If you want to put some money into the stock market, it could be as simple as downloading Robinhood’s trading and investing app and investing money in “meme stocks” like AMC or GameStop.
But a little planning can be the difference between treating stocks like a slot machine and building a portfolio to achieve financial goals.
Before opening a brokerage account, studying investment strategies and monitoring the price-earnings ratio, new investors must first get to know themselves and the answer to this very important question: What is your risk tolerance?
“I couldn’t give general advice. Everyone’s risk tolerance is different,” said Chris Kruse, a financial planner at Edward Jones. “How do you start? Start with the individual and the uniqueness of their situation.”
Individual or retail investing, which takes an active role in portfolio decisions rather than passively contributing to a 401(k) or other managed retirement plan, had a great time during the pandemic. Locked-down people looking for new ways to spend money that would otherwise be earmarked for unexpectedly stalled expenses like gas or student loans turned to Reddit’s (questionable) advice on which stocks might be the best get-rich-quick stocks.
“The majority of new investors, that is, those who opened a non-retirement investment account for the first time during 2020, were under the age of 45 and had lower incomes than investors who already had investment accounts subject to to taxes before 2020,” according to a study by FINRA, the self-regulatory agency for stockbrokers. “New investors were also more likely to be racially or ethnically diverse.”
If you are just now deciding to put some money in securities for long-term investment, and have never used the term securities before, here is a guide for you:
realizing your potential
There really is no minimum commitment needed to make the investment “pay off.” If you have a long-term financial goal, investing is one way to achieve it by setting aside a little money at a time.
Minneapolis-based Thrivent says $50 invested each month can turn into $7,750 in 10 years or $20,373 in 20 years, and that’s a low estimate based on actual historical growth in the stock market.
“It’s a common myth that you need a few thousand dollars to start investing. It’s actually in your best interest to start investing early, even with as little as $50 a month, rather than waiting until you have a few thousand dollars saved.” Thrivent advises individual investors. “Note that achieving this [growth in your investment] It will, however, depend on the performance of the funds you select for your investment and the investment over the long term.”
Definition of basic concepts
Owning a stock is having an ownership interest in a company, the value of which changes based on the company’s financial performance and other factors.
Owning a bond is owning a debt that a company or government promises to pay at a fixed rate over a set period of time.
Investing in a mutual fund or exchange-traded fund (ETF) means putting money in a pool with other investors that is used to buy a wide range of stocks.
There are many other financial instruments and types of orders to place on the stock market, such as options and shorts, but these are the main securities that make up the stock market every day.
Individual investors need a brokerage account to buy and sell securities on a stock exchange. For those looking for little to no guidance, and no to few additional fees, this could be a website like E-Trade or an app like Robinhood. For investors who want help with investment decisions or leave the entire process in the hands of a professional, which could carry fees of hundreds or thousands of dollars annually depending on how much money is managed. — A full-service stockbroker or financial advisor is a better option.
The American Association of Individual Investors (AAII) promotes long-term investing, selecting stocks or funds for long-term returns rather than short-term gains.
“Nuanced investing, which is more likely to produce strong results over the long term, requires understanding your risk tolerance and building a portfolio that aligns with your corresponding asset allocation,” the group says.
A portfolio could hold a variety of stock types, including well-established companies with predictable earnings known as blue chips; stocks that pay dividends; expensive stocks that outperform the broader market and “cyclical” stocks that track the ups and downs of the economy, according to the AAII.
And a portfolio should include bonds as a means of balancing potential losses from stocks, the organization says. The ratio of stocks to bonds is called asset allocation, and AAII says that “how you allocate your portfolio between these two categories will have by far the biggest impact on your performance of any investment decision you make.” More bonuses means less risk but less reward. The opposite is true for a portfolio made up almost entirely of stocks.
Those who want to become day traders are probably more interested in speculative stocks, which are generally lower priced and highly volatile, meaning prices swing much higher and lower than normal in the market. Speculation can also involve buying a larger stake in a company in the belief that it will outperform the market or similar stocks in a relatively short period of time.
“While we are advocates of long-term investing, telling people never to speculate is like telling people never to eat dessert,” AAII Journal editor Charles Rotblut wrote in May. “If you’re going to deviate a bit from a long-term approach, do it in a controlled way.”
Risk tolerance is a measure of how well someone can psychologically handle the ups and downs of investing and weather stormy market conditions without making reckless and reactionary decisions.
Because there will be casualties.
Risk tolerance means “how much volatility in portfolio returns you can withstand and still hit your targets,” says the AAII. Translation: How much of your money can you see disappear during a day, month, or year of decline in the stock market? Can you trust that over the long term, money will probably come back and continue to grow as it has historically done in the stock market?
Kruse, the financial planner for Edward Jones, said a general rule of thumb is that if you need money in the next three to nine months, you shouldn’t put it into a relatively risky investment.
“For targets that are further away, you can take a chance with that money,” he said. But it still comes down to the type of individual investor. Someone who enjoys the risk/reward of day trading is different than someone nearing retirement or just entering the workforce.
How aggressive or conservative a portfolio should be depends on the person’s goals and how long they plan to keep the money invested before withdrawing it. For example, those nearing retirement are generally encouraged to put more money into bonds, a conservative approach that will reduce risk.
Those early in their career are more likely to want a larger share of stocks in their portfolio to maximize potential long-term gains, as a few down years may not matter compared to the overall gains over the course of more than 20 years.
For every situation, buying stocks and bonds isn’t a matter of “set it and forget it,” experts say. It’s “set up and monitor,” Kruse said.
“No matter what your level is, at least check the market with someone. Even the best of us need extra eyes to be sure,” he said.
Some experts suggest setting up-front limits on how much you’re willing to lose on a particular investment before you sell it. Investors can use the same strategy to get paid when a stock grows to a certain level.
E-Trade says that investors shouldn’t just hang on to a stock for the sake of long-term growth at all costs.
“Try to stick to a regular schedule for viewing and rebalancing your portfolio. This can prevent you from checking in too often and getting caught up in the emotions of the moment,” the broker suggests. “In short, it’s all about striking a balance. Don’t turn a blind eye to your investments, but at the same time, try not to react emotionally every time they go up or down.”
Robinhood, the app that ushered in a new generation in retail investing, recommends setting goals, paying off high-interest debt and starting an emergency fund before users start investing.
“Why try to pay off high-interest debt before you invest? Well, because it’s very rare (read: virtually impossible) to find an investment that can outpace the rate at which your debt is growing,” the company says.
E-Trade also offers a range of practical resources for beginners and pre-built portfolios to take some of the guesswork out of those first decisions.
“As investors today, we are incredibly fortunate. We have access to more information about markets and investments than at any time in history,” says the Morgan Stanley-owned brokerage.
Many first-time investors are drawn to mutual funds, which are pooled investments that offer preselected stocks and strategies tailored to different situations.
AAII and FINRA also have educational resources for individual investors, ranging from investment basics to choosing a strategy tailored to a person’s financial goals, whether it’s retirement, travel, money to inherit children, or just making a foray.
But as Robinhood reminds users: “Keep in mind that diversification, asset allocation, and research don’t stop you from losing money.”
Without risk there is no reward.