Investing in the stock market can be an excellent way to build wealth. In this step-by-step guide, you will learn how to invest as a complete beginner.
Let’s be honest, the stock market can be quite intimidating. Although the markets may appear complex, I believe that anyone can learn to invest and create a bright financial future for themselves.
I am often frightened to see the number of individuals who blindly trust others with their life savings. Although hiring an investment or financial advisor can be rewarding, it is crucial to understand where and how they are investing your hard earned cash.
This guide will comprise of five key steps to buying your first stock:
Decide your investing approach
Open an investment account
Setting a budget
Diversification and loss prevention
1. Decide your investing approach
First, let’s briefly discuss what a stock is to ensure that we are on the same page.
What is a stock?
A stock is a security that represents the partial ownership of a corporation. In short, when you purchase stocks, you own a piece or share of a company. When you own stock, you are entitled to a proportion of a company’s assets and profits equal to the amount of shares or stock that you own. In today’s world, it is believed that there are more than 630,000 publicly traded companies, many of which issue common stock.
What is a stock? Why have you chosen to invest? What type of returns on your investment do you expect?
These are all very important questions to ask yourself before you begin your new financial journey.
What type of investor are you?
As you might expect, there is more than one type of investment strategy used in today’s world. In the stock market, there are four primary tactics that investors can use to determine whether to buy or sell a stock:
- Fundamental analysis
- Technical analysis
- Behavioral analysis
- Passive investing
Although many people have found success with any one of the four strategies listed above, we will primarily focus our efforts on the most popular of these methods: fundamental analysis. Fundamental analysis uses a company’s financial data and metrics to determine the health and proper valuation of the organization.
Another popular investing strategy is to take a passive approach through the use of stock funds typically referred to as index funds, mutual funds and exchange traded funds (ETF’s). The practice of passive investing through stock funds allows for diversification and, in theory, better protection against mass losses. We’ll talk more about the importance of diversification in the latter half of this guide.
Whether you are picking individual stocks or investing into stock funds, it’s imperative that you fully understand the financial decisions that you make.
2. Open an investment account
Generally, when you buy or sell stocks, you’ll need to do it through an investment account or broker.
When you think of a stock broker, what comes to mind?
For many of us, we envision someone on a crowded trading floor, yelling into two phones, one pressed to each ear as they buy and sell stocks for their clients.
Luckily, the process of buying stocks in 2020 has become much less, shall we say… stressful.
Many investing apps and brokerage firms have similar features to each other, however, you may find one to be the best fit for your goals
Here are some of our top places to open an investing account:
We have found this app to be quite useful, especially for beginner investors.
Webull specializes in four types of investment products:
- Exchange-traded funds.
- Cryptocurrencies (coming soon)
This investing app continues to introduce new features on a near weekly basis, making it one of the fastest growing companies in the Fintech industry.
Currently, Webull is running a promotion for 2 free stocks when you deposit your first $100 into your account (valued up to $1,400). This offer is valid as of May 20th, 2020 and is subject to change. Please read details to ensure that you qualify.
Like Webull, M1 Finance offers 100% free trading, allowing users to save on traditional broker commissions. With more than $1 billion in assets under management, M1 Finance has been establishing itself as a major player in the investing app community. One of the key features of the app are fractional shares, which allow users to own stocks, regardless of share price. This feature can be especially useful for investors who may not have enough cash to purchase high cost stocks such as Amazon and Google which tend to have prices greater than $1,000.
For example, if you wanted to buy Amazon stock ($2,450 as of May 2020) you would traditionally need at least $2,450 to purchase one share of the company. With M1 finance, you can purchase a fraction of a share rather than the entire piece. This feature allows investors on a tight budget to invest into a greater range of stocks.
The brokerage firm allows you to open a variety of investment accounts, including Individual, Joint, IRA’s, and Trust accounts. In addition, the company has recently been expanding into a range of useful financial services such as M1 Spend and M1 Borrow which make the app more than just a brokerage firm.
3. Setting a budget for your stock investment
Although you may be eager to begin investing, it’s important to create a game-plan before jumping into the markets head first.
How much money are you willing to invest?
While there is no one-size-fits-all answer to this question, we can use a few guidelines to make sure that we don’t lose all of our hard earned money within the first day of investing (trust me, we’ve seen it happen).
