It has been a few years since I started my first job, but I still remember the first few months very well. As a new college graduate who was earning money for the first time, learning how to invest in stocks was the last thing on my mind.
However, I soon realized that any money that remains in my bank account is doomed to be spent. Unless I brought some financial discipline to my life, I would not be able to save anything at all. This is a situation that many people find themselves in right now.
Today, I shed some light on the topic, show you how to invest in stocks and what’s the best path to take when you’re getting started in 2020.
📚 Table of contents:
👉 Disclaimer: This post is not legal advice or professional investing advice, and should not be considered as such. If you want to learn the technical details of how the financial products and instruments discussed here work and what impact they can have on your savings, speak to a professional in your country.
🥜 The absolute beginner’s explanation of stocks
There are many financial vehicles available if you want to save your money and put it in places where it can grow. Investing in stocks is one of them.
When a company goes public, it offers a number of shares for investors to buy. Once the initial shares are bought, they can be traded on a stock exchange – a marketplace for shares. These shares are collectively called stock, also known as equity.
Investing is defined as the process of putting money into a financial instrument. The funds that you invest in stocks typically give you good returns over a period of time. Stocks are still volatile investments that depend on the market sentiment. However, they have the potential to give you really good returns given that you invest for the long term.
📈 How to invest in stocks
Now that you have decided to start investing in stocks, you should choose the process through which you would like to invest.
Typically, to invest in a stock, you need a trading platform and a broker.
- A trading platform is a tool that analyzes stocks and makes trades by sending them to a broker as orders.
- A broker holds assets on your behalf and executes the trades with the exchange. You need a broker as you cannot directly trade stocks with an exchange.
Here are the most popular options when investing in stocks:
Online brokers 🖥️
When you’re just starting to invest, consider opening an investment account with an online broker, which also gives you a trading platform to search for and trade in stocks. Brokers and platforms can charge you fees for period maintenance (“taking care” of your stocks) and a percentage cut on every trade (a cut when you buy and sell stocks).
There are a few things to consider when selecting an online broker to invest in stocks. If you are on a low budget, do set aside a moment to check if an online broker allows small, minimum deposits.
If you plan to primarily use your mobile device for trading, does the stock broker have a good mobile app? Further, an online broker’s add-on features like any educational material may interest you if you are new to the market.
While online brokers enable you to trade in stocks, you still need to decide which stocks you want to purchase all by yourself.
As a beginner, you may feel the need for some assistance while purchasing stocks. For a low cost service, you may opt for what’s called robo-advisors.
Robo-advisors are automated, algorithm-based recommendation systems that offer suggestions based on information from other clients.
Since robo-advisors do not require human intervention, they are fairly inexpensive and may often be bundled with the services provided by your online broker.
Based on online reviews, the most commonly recommended robo-advisors in the US are Betterment and Wealthfront. For the EU market, the leaders are companies like Finax or Trading 212. Though in EU’s case, make sure that the specific robo-advisor is available in your country.
For more recommendations, you can read these roundups:
Fund managers 💼
The most expensive option is to get a fund manager to manage your investments for you.
Since a human is analyzing your wealth, income, and expenses to find optimum investment opportunities, this costs a fairly large amount of money. Additionally, they require a large minimum sum to invest.
If you find yourself with the need to invest a large amount (from a sale of an asset, an inheritance, or even a successful app launch), you should consider hiring a fund manager to develop an investment strategy to get the most benefit.
You may also be interested in:
👊 Low vs high risk strategies when you invest in stocks
Now that we have briefly discussed how you can open an investment account and start investing in stocks, let us go through various investment strategies.
Should you invest in stocks or stock mutual funds?
While you have the option of purchasing individual company stock, it may be risky. For instance, in May 2020, Tesla CEO Elon Musk tweeted that he felt that Tesla stock was too high. This led to a drop of Tesla’s share price by 12% that day . While the Tesla share price recovered in the coming weeks, this event demonstrates how stock prices can be volatile.
One common term that you may have heard is “stock mutual funds”. Let us try and understand how they are different from regular company stocks. A mutual fund pools together funds from a large number of investors to purchase stocks, bonds, and other financial assets to form a diverse portfolio.
Such a portfolio is difficult to build for an individual investor with moderate investment capabilities. A mutual fund is managed by a mutual fund manager, who has the responsibility to re-allocate funds when needed. For an investor who does not follow world events that affect share prices, mutual funds offer a relatively low-risk strategy to invest in stocks.
There are many types of mutual funds, with varying degrees of risk. A common type of mutual funds are index funds. The holdings of an index fund match or mimic a particular index. Their growth is generally pegged to the index, and their goal is not to beat the market returns.
Including index funds in your portfolio can help balance your risk, as market swings are generally less volatile across an index as compared to individual share prices.
A popular term you may stumble upon related to to concept of index funds is ETF. ETF stands for Exchange Traded Fund. Simply speaking, an ETF is a type of fund that tracks an underlying index and buys every stock that’s part of that index.
In other words, when investing in an ETF, you’re investing in the market as a whole vs investing in individual companies.
You can read on quality ETFs on these websites:
Concept of dollar cost averaging (DCA)
Dollar cost averaging is an investment strategy where an investor invests equal amounts of money in the market at periodic intervals of time.
These purchases are executed irrespective of the share price of a company or market trends at regular intervals, say once every month. Consequently, you end up purchasing more shares when prices are lower and less shares when prices are higher, thus reducing the average amount spent per share.
