Trying to learn about stocks and figuring out how to invest for beginners can be daunting. Some people have even said a trip to the dentist is less stressful when it comes to investing for retirement.
This comprehensive guide wants to give you the confidence to learn how to invest in the stock market.
How these seven steps fit into your overall money map (e.g. paying down debt, contributing to a tax-discounted retirement account, investing in the stock market) could differ based on your specific circumstances.
Step-by-step guide on how to invest for beginners in the stock market
1. Organise your finances
In my previous post, we covered the seven steps on budgeting your money effectively in greater detail. I’ve summarised the key points here.
Budget and net worth
Track your actual income and expenses.
Maximise your ability to save by optimising your essential living costs and minimising unnecessary discretionary expenditures. Ask yourself how you can increase your income and whether you are fulfilling your earning potential. Always spend less than you earn.
Make a list of all the assets and debts in your name. Subtract your assets from your debts to get your net worth.
Emergency fund
Build up sufficient savings to cover at least 3-6 months of expenses. One study has shown it takes a person an average of five months to find a new job.
Consider setting aside more if you know your possible emergencies might be expensive (e.g. medical procedures for chronic conditions, etc.).
Debts
Pay off any double-digit rate, high-interest debts. Especially for loans you used to buy depreciating assets or finance your living expenses (e.g. credit card debt, car loans, payday loans).
Weigh up the financial, tax and psychological pros and cons of paying off any middle rate debt (e.g. student loans, mortgages) before you start investing in the stock market.
Capital allocation
Make sure you don’t have any large expenses on the horizon (e.g. expensive babies, education or certification fees). Check you won’t need the spare cash you plan to invest for the next 5-10 years.
What proportion of your net wealth do you plan to invest in stocks? Do you have other forms of investments to balance this out with?
2. Write down your goals
People who write down their goals are 42% more successful than those who do not. Now, tons of people out there will tell you that you need SMART goals.
Don’t listen to them.
Instead, your goals should be FARTS 😏 . They also need to align with your core values.
- Focused (not vague)
- Appraisable (you can measure your progress)
- Reachable (they should be realistic)
- Timebound (set deadlines)
- Sincere (it is meaningful to you)
What do you want to achieve by investing in the stock market? What will you do with the profits and when will you need them by?
- Buy a $5,000 car before I start college
- Blow a $30,000 trip to Europe during my long-service leave in three year’s time
- Six-month career break starting next year
- Save for a $80,000 house deposit in five years’ time
- Retire by 45 and live off 75% of my current income each year
- Retire at 65 so I can afford scuba diving lessons, a yearly volunteer trip to West Africa AND feed my exotic pets until I die
Setting goals can feel like a waffly exercise when you don’t feel strongly about what you want to achieve. Not all people find finances and investing super sexy. If this is you, then being crystal clear about your goals (read: motivation) is going to be mission critical.
“Successful people have the habit of doing the things failures don’t like to do. They don’t like doing them either, necessarily, but their disliking is subordinated to the strength of their purpose.”
Albert E. Gray
Prioritise your goals and group them into short (0-2 years), medium (2-5 years) and long-term (5+ years) objectives.
This helps you know what and how much risk you can take on. It helps you match the purpose of your funds to the investment vehicles and strategies you use to get there.
For example, if your goal is to invest for retirement, you’d want to weigh up whether investing via your superannuation is going to work out better in the long run compared to investing DIY in the stock market. You’ll pay less tax, but only get to access your funds when you retire or perhaps save for a first home deposit. So there are pros and cons to this as well.
3. Set your investing boundaries
Your investment plan needs to align with your temperament, investment timeframe, risk appetite, purpose, and the amount of time and effort you are willing to put in.
Recognise your biases and limitations
To be a successful investor, you need to be keenly aware of your limitations and know when you’re out of your depth. But many investors also fail because they make financial decisions based on emotions instead of logical reasoning.
Our cognitive biases and psychological reactions to fast-moving share prices, thrilling news headlines or alarming analyst opinions are harder than you think to resist. We often pose a greater threat to ourselves than the risks to do with the investment itself.