So how much should you invest?
Well, the real question that you should be asking yourself is: how much money are you willing to lose?
Let me explain. Nearly all investments carry a level of risk, some more than others. The most important aspect of setting an investing budget is to ensure that you do not need your investment money to survive or pay bills.
If you currently spend more money than you earn on a monthly basis, our suggestion would be to focus on budgeting and saving money before you begin your investing journey.
There are two primary ways to learn how to invest:
- Education (books, videos, mentors, classes)
The second method for learning how to invest is one which cannot be rushed, experience. Although it may not be optimal, it’s important to understand that you will likely make some mistakes as you begin to learn how to invest. For this reason, it is typically advisable to begin investing with a small amount of money.
4. Gathering Information
The process of gathering and interpreting financial data from a corporation is a critical step for successful investors.
There are two methods for analyzing a stock for long term growth:
Qualitative data tends to be descriptive and conceptual, meaning that in some cases, it can be difficult to measure. The process of using qualitative analysis to research stocks can involve researching a company's board of executives, CEO, customer loyalty, brand awareness, company culture, and even factors such as employee happiness levels.
The goal of qualitative analysis is to understand how the company operates on a level outside of numbers and financial metrics.
Some important questions to ask during qualitative analysis of a stock:
- Does the company have a competitive advantage to prevent others from replicating their business model?
- Do consumers trust this brand?
- Is this brand globally recognized?
- How much room for growth is available in the industry?
- Any red flags? Scandals? (think: Papa John, Enron, Cambridge Analytica)
For most investors, Qualitative analysis consumes roughly 30%-40% of total research efforts when analyzing a company.
The other 60%-70% of research efforts tend to funnel into a strategy known as quantitative analysis.
Quantitative analysis using mathematical and statistical modeling to assess the valuation of a company. This strategy of assessing companies can become quite complex.
When using quantitative analysis, an investor will focus on evaluating the underlying financials or health of a company.
Let’s imagine that you head to your doctors office for a routine checkup. While you may feel perfectly healthy, it’s still very important for your doctor to measure quantitative data in order to properly understand your current health situation. In this case, your doctor may draw blood, calculate your white blood cell count, cholesterol, blood pressure etc..
Just as a doctor needs quantitative data to understand the full picture, you will likely want to apply a similar strategy to your potential investments.
Some important quantitative data to consider:
- Revenue growth
- Net income
- Price to earnings ratio (P/E)
- Earnings per share (EPS)
- Total assets
- Total liabilities
- Debt to equity ratio
- Return on assets (ROA)
- Return on equity (ROE)
When analyzing a company, spend extra time reading three of their most important financial statements:
- Income statement
- Balance sheet
- Statement of cash flows
A useful method to understand the financials of a company is to read a beginners accounting book or course.
Choosing A Stock
5. Diversification and loss prevention
Picture this: It’s late 2019 and you’ve just wagered your entire life savings on your favorite cruise stock valued at $100 per share. Now let’s fast-forward to mid-2020. The cruise company that you have invested into is on the verge of bankruptcy, with the stock price teetering below $5 per share.
Unfortunately, an event like this has happened to far more investors than we would like to see.
Diversification of stocks and assets allows many investors to sleep better at night, knowing that their life savings are not hinging on one or two specific companies.
Diversifying your investment portfolio is the act of varying or expanding your assets to hold more than one stock at a given time. For many, diversification provides peace of mind and in most cases, some level of stability.
Your level of diversification will likely depend on the amount of risk you are willing to take on while investing. As a general rule of thumb, try not to have more than 25% of your investment portfolio in any one particular stock.
Some investors will choose to automate their diversification process by purchasing stocks funds such as index funds.
Purchasing an index fund that tracks the S&P 500 would provide expose to 500 companies, ensuring some level of security for your investment portfolio, though, it is still very possible to lose money with nearly any investment vehicle.
- Continuing education: If possible, try to read a book per week for the next 12 weeks. Long-term growth investing is a marathon, not a sprint. Take the next few weeks to thoroughly research the best investing practices to suit your needs. And remember, investing involves risk. Be sure to do your homework before jumping into the markets head first.
- Read: How To Stop Living Paycheck To Paycheck