A Guide to Investing in Stocks

While you may be eager to jump in like a character from the 1987 movie “Wall Street” – one of my husband’s favorites – a good first step when investing in stocks is to take a step back. I mean, make a personal inventory of your goals, your tolerance for risk, and your investment budget. Sounds tedious, but these important personal characteristics can shape every subsequent decision an investor makes.

• Identify your investment goal. Are you investing to fund a purchase, for future education, for retirement, or something else? Your goal affects your timeline and the type of account to set up. Many experts suggest a minimum investment horizon of five years in order to ride out most market dips.
• Assess your risk tolerance. Will you lose sleep over short-term dips in the market? Investing involves the risk of losing money, at least in the short term. How much money are you willing and able to invest without creating household hardships? Do a serious gut check of your risk tolerance because it influences the type of stocks you’ll pick and may even lead you to investing outside of the stock market.
• Set a realistic budget. You can begin investing in stocks with a small budget and make regular, recurring additions. In fact, “dollar-cost averaging” is a fancy term that suggests investing in small amounts, consistently over time, is a more prudent approach to buying stocks than making one large, lump-sum purchase. The reason is that regular, periodic purchases – say, every week or month – temper your exposure to short-term highs and lows.

You’ll need to open a brokerage account to hold your stock investments and complete trades. Many people begin by opening a taxable brokerage account, unless their investment goal is for retirement. If that’s the case, tax-advantaged accounts like individual retirement arrangement (IRA) accounts may be more appropriate. Different types of tax-advantaged retirement accounts offer various kinds of tax benefits; some may be exempt from tax depending on certain circumstances, or defer taxation to a later time.

After selecting the right type of account for your goals, think about how much investing help you want and are willing to pay for. Managed accounts include advice and guidance from professionals, and generally come with higher trading and account fees. Some online brokerage accounts have robo-advisors, which are software programs that help you choose investments based on data you provide regarding your goals and risk tolerance. Or, you can opt for a no-frills self-managed brokerage account. In general, traditional brokers charge a management fee of 1% to 2% of the value of your portfolio in addition to trading commissions for purchases and sales. Most robo-advisors charge 0.25% to 0.50%. Most people who are learning how to invest in stocks choose a managed account or an online broker with a robo-advisor.

Other account features you might consider as a new investor are the availability of research tools, integration with your bank, and user-friendliness of online trading platforms. If you tend to manage your life from your mobile device, it’s especially important to try out a demo version before funding a new online brokerage account.

Many experts recommend a “set-it-and-forget-it” approach for beginners. Using the budget you established earlier, you can set up automatic transfers from your paycheck into your brokerage account. Regular, consistent investing habits help you stay on track to achieve your goals, support dollar-cost averaging, and reduce the emotion and stress of constant decision-making.  

Before we discuss the mechanics of buying stocks, let’s review a few basic things for beginning investors:

• Stocks (or equities) represent a share of ownership in a company and its income.
• There are two ways to make money from investing in stocks: dividend payments and selling stock at a higher price than you purchased it. 
• Pros say you should never invest in something you don’t understand, no matter how much of a novice you are now or how seasoned you become.
• Reduce emotion. The investor’s saying, “Invest with your head, not over it” urges people to make rational, not emotional investment choices. 

When you begin to pick stocks, consider your level of risk tolerance. In general, stocks of large, well-established companies (aka “blue-chip”) carry less risk than those of smaller or high-growth companies. Blue-chip stocks tend to be from companies that are household names and are often cited as good starter stock picks for beginning investors. Blue-chip stocks tend to provide balance and stability with moderate growth and often pay dividend income. The definition of a blue-chip stock varies, but most often they are those companies included in the Dow Jones Industrial Average. 

In general, experts suggest deferring investments in small company stocks, high-growth stocks, or penny stocks until you’ve become a more seasoned investor because they have higher volatility. Be mindful of diversification as you select your investments. It’s a long-honored strategy that lowers risk by spreading your investments among different industries.

Once you’ve picked the stocks you’re going to invest in, you will choose an order type to make the purchase. The two basic types are:

• Market order: Directs your brokerage to buy a stock now at whatever the market price is. Market orders can be risky when prices are constantly changing in fast-moving markets. The benefit of a market order is that it will be executed quickly.  
• Limit order: Tells your brokerage to purchase a specific number of shares at (or below) a set price, at some time in the future. The price you set on a limit order must be at or below the current market price, so there is no guarantee that this order will ever be triggered unless your conditions are met. 

You can use both types of orders to sell stocks as well. With more experience, you can use more specialized orders; check with your brokerage to see which types of orders are available. Be aware, there likely are different fees associated with more specialized order types.

The good news for beginning investors is that often the most lucrative strategies are also the most basic. Taking a personal inventory of your goals and appetite for risk, together with setting up the right brokerage account, are important steps. Deciding which stocks to buy, how to buy them, and knowing when to sell, follow.