Things to know before investing in stocks
If you’re interested in stock investing, there are a few things to keep in mind before you take the leap.
- Investing in stocks is one of many options for investing your money.
Stocks are a popular avenue for investment, but it’s far from the only option. Depending on your needs, income and when you’ll need to access the money, you can take advantage of a variety of different investment strategies. These include putting money in a savings account, purchasing real estate or investing in bonds, precious metals and foreign currency. All of these investment strategies involve varying levels of risk and return.
- Investing in stocks comes with substantial risk, especially in the short term.
While stocks are often viewed as a safe investment strategy in the long term, nothing is guaranteed. The stock market is volatile, especially in the short term, and can swing wildly in between extremes. If you’re looking to invest your money in the short term, there are usually much more reliable, low-risk investment strategies available.
The stock market has historically grown at an average rate of about 7% per year. From year to year, however, the stock market can experience dramatic highs and lows. Even over a long period, a return on an investment in the stock market is never guaranteed. Investors should be cautious when it comes to investing in the stock market, and understand that nothing is a sure bet.
- Most people invest in stocks by opening an account with a brokerage — today, that’s usually done online at the brokerage’s website.
Investors generally invest in stocks through a brokerage firm. To do so, they must open an account and deposit money. Once you’ve added money to your account, you can direct the brokerage to purchase a certain amount of stock. A brokerage usually charges a small fee for these services.
Now, an unpredictable stock market and stay-at-home restrictions are encouraging trading activity and new accounts on mobile devices. Take Robinhood, for example. Its simplicity and free service made its app and website reach 10 million accounts in 2019. Combine it with low trading costs, and you’ve got an effective model for curious newcomers who aren’t ready to trade large quantities yet.
TD Ameritrade, Charles Schwab and E*TRADE, three of the largest online brokerages in the U.S., have also added hundreds of thousands of new accounts since January 2020.
- Different brokerages have different strengths and weaknesses.
Not all brokerages are the same. Depending on your investing needs, you may want to pursue brokerages with different strengths and weaknesses. Some might have especially robust customer service, while others may offer low (or even no) fees. Which brokerage is right for you will depend on your investing goals and how much guidance you need when it comes to investing.
- Investing all of your money in the stock of a single corporation is very risky.
It can be tempting to go “all in” on a promising young company that you think might turn into the next Apple or Amazon. However, investing all of your money in a single company is a risky proposition. There’s no way of reliably predicting which companies will be an overnight success. If you guess wrong, you may lose some or all of your investment.
- A good strategy for reducing risk is to spread out your investments.
A common investment strategy is to invest in many different companies to reduce risk. This spreads out your investment and protects it in the case that one company’s stock plummets. However, this strategy often involves additional brokerage fees, which can hamper your returns in the long run.
- Most stocks pay your dividends, which provide a stream of income for you without having to sell the shares.
Dividends are small payments that companies distribute to shareholders, usually quarterly. If you own shares in a company, you’ll usually be eligible for dividends. While dividends generally represent a small percentage of your overall investment, they can add up, especially if you’ve invested a lot of money in the stock market. Companies can raise, lower or eliminate dividends depending on their financial health.
- A mutual fund is just a collection of investments, often stocks.
Mutual funds are collections of investments. These funds can be composed entirely of stocks, but can also include other types of investments, such as bonds, precious metal and foreign currency. Mutual funds generally charge a small fee each year for maintenance and management costs. What exactly a mutual fund invests in and how it is operated varies from company to company, so be sure to do your research.
- An index fund is a specific kind of mutual fund governed by very simple rules, which usually means the management costs are very low.
Index funds are a common type of mutual fund. They usually operate under a very simple set of parameters and often invest in shares represented in a stock market index like the S&P 500 or the Dow Jones Industrial Average. Because management is minimal, index funds typically have very low associated fees. Index funds are usually a good choice if you’re trying to match the return of the stock market as a whole and diversify your investments as much as possible.
- For most people, the smartest stock investment is index funds.
If you’re not sure how you should be investing your money, index funds are usually a good option. Index funds might not see the dramatic returns that investing in an individual stock might, but they’re also a much lower risk investment. Index funds usually have low fees, which can have a significant impact on your investment over the long term. They’re also a convenient investment since they match the market, reducing the need for research, studying and guesswork when it comes to investing.
- Tax-deferred accounts like a 401(k) are a great option if you’re investing for retirement.
If you’re looking to invest money that you’re saving for retirement, tax-advantaged retirement accounts are usually your best option. These can include 401(k)s, IRAs and other types of retirement savings accounts. In most cases, these accounts are tax-deferred, meaning you don’t have to pay income tax on your money until you withdraw it during retirement. This can help your money to grow over time. A popular retirement investing option is a targeted retirement fund, which takes into account the time until you plan to retire and adjusts the level of risk in your investments accordingly.
- Taxes on stocks aren’t as scary as they might seem.
Many people worry about taxes when it comes to investments, but you shouldn’t stress about them too much. When it comes to retirement investments, you’ll pay regular income tax and tax-deferred investments, and your brokerage will usually help. If you’re investing in a normal brokerage account, you’ll only owe taxes on your gains and dividends. When transferring money from an investment into your bank account, you should always make sure to set aside a portion of your earnings for taxes – 20% is usually a good rule of thumb, but check with a tax professional if you’re not sure.