Some of the most renowned investors attribute their success, not to their superior knowledge or technical skills, but to their ability to stick to their investment game plan no matter the weather outside.
What is your investment timeframe?
Your goals will inform your investment timeframe. This will also help you decide what type of assets will best help you get there, because they have different risk/return/timeframes.
Most people recommend only putting money in the stock market if you don’t need it within at least the next five years (or 7-10 years).
Patience makes for successful investing. The most popular and proven approach is to ‘buy and hold’ for the long term.
A longer investment horizon (e.g. 20 to 40+ years) allows you to reap the immense benefits of compound interest. You also have more time to bounce back from market declines and capital losses
“Our favorite holding period is forever.”
Warren Buffett
What is your risk appetite?
Are you risk averse, risk neutral or risk loving? Could you stomach a 25% fall in the value of your portfolio? Would you be tempted to sell out and limit your losses?
When your risk of losses is related to the volatility of share prices (e.g. life gives you lemons), some factors that inform your risk preferences include your goals, age, health and ability to bounce back from a financial setback.
You can take a quiz to find out your risk tolerance here or here.
How much effort are you willing to put into your investment portfolio?
What kind of investor do you want to be? How much time and effort do you want to spend learning to invest in stocks?
It’s effort versus control.
- Do it yourself
- Autopilot. Buy and hold some low cost index funds (ETFs) via an online stockbroker or robo-advisor. Low effort, market average returns.
- Entrepreneur. Pick individual stocks using an online stockbroker. More effort required to learn about stocks, greater control than ETF-only portfolios.
- Hybrid. Combination of the two approaches. See more on portfolio design below.
- Done for you
- Professional investment manager or full-service stockbroker
- Financial advisor
Besides these options, there are also ways to invest via retirement accounts or employer sponsored programs depending on where you live and work. These could have different tax implications, rules, features, and pros and cons.
That said, your personal finances and investments are always your responsibility.
While you can delegate your investment decisions to a professional or a robo-advisor, you won’t be able to outsource the financial consequences. Always try understand what your financial babysitter is doing with your money and ask why.
When not to invest in the stock market
The evidence shows the following ways are not great for building long-term wealth. Especially if you’ve only just started learning how to invest.
> You’ve got the itchies
You fancy making a quick buck. You are here for the thrill of the chase: NFTs, the metaverse, electric vehicles are so exciting, naysayers be damned. That, or you’re feeling FOMO.
> Taking stock picking advice from a friend
Got a hot tip off the cabbie or that swag dude at the bar last Friday? Do not pick your investments out of a gossip magazine.
Do your own due diligence, understand the risks and measure this to size against your facts and circumstances.
No matter how well meaning your buddies are, everyone has to eat their own cooking at the end of the day.
> Day trading
This is perfectly legal, very risky, and historically unprofitable. Apparently, 90 percent of all day traders lose money and 80 percent quit within the first two years.
Trading also takes a lot of concentration and can be stressful.
The frequency at which day traders buy and sell shares is at odds with the longer timeframe that is more likely to earn you better returns with less risk.
Trading frequently also means you pay lots of brokerage and transactional costs and reporting your investments on your tax return will be an administrative headache.
4. Learn the fundamentals of investing
When it comes to learning to invest in stocks, Warren Buffett has some wise words for you:
“You don’t need to be an expert in order to achieve satisfactory investment returns. But if you aren’t, you must recognize your limitations and follow a course certain to work reasonably well. Keep things simple and don’t swing for the fences.”
Warren Buffett
What is investing?
Investing is using money now to buy an asset to make you more money in the future. Shares are assets. So is a college degree, a car assembly line robot, or real estate. It is a form of delayed self-gratification.
I define stock ‘investing’ as a long-term endeavor.
“Investing is a game of snakes and ladders. You need to be willing to slide down a few snakes in order to climb the ladders.”
The FinanceFem
Investing is not ‘speculation’ or ‘trading’. People who speculate or trade (same thing lol) base their buy/sell decisions more on the stock price’s movements and less on its underlying business fundamentals.
