Investing in the stock market is one of the most convenient and effective ways to put your money to work for you and create wealth. The stock market makes new millionaires (and breaks them) every year.
If you've decided to start investing in the stock market, congratulations! You are going to become involved in one of the most complex, interesting and rewarding of all human endeavors. However the world of the stock market is complicated and the stakes are high. Before you start investing in the stock market there are some key concepts you must understand and priorities you must set.
Before you start investing: priorities
Don't try to start investing without laying the groundwork. Investing in the stock market is a risk, but it should be a calculated risk. So before you start investing, make sure the following points are addressed:
- Emergency fund
Your emergency fund should be 3-6 months worth of living expenses. That includes all your bills, plus food, transportation, a little for entertainment, etc. Your emergency fund exists so that, if times become tough, you won't be tempted to tap into your stock market investments for cash. If you're dying to get started investing in the stock market, then you should at least put as much aside as you can in your emergency fund and set up an automatic investment plan to make up the balance of your cash. Many banks allow you to make small, periodic deductions from your checking account or automatic deposits into a savings account - and this is a great way to save money on autopilot.
Your emergency fund should be held in a no-risk or extremely low-risk, cash-equivalent account. FundAdvice.com recommends the Vanguard short-term investment-grade corporate bond fund (VFSTX, $3000 minimum). A savings account or money-market fund will work, too.
- Setting your investing budget
Now that your emergency fund is established, consider how much money you can invest. You will need an accurate budget that's up-to-date. Determine the amount of money you can invest regularly without straining your budget.
If you've received a lump sum, an inheritance or a bonus, consider investing it slowly, over time. If you invest a lump sum all at once then the roller coaster ride of the stock market may be too much for you, leading to sleepless nights, ulcers, and bad investment decisions.
- Setting your investing goals
Why are you investing in the stock market? Simply to increase your wealth? To save for retirement, or for the downpayment on a house (or boat)? Know why you're investing and establish goals for yourself. This will help you to balance your risks and set realistic milestones.
- Determining your risk tolerance
Before you put a single dollar into the stock market, you must understand the risk of investing. All investments can lose money. The riskier an investment is, the more volatile it is (big price movements), the more yield it pays (in dividends or interest payments), and the more likely investors are to lose big.
Determining your risk tolerance means understanding that you will lose money at some point in your investing career. How much money can you stand to lose? If you have an investment that's lost 50% of its value, will you sell it - or buy more? Most people hate losing money more than they love making money, so consider that. Learn more about risk and risk tolerance.
Start investing by determining your asset allocation
Now it's time to start your investing career by determining an asset allocation. This includes your risk tolerance, your desire for fixed income (monthly payments) vs. capital growth, and your comfort with different types of investing instruments. You're almost ready to start.
- Diversification and the stock market
Diversification should be a key goal of your stock market investing. "Diversification" most simply means that you own lots of different things. The more stocks you own (and, equally important, the more types of stocks you own) the less volatile, and less risky, your investments will be. Diversification is a critical concept and deserves its own article. Learn the benefits of diversification from investment advisor Paul Merriman.
- Mix stocks and bonds
By adding bonds to your stock market investments, you add a level of stability and predictability to your returns. Bonds are less volatile than the stock market and, more importantly, negatively correlated to the stock market. This means that when the stock market moves up, bonds tend to move down, and vice versa. Portfolios that contain bonds hold up better during bear markets. But during times of rapid stock market growth, bonds can hold a portfolio back. Determining the percentage of bonds in your portfolio is an important part of your diversification, asset allocation and risk tolerance.
Choosing a broker
You've set aside your emergency fund, budgeted and determined your goals, decided on your asset allocation and are ready to start investing. Now you need a "broker." A broker is a service provided by a company that makes trades on the stock market for you.
Twenty years ago, to make a trade you had to call your broker and give him verbal instructions. Today there are multiple competing services that allow you to trade, online, at very low cost. Online brokers include:
www.ShareBuilder.com
www.SoGoTrade.com
www.Zecco.com
www.eTrade.com
Each online broker charges between $4-$10 per trade. Sharebuilder is recommended - this service allows a scheduled, automatic trade every month for only $4. This is a great value but terrible if you're trying to time the market (buying and selling quickly).
There are dozens of traditional brokers, some of whom offer online brokerages. Others still use the phone-based trading system. More traditional brokerages include:
www.TRowePrice.com
www.Fidelity.com
www.Schwab.com
To start an account with any of the brokerages listed above, you'll need to fill out some forms online. You'll need your bank account information. The entire process takes anywhere from five to twenty minutes, and is surprisingly easy.
Deciding what to buy
Investing in the stock market means buying stocks, or mutual funds, or ETFs (exchange traded funds, a hybrid of the mutual fund and a stock). Choosing which stocks to buy is a science and an art, and is completely outside the scope of this guide. Before you purchase do your research and remember your goals, your asset allocation and your risk tolerance.
Making your first stock market trade
The specific instructions for making your first stock market trade will vary by the service you use. Follow the instructions provided by the brokerage step by step. Buying is usually called making an order, or making a trade. If you have any questions, call your broker for help. Don't confirm anything until you're certain you understand what's going to happen.
You should know that anything you buy isn't yours right away. It takes a few days for trades to "settle" - meaning that you take them into your possession.
Congratulations! You've started investing in the stock market. May your career be long, fun and successful.
Resources for learning more
There are many online communities that will help you fine-tune your asset allocation and evaluate the pros and cons of various equities and funds.
Here are some recommended resources for further research:
www.Investopedia.com
www.bogleheads.org
www.fundadvice.com
http://caps.fool.com
http://money.msn.com