Most people know that investing in the stock market could lead to significant returns, but many of us don’t understand enough about the stock market to make informed decisions. While stocks aren’t right for everyone, you shouldn’t avoid investing simply because you don’t know the best strategies.
This article will cover some of the most important things for new traders to understand before investing in their first stocks. Over time, you’ll develop an investment strategy that works for your financial needs—keep in mind that the earlier you invest, the easier it will be to reach your goals.
1. Time in the Market Beats Timing the Market
Everyone knows someone who invested in Bitcoin or Apple at just the right time, and every new investor dreams of timing the market for the best possible returns. That said, you should keep in mind that most people who are new to trading can’t play the stock market more effectively than experienced and professional investors working with large sums of money.
Timing can be useful for people interested in making money quickly, but most new investors are looking for ways to earn predictable returns over a longer period of time for goals like retirement and college. In these and similar cases, it’s almost always best to start building your portfolio sooner rather than later.
2. Stocks Aren’t Your Only Option
Stocks are obviously the first thing most people think about when they hear the word “investing,” but there are actually numerous ways to invest depending on your priorities and risk tolerance. Limiting yourself to stocks prevents you from making other worthwhile investments.
Savings accounts, for example, typically offer lower returns, but they also give you more convenient access to your money and aren’t subject to market fluctuations. They aren’t a good way to save for retirement, but it’s good to keep at least some money in a savings account for emergencies.
Similarly, other kinds of investments like bonds, mutual funds, and certificates of deposit provide advantages that stocks can’t offer on their own. Diversification is critical to building a balanced portfolio that isn’t overly vulnerable to any specific loss.
3. More Risk Is Acceptable on Long-term Investments
Long-term investment accounts are generally intended for important life goals, so many new investors assume they need to create a portfolio with a low level of risk to keep their money safe. In fact, it’s usually better to take on more risk for long-term compared to short-term investments.
Risk generally refers to the volatility, for example, a mutual fund based on short-term fluctuations. If you know that you’ll need to withdraw the money you’re investing a year from now, you should look for a low-risk investment that won’t lose as much value in a worst-case scenario.
On the other hand, if you’re investing in order to withdraw twenty or thirty years later, you can afford to take on short-term unpredictability without putting your portfolio at risk. Fluctuations tend to level out over time, so don’t worry if your retirement fund loses some value over one or two months.
4. Some Stocks Offer Dividends
An increase in value is the simplest way to earn money from stocks, but a variety of stocks also provide regular dividends in addition to anything you earn from holding them. Dividends are intended to provide an added incentive for stakeholders to keep their shares rather than selling, especially when things aren’t going well.
Of course, the advantage of dividends is passed onto their share price, so you aren’t exactly getting money for free. If a company offers dividends for the first time, for example, their share price will quickly adjust to match their new value. You could start earning a significant amount of money in dividends as you grow your portfolio, and you can reinvest that cash to generate even better returns.
5. Mutual Funds and Index Funds
Diversification is critical to success in investing, but most people don’t know enough about every stock to make the right investment decisions. Rather than going in blind, you can buy into a mutual fund or index fund that includes a wide range of investments to lower risk.
Both mutual funds and index funds are collections of investments including individual stocks, bonds, real estate, and more. The key difference between them is that mutual funds are actively managed by professional investors while index funds simply track market indexes like the S&P 500.
Mutual funds sometimes lead to higher returns than index funds, although they’re also more likely to lose money. Fund managers decide what to invest in, so no two mutual funds are exactly alike.
Index funds require much less overhead, so you can simply track the market while paying much less in fees. They’re essentially built to be average investments, so you should consider putting at least some of your portfolio into something with a higher potential long-term return.
6. Your Employer May Match 401(k) Contributions
401(k) accounts are one of the most common ways in which people save for retirement, and they come with valuable tax advantages compared to conventional brokerage accounts. The money you put in a standard 401(k) or IRA is tax-deductible, for example, so you’ll pay much less in taxes for years during which you made contributions.
On the other hand, Roth 401(k) and IRA contributions are made with after-tax income, but the investments you make grow completely tax-free. Furthermore, withdrawals aren’t subject to tax as long as you make them after reaching the age of 59.5.
Beyond these critical advantages, some businesses offer a free 401(k) contribution match to help employees save for retirement. A common 401(k) matching scheme is for an employer to match up to fifty cents on the dollar what an employee put in up to a certain percentage of their salary. So if you contribute $2,000, for example, you could earn an additional $1,000 toward your retirement simply by contributing enough to receive the full match.
Doubling your contribution is an incredibly rare opportunity in any kind of investing, so 401(k) match programs should almost always be one of your top financial priorities. Talk to someone in your company’s HR or accounting department to learn more about 401(k) match opportunities.