In this arena, you make bets. You compete against other people in the market. You are playing a win-lose game, because your gains come from winning money off other people.
So there’s something to be said here about having a social conscience…
- Speculators will hook up with stocks that look “hot”.
- Day traders will speed date their stocks.
- Long-term investors marry stocks for their personality.
Look, speculating or day trading is not a sin, but they are a poor choice if you are looking for a healthy relationship with your finances. They also do nothing to generate economic gains for society. Sounds nasty…
But the truly scary part is that you might not even realize you’ve slipped into speculation mode.
So as a sanity check, ask yourself why.
“I want to buy this share, because….”
- Speculating: I think the price will go up
- Trading: I think the price will go up in the next few hours
- Investing: I think the company sells a solid product that its customers love and the current share price is not too expensive for what I get in return.
You can basically reverse this script when it comes to making sell decisions.
What is a stock?
A stock, share, or security is a tiny piece of a business. Holding shares essentially makes you a part business owner.
That share of business ownership means two things:
- You own an equivalent proportion of the equity that the business holds (i.e. its assets less liabilities, that’s why stocks are also called “equities”)
- You are entitled to a portion of all future earnings the business generates
How can stocks make you money?
- Capital growth: When the equity of your share increases over time, the stock price generally follows suit. Or market speculation inflates the stock price when demand exceeds supply.
- Dividends: A portion of company earnings that is distributed to shareholders instead of being reinvested into the business.
Your return = capital growth + dividends
What is a dividend reinvestment plan?
A dividend reinvestment plan (DRIP or DRP) allows you to receive dividends in the form of additional stocks instead of as cash.
They are excellent for harnessing the power of compounding.
DRIP shares are taxed the same as if you had received it in cash. But on the plus side, DRP stocks are often granted to you at a small discount to the market price, because the company issues them directly to you and bypasses brokerage transaction fees. Nice.
What makes stock prices go up or down?
People buying and selling in the stock market take into account various factors that influence the (expected) demand and supply for a given stock. This, in turn, ultimately determines the share price.
- Economic factors: inflation, interest rates, exchange rates, international market conditions, federal policies, debt, spending, etc.
- Substitute investments: rates of return on bonds, property, commodity goods, cryptocurrencies, etc.
- Market factors: investor sentiment on world events and political news, speculation, etc.
- Business factors: the company’s actual or anticipated profitability, often measured relative to peers in the same industry, etc.
There are many methods and ratios for measuring the value of a share. Popular ones include the price-to-earnings (P/E) ratio, price-to-book, debt-to-equity, discounted cash flow method, etc.
What are the risks of investing in stocks?
The risks of investing in stocks arise from three sources:
- Yourself
- Asset
- Price
All three can impact the return on your stock investments.
Think of risks arising from within yourself as an internal factor. These include behavioral risks resulting from your unconscious biases and preconceived notions about investing and money in general, as well as your cultural values and beliefs about your place in society.
Risk inherent in the share or its price are external factors.
Some of these key risks are inflation risk, timing risk, interest rate risk, market or sector risk, currency risk, liquidity risk, credit risk and concentration risk
Any investment carries risk inherent in the asset itself, and some more than others.
