If you’re new to stock market investing and can’t for the life of you decide what stock to buy, rest assured you’re not alone. Millions of investors every day ask the question “What stock should I buy?” and it’s not an easy question to answer.
There are thousands of stocks and mutual funds to invest in; the choices seem endless. Knowing which ones to choose should involve more than a “hot” stock tip at a cocktail party or some strategic investing advice from your broke brother-in-law.
Performing some simple research before you invest in the stock market can put you on the right track to financial independence and the life you’ve always dreamed about. Follow these five tips to get your investments aligned properly with your retirement lifestyle goals.
Stock Market Investing Made Simple
Use these tips to turbocharge your investment portfolio
Having all your money invested in one stock means if the company fails, you lose your entire investment. Instead, spread your money around across several investments. You can do this through Exchange Traded Funds (ETFs) or by restricting your investing to mutual funds for added security and growth potential.
A mutual fund is a pool of money from thousands of investors that’s managed by a team or an individual whose job is to invest and grow the money invested with them. By federal law, they can only buy so much of one particular company, so they end up with hundreds or thousands of individual stocks in the mutual fund. Some are growth oriented and invest in companies that will grow in value; others are more conservative and only invest in bonds, as in a bond mutual fund.
You can also find international, equity, and even Christian-focused mutual funds, the latter of which invests only in companies that profess the Christian faith and don’t manufacture sinful things like alcohol and tobacco.
Read the prospectus before investing in a mutual fund to learn what kind of investing strategy the manager is using with your money. The prospectus will give you everything you need to know to make a wise choice.
If you’re working within a retirement account such an employer-sponsored 401(k), ask your company’s representative for this information, or go online to the investment firm’s website to plan your 401(k) investment strategy.
Start With Zero (debt, that is)
Do you want the one single best investing strategy? It's this: Get out of debt, and stay out of debt.
In the book The Millionaire Next Door by Thomas Stanley, you learn that a full 75% of first-generation millionaires say that the number one strategy for investing and wealth building is to become and stay debt-free.
No matter your current income, your best tool for long-term wealth building is your income. When that's reduced by your debts, so is your future wealth. Sacrificing today for a brighter, more financially secure tomorrow isn't easy, but it's totally worth it.
When you get to keep all the money you earn, you can invest it at 10%-12% (the stock market's annual average return since 1912 is 10.9%) instead of paying it out at 18% or more. Even if you don't change anything else, if you become debt free you'll enjoy a greater sense of financial peace than ever before.
Invest for the Long-Term
Historically, a portfolio of 100% stocks invested for the long-term has outperformed more conservative 100% bond portfolios by more than 4% per year. Likewise, a 100% stock investment portfolio has earned 1.7% more annually than a balanced 50/50 mix of stocks and bonds.
Bonds are safe because they are guaranteed to be repaid by the bond’s issuer. Bonds typically only increase in value when the stock markets are sliding downward. Investors flee to bonds when their stocks aren’t looking so hot anymore for a guaranteed return on investment, no matter how small.
Watch out for those opportunities when the stock markets are falling in value, they are the best times to buy. Nowadays there are thousands of websites, great free smartphone apps, and more that will help you time your purchases. These are only as helpful as you are knowledgeable, so do the research with trusted sources before relying on automated advice.
If you’re looking for the best place to buy stocks, now’s the time to stop. What really matters is the best time to buy stocks. Invest a little bit each month and take advantage of Dollar-Cost Averaging so you’ll be buying when nobody else is. That’s where the money is made. Remember: buy low, sell high.
Buy and Hold
Day traders often brag about their latest investment strategy. What they fail to realize is that day trading can easily become an addicition. Chasing the next big "hot stock tip" can be exhausting emotionally and can end up losing thousands of dollars. Intraday trading can quickly increase turnover and transaction fees, minimizing any potential earnings gain.
Investing in companies and mutual funds with proven track records is no guaranteed path to riches, either. Large companies struggle, and sometimes fail. Remember Enron? How about WorldCom?
Typically a large company is much more stable than a hot new startup. Facebook was going to make millionaires out of us all, wasn't it? With nearly a billion registered users at the time of its IPO, Facebook was destined for stock market success. Or so we thought.
When a company goes public through an IPO, they transfer ownership from a few people on the inside management team to thousands, if not millions, of individual investors. And don't forget about large institutional investors who make a living off of their investments' successes. Everybody's in charge all of a sudden, and everybody wants a big return on their investment.
Facebook hadn't quite figured out its revenue model yet, though, and was unable to produce the ROI (return on investment) that investors were expecting.
This is one hot stock tip gone bad. And there are thousands of others just like it out there.
Here's a general filter for investments that can save your financial butt:
- Do I understand what the company does? If your answer is No, don't buy it- you are an owner of a company when you purchase its stock, and you have decision-making power, albeit limited. Not understanding what they do is a sign you're not a good fit.
- Can I explain it to a Kindergartener? Better yet, can they explain it to you? If it's easy enough for a six-year old to understand, it might have a spot in your investing strategy.
- Do I buy or use this product myself? This one's not as fundamental as the others. I do not drink soft drinks, but Coca-Cola makes great money and it's easy to understand what they do.
Whatever you buy, hold on to it. Even if the stock market takes a dive, hold on. You don't lose any money unless you sell. Almost always, it will bounce back. Especially if the stock market is freaking out about something done in Washington, D.C. (like the pending Fiscal Cliff). There's never a good time to panic.
When your investing strategy includes regular investment purchases, you get the opportunity to buy when prices are low, as in when everybody else is selling.
You'll also be creating and strengthening your investing discipline muscle, which can be easy to neglect. So many ads, so many things marketers want us to buy. (be strong, young investor, be strong...)
The best way to go about regular investing is by setting up automatic purchases from your brokerage account. You can do this through many of the large online brokerages such as E-Trade, Scottrade, ING Direct, and more. Make sure you set your dividends to be automatically reinvested as well.
If you buy your investments directly from the company (as in individual stocks), set up your DRIP at the same time.
DRIPs are Dividend ReInvestment Plans, and will automatically purchase more of the stock or mutual fund with dividend returns. It's like compound interest for your brokerage account. Albert Einstein called compound interest the "Eighth Wonder of the World." He was pretty smart, so we'll go with him on this.
If you automatically invest as little as $50 per month, you'll end up with more than half a million dollars after 40 years. Bump that up to $100 per month and you're looking at almost $1.2 million dollars!
Many financial advisors recommend saving 10%-15% of your income for retirement. If you earn $40,000 per year, this equates to $333.33 to $500 per month.
Get this: $350 invested for 40 years (earning 12%) nets you...
How do you get to the point where you can invest that much money, you ask?
Here are a few tips:
- Give up your car payment (average of $492/month)
- Skip the daily latte and lunch with friends ($260/month)
- Pick up a part-time job ($200-$1000/month)
Bonus Investing Tip:
Look for Solid Track Records
When investing in mutual funds, look for funds that have historical returns greater than the stock market’s average of 11.1% (Dow Jones Industrial Average, 1932-2011.) Funds that have performed well in the past will likely continue to outpace the market in the future, of course I can't guarantee this.
I use free online investing tools like Morningstar to research a fund’s performance and read its prospectus to understand what companies the fund invests in before I share my hard-earned money with the fund manager. Morningstar’s reporting system is the best in the world and has reports on all mutual funds, including historical facts to 1924 when the mutual fund as we know it came into existence.
If you're already out of debt, now's the time to apply these principles to (or create) your stock market investing strategy. If you're still battling consumer debt, read this before you start investing.