7. Growth Takes Time
Everyone wants to watch their portfolio grow from one day to the next, but investments typically gain and lose value on a much larger time scale. Novice investors are more likely to overreact to fluctuations rather than staying the course and giving their portfolio time to grow.
If you feel compelled to check your portfolio every day, week, or even month, you’re probably thinking of investments on too small of a scale. You can’t reach your long-term financial goals in a single quarter—you shouldn’t panic when things are going poorly or expect to match your best return every quarter.
With that in mind, it’s best to make investing decisions that match your financial goals and then stick to those choices even if they don’t immediately gain value. While you can obviously adjust your approach over time, it’s important to avoid making reactionary decisions based on a small set of data.
8. You Have Trading Options
At one time, most investors worked with a human broker who managed their portfolios and helped them identify the best investments. Although conventional brokerages are still available, there are a growing number of alternative investment platforms that offer their own benefits.
Robinhood and other digital solutions, for example, provide no-fee investing, while most traditional brokers charge a commission on each transaction. Commissions can have a significant impact on your earnings, and the advantage of an expert broker isn’t necessarily worth the cost.
While brokers were once seen as stock market experts, the democratization of information has led to a more even playing field. You can often achieve the same or even better results without working with a brokerage or even a financial advisor.
It’s always important to do your own research, and a number of digital applications give you access to the most relevant information about each stock with just a few clicks. Some applications, including M1 Finance, provide their own expert portfolios for those who aren’t confident in their ability to pick out individual stocks or funds.
9. Bonds Can Be a Good Investment
Stocks are obviously a more exciting way to invest than bonds, as they have the potential to achieve much more growth in a single year. That said, bonds are a worthwhile investment in nearly every portfolio for a number of important reasons.
In contrast to stocks, bonds are bought and sold at a fixed rate which is agreed upon during the transaction. Bonds are available in both the private and public sectors, and less reliable bonds typically offer higher interest rates to compensate for their elevated risk.
While the value of a stock is closely tied to the market conditions at any given time, bonds tend to decrease in value when the economy improves (and vice versa). This makes bonds a great way to add diversity to your portfolio and prevent a recession from impacting all your assets.
Bonds are a low-risk, low-reward investment, so most people begin to buy more bonds as they get older. The closer you are to retirement, the more important it becomes to get a guaranteed return over a given period of time. You may not want to invest more than 10 or 20 percent of your portfolio in bonds if you’re in your 20s or 30s.
10. You Should Have an Emergency Fund Before Investing
Some people start investing as soon as they start earning enough money to save, but this isn’t always the best way to use your extra cash. In general, you should save at least several hundred dollars in an emergency fund before you turn your attention to investing.
The idea behind an emergency fund is simple. It’s impossible to predict when you’ll need cash on short notice, and you don’t want unexpected circumstances to prevent you from reaching your financial goals. The last thing you want to do is withdraw cash from a retirement or college account to cover short-term expenses.
Many Americans don’t have enough in savings to cover just $400 in an emergency, and there’s a good chance that you’ll need to take money from your investment account if you don’t have another source of cash to fall back on. You could cancel out months or even years of progress and find yourself back where you started.
With an emergency fund, you can keep your investments separate from a savings account that’s intended to cover these kinds of circumstances. Similarly, you should focus on your balances before investing if you’re currently paying off debts—even a strong return in the stock market may not provide as much value as paying off debts with minimal interest.
You can start thinking about investing once you’ve saved a few hundred dollars, but that doesn’t mean you should stop contributing to your emergency fund after reaching this goal. $500, for example, probably won’t be enough to cover more serious situations like losing your job or suffering a long-term injury. Most financial experts recommend saving enough to cover expenses for around three to six months.
11. Alternative Options
Most people trade common investments like stocks, bonds, and funds, but these are far from your only options as a new investor. Alternatives like precious metals, cryptocurrencies, and even real estate can generate even better returns than a conventional investment portfolio.
Of course, putting your money in these kinds of investments involves a variety of factors and challenges that you probably don’t think about when trading stocks and bonds. It’s important to have a thorough understanding of any new field you want to invest in—for example, you probably don’t want to put any money in cryptocurrencies that you couldn’t afford to lose.
The stock market can appear complex and confusing to beginners, but you’ll learn more about investing as you spend more time in the market. Over time, you’ll develop a unique investment strategy based on your budget, level of risk tolerance, and both short- and long-term financial goals.
This is a guest post by Logan Allec. Logan is a CPA, personal finance expert, and founder of the finance blog Money Done Right, which he launched in July 2017. After spending nearly a decade in the corporate world helping big businesses save money, he launched his blog with the goal of helping everyday Americans earn, save, and invest more money.