| Interest rate risk | Interest rate changes reduce your returns or cause you to lose money, especially on fixed interest investments (e.g. bonds). For example, interest rates rise, investors sell shares for bonds that earn an increasingly attractive interest rate of return. The company you hold shares in may also be facing higher interest costs on its debt, leaving less profit for shareholders. |
| Market risk | Share price falls because of economic, political or other market-driven changes. For example, rumours spread that a new super strain of Covid will shut down the economy again. Your market index fund shares fall as a result. |
| Sector risk | Share price falls because of economic, political or other changes specific to an industry or sector. For example, Chinese regulators fine Alibaba for monopolistic practices. Your shares in a China technology index fund fall as fellow investors yank their funds out of the company and its peers in the industry. |
| Currency risk | Currency fluctuations reduce your returns on international shares you buy/sell in a different currency to your home currency, or companies you invest in have overseas business operations that expose them to potential foreign exchange losses. Say you sell your international shares for a neat 30% profit, but the FX rate depreciates by 30% and wipes your gains when you convert back to your home currency. |
| Liquidity risk | You are unable to sell your shares and convert your holdings to cash quickly or when you want to. Or you, or the company you invest in, do not have sufficient cash or liquid assets to meet short-term obligations (e.g. living expenses, debt, etc.). |
| Credit risk | A company or government you lend to defaults on its debt and you are unable to recover the money you loaned. |
| Concentration risk | Your shares or overall investment portfolio is concentrated in a number of assets that are all exposed to common risk factors or their performance is highly correlated with each other. This is like putting all your eggs in one basket. |
| Inflation risk | The value of your shares does not grow fast enough to keep up with rising living costs. |
| Timing risk | The timing of your investment trades leads you to buy high and sell low. |
What is a stock exchange?
Stocks are traded via brokers on a stock exchange, which is essentially a public marketplace that facilitates buys and sells. When the bid (buy) and ask (sell) prices match, a transaction takes place.
Some of the main stock exchanges in the world are:
- New York Stock Exchange (NYSE)
- Nasdaq (NDQ)
- Australian Securities Exchange (ASX)
- Shanghai Stock Exchange (SSE)
- Tokyo Stock Exchange (TYO/TSE)
- Hong Kong Stock Exchange (HKG)
- Toronto Stock Exchange (TSX)
- London Stock Exchange (LSE)
- Euronext (EPA)
- National Stock Exchange of India (NSE)
How are shares taxed?
Unless you are holding your investments in a tax advantaged retirement account, you need to pay capital gains tax (CGT) when you sell investment assets for a profit.
What is the capital gains tax rate?
The CGT rate is whatever your personal income tax rate is if you sell your shares in less than a year.
BUT if you have owned your share investments for longer than a year, then you only have to pay tax at 50% of your personal income tax rate in Australia.
The tax office does this, because they want to encourage people to invest for the long-term which is good for the economy overall. This is another incentive not to day trade, okay?
What happens if I make a loss on my investments?
That’s called a capital loss. You can use it to offset your net taxable income and effectively reduce the amount of tax you pay on your overall earnings. Or you can “carry it forward” to offset your income in future years.
You need to report the profits you made during the year in your tax return
When you start buying and selling shares, your broker will send you pieces of documentation (e.g. trade confirmations, trade receipts, dividend notices and tax summaries, etc) that show the buy price or sell price and amount of dividends received.
You need to keep these for five years after you submit your tax return.
These details will often be automatically filled out in your tax return if you provided your tax file number to your broker when you signed up your account. So you only need to check the pre-populated numbers.
You only need to report the profits on stocks you have actually sold. And not the unrealised profits on stocks you still own that are up in the green.
5. Open a brokerage account
What are stockbrokers?
Stockbrokers will execute trades on the stock exchange on behalf of investors. They charge a brokerage fee or commission when you buy and when you sell. They act as agents for you in the stock market.
They can be online discount brokers or a full-service stockbroker who is a licensed professional.
Online only brokers tend to be cheaper than full-service brokers, because they have less overheads that keep the cost of providing services low for them.
We discuss online brokers as the focus of this article.
Why do I need a stockbroker?
A broker gives you access to one or many of the world’s stock exchanges. You can’t do it without one. They handle the clearing, settlement and administrative processes involved with trading shares and other listed assets.
How to choose an online stockbroker
Things to consider when comparing stockbrokers:
- commissions and fees, including inactivity fees
- account or deposit minimums
- fast deposit and withdrawal clearance times
- trade execution speed
- access to international stock markets and breadth of investment products
- FX margins and conversion fees
- client reviews
- platform and trading features including ease-of-use
- research and market analysis tools
- customer service and phone support
Nowadays, most online brokers offer very cheap or no-commission shares, company analyses and market newsfeeds, robo advisor services for a hands-off investment approach and educational resources on investing and personal finances.