This reduces the risk and helps one build good returns over a long period of time. The goal of dollar cost averaging is to reduce the impact of volatility of share prices.
This is a good strategy for individuals who earn a salary. After accounting for their expenses, they can set aside a fixed amount to invest in the market every month.
The riskiest way of investing in stocks is to indulge in day trading. Day trading is a process where an investor buys and sells stock within the same trading day to earn a profit.
The objective of day trading is to earn a profit by tapping into the intra-day variation of stock prices. Day trading can also apply to trading of commodities and forex.
It is a lucrative career option, but not appropriate for the everyday investor. If you are new to investing in stocks, it is a good idea to avoid day trading completely.
💰 Setting a budget to invest in stocks
Now that you have some idea about how to invest in stocks and know some common investment strategies, let’s further explore how you can set a budget to start investing.
The typical way to budget your expenses can be found in the 50-30-20 model described in Elizabeth Warren’s book, All Your Worth: The Ultimate Lifetime Money Plan.
The simple model says that you should divide your income into three buckets.
- 🪣 The first bucket, comprising of 50% for necessary expenses like rent, groceries, and loan repayments.
- 🪣 The next bucket, comprising of 30% of your income, should consist of your wants, like eating out and vacations.
- 🪣 The final bucket, which comprises of 20% of your income should be invested for your future.
While the composition of the buckets may vary across individuals, you can use the approach to decide how much you would like to invest every month. Remember that no amount is too small, and you can start with even $100 a month.
🤕 5 common mistakes while investing in stocks
In this section, let us look at some common investor mistakes and why you should avoid making them.
1. Checking your portfolio too frequently
If you are not a day trader, and you have invested your money for at least a few years, you should refrain from checking the performance of your portfolio on a daily or a weekly basis. Doing so is counter productive, as short term volatility can influence your decisions.
For example, take a look at this chart of what happened with Microsoft stock around March 2020 (or any other stock, for that matter):
Charts by Visualizer.
Had someone decided to sell their Microsoft stock in panic around mid-March, they wouldn’t have enjoyed the rises that came soon after:
Charts by Visualizer.
2. Taking part in herd mentality
Herd mentality is a phenomenon where people mimic the behavior of other people around them. In investing, a common error is that people often talk about stock market gains when the market is doing really well. If you invest at that point in time, your investment may show a loss in the short term due to market volatility.
It makes sense to question conventional wisdom and use common sense when investing. In Warren Buffett’s famous words:
Be greedy when others are fearful, and fearful when others are greedy.
3. Confirmation bias
Confirmation bias is a tendency of people to favor facts that reinforce their prior beliefs but ignore information that contradict their beliefs.
Occasionally, confirmation bias can lead to uninformed investment decisions. A well-informed decision is critical to having a healthy portfolio.
4. Recency bias
Recency bias is a phenomenon where one gives more importance to a recent event. For instance, you may wish to pick up a stock with high one year returns as compared to a stock with healthy five year returns. Therefore, it is generally a bad idea to make a decision based on short term performance of a stock.
5. Negativity bias
Negativity bias is a phenomenon where negative events have a stronger impact on your decision that positive events. A good example of negativity bias is the large number of investors who existed the market after the 2008 market crash. These investors did not see the huge rebound over the course of year 2009 and beyond.
With negativity bias, you can avoid losses with a safe approach. However, it can adversely impact you by influencing you to miss opportunities to grow your investments. A careful approach to negative news events can help you critically analyze your investment decisions before you commit to something.
💉 Revisit your strategy to invest in stocks: learnings from the pandemic
The pandemic over the course of the year 2020 introduced unprecedented changes to the economy and the stock market. In this section, let us go through the learnings that one can draw from these recent events.
Maintain an emergency fund
Millions of workers lost their jobs in a matter of weeks as nations around the world embraced partial to total lockdowns. The stock market crashed in a matter of days, and eventually rebounded in subsequent quarters.
Charts by Visualizer.
The risk of job loss is real, and in such crisis, you need investments that are not affected by the market. You should also consider setting up an emergency fund, with a value of three to six months of your monthly expenses in case of such crisis.
You should consider risk-free investment opportunities for your emergency fund. Corporate bonds and government securities like the US Treasury Bonds are examples of risk free investments. They offer the lowest rate of returns, but your investment is secure.
If you already have an emergency fund, consider increasing it. If you do not have an emergency fund, reassess your budget to build one before investing in stocks.
Reassess your budget
In addition to the emergency fund, the pandemic may force you to revisit your budget-setting process. Consider the following questions:
- Have your needs and luxury expenditures changed over the course of the pandemic?
- Do you think that you can shave off unnecessary expenditures to increase your stock investments or add to your emergency fund?
- Do you want to allocate a higher percentage of your income for a better health insurance?
Rebalance your portfolio
If you have a portfolio, ensure that you reassess the asset allocation based on your risk appetite. This is relevant for existing bad investments that you should consider selling off.
The effects of the pandemic are permanent, and many industries have changed completely. Consequently, stocks that were earlier in a particular risk category may have shifted to a different one. Consider reassessing each investment and question whether you still need it.
🤔 Final thoughts on how to invest in stocks in 2020
In this post, we looked at the key considerations for a first time investor in stocks. We followed a possible journey that such an investor would take and tried to answer some common questions.
I hope that the considerations and strategies explored here will help you enter the market and earn your first experience. 📈📉
Even though it’s tough to predict the long-term effects that the pandemic might have on the markets, I still believe that now is as good a time as any to start investing in stocks.
Have any questions about investing? Ask away in the comments section!
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