieving the Portfolio

Once you’ve determined the right asset allocation, you need to divide your capital between the appropriate asset classes. On a basic level, this is not difficult: equities are equities and bonds are bonds.

But you can further break down the different asset classes into subclasses, which also have different risks and potential returns. For example, an investor might divide the portfolio’s equity portion between different industrial sectors and companies of different market capitalizations, and between domestic and foreign stocks. The bond portion might be allocated between those that are short-term and long-term, government debt versus corporate debt and so forth.

There are several ways you can go about choosing the assets and securities to fulfill your asset allocation strategy (remember to analyze the quality and potential of each asset you invest in):

  • Stock Picking – Choose stocks that satisfy the level of risk you want to carry in the equity portion of your portfolio; sector, market cap, and stock type are factors to consider. Analyze the companies using stock screeners to shortlist potential picks, then carry out more in-depth analysis on each potential purchase to determine its opportunities and risks going forward. This is the most work-intensive means of adding securities to your portfolio, and requires you to regularly monitor price changes in your holdings and stay current on company and industry news.
  • Bond Picking – When choosing bonds, there are several factors to consider including the coupon, maturity, the bond type, and the credit rating, as well as the general interest-rate environment.
  • Mutual Funds – Mutual funds are available for a wide range of asset classes and allow you to hold stocks and bonds that are professionally researched and picked by fund managers. Of course, fund managers charge a fee for their services, which will detract from your returns. Index funds present another choice; they tend to have lower fees because they mirror an established index and are thus passively managed.
  • Exchange-Traded Funds (ETFs) – If you prefer not to invest with mutual funds, ETFs can be a viable alternative. ETFs are essentially mutual funds that trade like stocks. They’re similar to mutual funds in that they represent a large basket of stocks, usually grouped by sector, capitalization, country, and the like. But they differ in that they’re not actively managed, but instead track a chosen index or another basket of stocks. Because they’re passively managed, ETFs offer cost savings over mutual funds while providing diversification. ETFs also cover a wide range of asset classes and can be useful for rounding out your portfolio.

Step 3: Reassessing Portfolio Weightings

Once you have an established portfolio, you need to analyze and rebalance it periodically, because changes in price movements may cause your initial weightings to change. To assess your portfolio’s actual asset allocation, quantitatively categorize the investments and determine their values’ proportion to the whole.

The other factors that are likely to alter over time are your current financial situation, future needs, and risk tolerance. If these things change, you may need to adjust your portfolio accordingly. If your risk tolerance has dropped, you may need to reduce the number of equities held. Or perhaps you’re now ready to take on greater risk and your asset allocation requires that a small proportion of your assets be held in more volatile small-cap stocks.

To rebalance, determine which of your positions are overweighted and underweighted. For example, say you are holding 30% of your current assets in small-cap equities, while your asset allocation suggests you should only have 15% of your assets in that class. Rebalancing involves determining how much of this position you need to reduce and allocate to other classes.

Step 4: Rebalancing Strategically

Once you have determined which securities you need to reduce and by how much, decide which underweighted securities you will buy with the proceeds from selling the overweighted securities. To choose your securities, use the approaches discussed in Step 2.

When rebalancing and readjusting your portfolio, take a moment to consider the tax implications of selling assets at this particular time.

Perhaps your investment in growth stocks has appreciated strongly over the past year, but if you were to sell all of your equity positions to rebalance your portfolio, you may incur significant capital gains taxes. In this case, it might be more beneficial to simply not contribute any new funds to that asset class in the future while continuing to contribute to other asset classes. This will reduce your growth stocks’ weighting in your portfolio over time without incurring capital gains taxes.

At the same time, always consider the outlook of your securities. If you suspect that those same overweighted growth stocks are ominously ready to fall, you may want to sell in spite of the tax implications. Analyst opinions and research reports can be useful tools to help gauge the outlook for your holdings. And tax-loss selling is a strategy you can apply to reduce tax implications.

The Bottom Line

Throughout the entire portfolio construction process, it is vital that you remember to maintain your diversification above all else. It is not enough simply to own securities from each asset class; you must also diversify within each class. Ensure that your holdings within a given asset class are spread across an array of subclasses and industry sectors.

As we mentioned, investors can achieve excellent diversification by using mutual funds and ETFs. These investment vehicles allow individual investors with relatively small amounts of money to obtain the economies of scale that large fund managers and institutional investors enjoy.

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