Examples of stockbrokers
In Australia, stockbrokers include CMC Markets, Interactive Brokers Australia, IG, Sequoia Direct, CommSec, nabtrade, SelfWealth and more. See a list on the ASX website here.
Globally, most of the largest stockbrokers are based in the US. You might hear of the names Charles Schwab, Fidelity, E*TRADE, Vanguard, Interactive Brokers, Merrill Edge.
Each stockbroker may vary in the markets they give you access to, the brokerage fees and the services, products or features that they offer.
How to open an online stock brokerage account
- Choose a stockbroker based on your investment needs, goals and strategy
- Open an account through their website or app once you enter your personal details for tax and identification
- Transfer funds to your brokerage cash account. This is a linked bank or checking account that your stockbroker opens for you once you sign up.
- Buy stocks but first, read Step 6 to decide what your portfolio will look like. To buy a stocks, type the stock ticker (e.g. “AAPL” for Apple) in the search bar. You will get an order confirmation once the transaction is completed.
Robo advisors
Robo advisors are well suited for a low-cost, no-fuss investment strategy that targets long-term wealth generation. Think AI meets financial advisor.
Robo advisors are digital algorithms that provide simple investment advice and automated portfolio management services based on your risk profile, investment goals and timeframe. The algorithms incorporate basic investing principles, such as diversification, asset allocation, rebalancing and tax-loss harvesting.
The system will invest your required amount into a pre-designed portfolio that matches your goals. The portfolio is usually a composition of passive ETFs, rather than individual stocks.
If you have chosen to work with a robo advisor, check their account fees and features, including how much discretion you have over which index funds the robo advisor will invest in.
Robo advisors include Wealthfront, Betterment, M1 Finance, E*TRADE Portfolios or other auxiliary platforms to the online discount brokers listed above for US-based investors.
6. Plan your investment portfolio
So, how do you choose the best stocks to invest in for beginners? Let’s take a step back.
First, let’s think about how to allocate funds across asset classes BEFORE you start buying any stocks. I have included some basic example portfolios further below.
This is a bit like meal planning before you go buy groceries.
What are the different types of asset classes?
- International shares: Investing overseas exposes you to exchange rate risk (unless you are hedged), because the shares must be bought and sold in foreign currencies and the business you invest in runs its operations in a ‘foreign’ currency.
- Domestic shares
- Property: Commercial, residential, industrial, land-only
- Infrastructure: ports, bridges, utilities, telecommunications, etc.
- Commodities: cocoa, coffee, sugar, wheat, gold, copper, cattle, oil, natural gas, etc.
- Private equity: You can sometimes buy stocks in a publicly-listed company or fund that in turn, invests in assets that are essentially bought and sold via private sales
- Credit: Debt securities, leases, royalties, hybrids and loans
- Bonds: Fixed interest securities such as loans, bonds and securitised debt issued by governments, the private sector and banks
- Cash: Deposits, bank bills and short-term bonds
- Cryptocurrency: So volatile and speculative that it is difficult to avoid and resist playing the game of “timing the market”. The underlying blockchain technology is highly technical and the use case for each coin tends to have niche applications.
Asset allocation vs. risk-return exposure
The exact allocation will depend on your financial goals, timeframe, risk tolerance and investment strategy, because each asset class has a different risk-return profile.
For short-term goals, lower risk-reward investments are less volatile and more liquid, but will do a better job at preserving your original capital.
For longer-term goals, investments with a greater risk-reward profile will expose you to greater upside potential on average. Meanwhile, you have time on your side to wait out any occasional short-term drops in value.
(Source data: 2021 Vanguard Index Chart)
Diversify your portfolio to spread risk and reduce volatility
Diversification is a fundamental strategy for spreading unsystematic risk and tempering the fluctuations (both up and down) in the value of your overall holdings.
The averaging effect of diversification should give you greater protection of capital and more stable returns.
You can diversify across companies, sectors, geographical markets, investment strategies and most importantly, across asset types that are typically non-correlated (e.g. bonds vs stocks).
