Stock investing, when done well, is among the most effective ways to build long-term wealth.
Here’s a step-by-step guide to investing money in the stock market to help ensure you’re doing it the right way.
5 Steps to Start Investing
1. Determine your investing approach
The first thing to consider is how to start investing in stocks. Some investors choose to buy individual stocks, while others take a less active approach.
Try this. Which of the following statements best describes you?
- I’m an analytical person and enjoy crunching numbers and doing research.
- I hate math and don’t want to do a ton of “homework.”
- I have several hours each week to dedicate to stock market investing.
- I like to read about the different companies I can invest in, but don’t have any desire to dive into anything math-related.
- I’m a busy professional and don’t have the time to learn how to analyze stocks.
The good news is that regardless of which of these statements you agree with, you’re still a great candidate to become a stock market investor. The only thing that will change is the “how.”
The different ways to invest in the stock market
2. Decide how much you will invest in stocks
First, let’s talk about the money you shouldn’t invest in stocks. The stock market is no place for money that you might need within the next five years, at a minimum.
While the stock market will almost certainly rise over the long run, there’s simply too much uncertainty in stock prices in the short term — in fact, a drop of 20% in any given year isn’t unusual. In 2020, during the COVID-19 pandemic, the market plunged by more than 40% and rebounded to an all-time high within a few months.
- Your emergency fund
- Money you’ll need to make your child’s next tuition payment
- Next year’s vacation fund
- Money you’re socking away for a down payment, even if you will not be prepared to buy a home for several years
Asset allocation
Now let’s talk about what to do with your investable money — that is, the money you won’t likely need within the next five years. This is a concept known as asset allocation, and a few factors come into play here. Your age is a major consideration, and so are your particular risk tolerance and investment objectives.
Let’s start with your age. The general idea is that as you get older, stocks gradually become a less desirable place to keep your money. If you’re young, you have decades ahead of you to ride out any ups and downs in the market, but this isn’t the case if you’re retired and reliant on your investment income.
Here’s a quick rule of thumb that can help you establish a ballpark asset allocation. Take your age and subtract it from 110. This is the approximate percentage of your investable money that should be in stocks (this includes mutual funds and ETFs that are stock based). The remainder should be in fixed-income investments like bonds or high-yield CDs. You can then adjust this ratio up or down depending on your particular risk tolerance.
For example, let’s say that you are 40 years old. This rule suggests that 70% of your investable money should be in stocks, with the other 30% in fixed income. If you’re more of a risk taker or are planning to work past a typical retirement age, you may want to shift this ratio in favor of stocks. On the other hand, if you don’t like big fluctuations in your portfolio, you might want to modify it in the other direction.
3. Open an investment account
All of the advice about investing in stocks for beginners doesn’t do you much good if you don’t have any way to actually buy stocks. To do this, you’ll need a specialized type of account called a brokerage account.
These accounts are offered by companies such as TD Ameritrade, E*Trade, Charles Schwab, and many others. And opening a brokerage account is typically a quick and painless process that takes only minutes. You can easily fund your brokerage account via EFT transfer, by mailing a check, or by wiring money.
Opening a brokerage account is generally easy, but you should consider a few things before choosing a particular broker:
Type of account
First, determine the type of brokerage account you need. For most people who are just trying to learn stock market investing, this means choosing between a standard brokerage account and an individual retirement account (IRA).
Both account types will allow you to buy stocks, mutual funds, and ETFs. The main considerations here are why you’re investing in stocks and how easily you want to be able to access your money.
If you want easy access to your money, are just investing for a rainy day, or want to invest more than the annual IRA contribution limit, you’ll probably want a standard brokerage account.
On the other hand, if your goal is to build up a retirement nest egg, an IRA is a great way to go. These accounts come in two main varieties — traditional and Roth IRAs — and there are some specialized types of IRAs for self-employed individuals and small business owners, including the SEP IRA and SIMPLE IRA. IRAs are very tax-advantaged places to buy stocks, but the downside is that it can be difficult to withdraw your money until you get older.
Compare costs and features
The majority of online stock brokers have eliminated trading commissions, so most (but not all) are on a level playing field as far as costs are concerned.
However, there are several other big differences. For example, some brokers offer customers a variety of educational tools, access to investment research, and other features that are especially useful for newer investors. Others offer the ability to trade on foreign stock exchanges. And some have physical branch networks, which can be nice if you want face-to-face investment guidance.
There’s also the user-friendliness and functionality of the broker’s trading platform. I’ve used quite a few of them and can tell you firsthand that some are far more “clunky” than others. Many will let you try a demo version before committing any money, and if that’s the case, I highly recommend it.