On the other hand, having a concentrated portfolio means putting your eggs in one basket.
This is not necessarily a bad thing if you have done your homework and are reasonably confident in your stock picks. It does require conviction and some research though.
What is the optimal number of stocks to have in your portfolio?
Nowadays, this is a bit of a moot point, because so many people are simply investing using index funds and ETFs (i.e. cheap diversification).
Many studies show there is no consistently optimal number of individual stocks in a portfolio, but a general rule of thumb is 10-30 shares.
Beyond this, the costs of diversification start to outweigh the benefits. The more stocks, the more costly and time-consuming it will be to realign your portfolio to your goals and risk tolerance on a regular basis.
In an ideal world, you could actually aim to hold a handful of high-quality stocks, or as Warren Buffett puts it, a handful of outstanding businesses with “mouthwatering economics” you understand.
High quality implies lower risk and you wouldn’t want to dilute stellar performance if you can help it. This approach is favored by some DIY entrepreneurial investors who subscribe to the value investing school of thought.
But if you don’t have the time nor inclination to do in-depth research on the caliber of each company, the bottom line is to hold a sufficient number of stocks to be able to spread your unsystematic risk, particularly across geography and asset class.
I personally hold about 5-10 stocks, because some of those holdings are already inherently diversified (e.g. ETFs or companies whose business it is to invest in a bunch of different things).
Examples of stock portfolios
The following are some example investment portfolios to jog your brain, from least to most effort required:
- All-in-one fund: A broad-based basket of stocks, bonds and other assets all bundled into a single index fund, called a “Diversified Portfolio ETFs“.
- Three fund approach: Three index ETFs comprised of domestic equities, international equities and bonds
- Core and satellite: Low-risk, low-volatility core holdings (e.g. broad-based index funds and bonds) supplemented by high-risk, high-return satellite shares of individual companies or specialised ETFs that are usually sector specific or thematic (e.g. tech play, consumer cyclical, etc.)
- The 90/10 strategy: 90% index ETFs of shares and 10% of low risk investments, such as fixed interest products (e.g. bonds, etc.) This portfolio strategy was first advocated by Warren Buffett for people whose investing purpose is saving for retirement.
- Custom: Pick your own stocks based on your research of company fundamentals and business prospects
Just like how you can order any kind of coffee but sub the dairy with [insert favorite nut] milk, you can apply an ethical investing lens to any of these portfolios if that floats your boat.
Again, bear in mind that the more stocks or types of assets you own, the more costly and time-consuming it will be to rebalance and monitor your portfolio to keep it aligned to your goals and risk tolerance.
Other investment categories
Besides asset classes, there are many different categories of listed stocks, bonds and corresponding market indices to consider for a diversified investment portfolio.
- Sectors: financials, energy and resources, consumer, technology and communications, industrials, healthcare, real estate, materials
- Markets: domestic or international, developed (e.g. US, Japan, Europe, Canada, Australia, UK, etc.) or emerging (e.g. Brazil, China, India, Peru, etc.)
- Company size by market capitalisation: small cap, mid cap, large cap, mega cap (no, not talking about cappuccinos here)
- Company profit potential: growth (growth potential), value (undervalued) or mixed
Exchange-traded funds
When it comes to investing for beginners who want a low maintenance portfolio, exchange-traded funds (ETFs) are the star choice.
What is an ETF?
An ETF is an investment asset that allows you to buy a collection of stocks, bonds or other assets in one bundle, kind of like a goodies hamper. You don’t actually own the stocks, but you own a share in the basket that carries them.
It is a “fund”, because it pools the money of multiple investors, just like how you would team up with friends to bulk buy at Costco.
It is “exchange-traded”, because it can be publicly bought and sold on stock exchanges (unlike hedge funds and private equity funds).
How does a passive ETF work?
Passive ETFs (aka index ETFs) track a market index. They aim to earn average returns of the selected basket of stocks. On the other hand, active ETFs are more costly, since they are run by investment managers whose aim is to beat the market through proactively selecting and managing the stock picks held by the fund.
For example, an S&P 500 ETF follows the S&P 500 benchmark index. This index is made up of the roughly 500 largest publicly-listed US companies by market capitalisation.
Just as songs come and fall off The Billboard Hot 100 chart, an index ETF will automatically acquire or dispose of shares in companies as long as they make the list. The ETF will hold these 500+ shares using aggregate investor funds, while each investor owns a share in the ETF itself.
Should you buy ETFs?
You’ll first need to weigh up the pros and cons of investing in ETFs, understand their risks and know what to look for in an ETF. Then decide whether they fit into your overall portfolio strategy.
That said, one of the most attractive reasons why people invest in ETFs is cheap diversification. So it’s a fitting strategy for a low-cost, low-maintenance investment portfolio.
Pros
- Historically higher returns versus an active strategy
- Diversification
- Automatic balancing
- Easily bought
- Cheap management fees
- Efficient brokerage costs
- Access to more markets
- Greater liquidity
Cons
- Still exposed to broad risks
- Less control over company directives
- Less control over tax consequences
- Beware of overlaps between your ETF holdings
- Watch out for tracking errors
But besides buying baskets of stocks via ETFs, you can also opt to buy stocks in individual companies.
What are the benefits of picking individual stocks?
The process of researching and selecting companies to invest in can be enjoyable – like sitting through the early stages of America’s Got Talent auditions and discovering gems before they go mainstream.
It often means reading company financial statements, analyst reports and news press releases or interpreting technical graphs and crunching numbers in Excel.
Individual stock picking gives you greater control over what you sink your money into. This could be for ethical and socially responsible investing reasons, or because you have strong convictions in the future prospects of a particular company.
This “hands-on” approach to investing works best if you are the thorough, analytical type and would enjoy doing deeper research on a company.
How to choose the best stocks to buy
Remember, you owning a stocks is essentially you owning part of a business. So think about what you’d want to know if you were a prospecting business owner.
- What is the company’s position and positioning in the market? What is its market capitalisation? Are they mature or growing out of the start-up phase?
- What is the company culture like? Does it enable them to attract the best talent in the market? Don’t underestimate the effect of culture on profitability and the longevity of the company.
- How well does this company’s ethos and actions of the management team align with my core values and financial goals?
- How well does the company’s projects or future growth initiatives match with my investment timeframe?
- Are the goods and services it provides likely to be in demand in years to come?
- Who are its competitors? How does it compare to its peers?
- Are they actually turning a profit or just super popular and well-known? Do they have a track record of profitability and solid company leadership?
- Are there opportunities for the company to grow in the future?
- What foreseeable threats are there to the company sustaining its profitability in the future?
- What are its valuation metrics (e.g. P/E, P/B, D/E ratio, dividend yield, etc.)? How do these compare with its competitors or industry?
- Et cetera
What are the different investing schools of thought?
These include value investing, dividend investing, growth investing, technical analysis, efficient market hypothesis, momentum investing, factor investing and more.
Your investment philosophy will influence your investment strategy. It depends on how you believe stock markets and share prices behave.
Value investing
- Buy shares that are priced lower than their intrinsic value when the market is being a drama queen
- Calculate the intrinsic value using fundamental analysis techniques such as DCF, book value, P/E or other ratios based on the company’s financials
- “Margin of safety” concept per Benjamin Graham: mitigate risk and increase upside potential by only buying when price is well below estimated value
- “Economic moat” concept per Warren Buffett: seek businesses with durable competitive advantages
- Focus on value stocks that tend to be mature, blue-chip companies and low risk-takers with a track record of steadily increasing earnings.
Dividend investing
- A derivative of value investing, but relates specifically to investing in companies with a reliable history of dividends
- Dividend investors like stocks that are “dividend aristocrats” or “dividend kings”. These are exclusive lists of companies that have maintained or increased dividends over 25 or 50 consecutive years.
- A favoured strategy is to reinvest dividends via DRIP or DRP
- People close to retirement tend to like dividend stocks for their income stream
Growth investing
- Focus on growth stocks like companies that are typically young, fast-growing, small, pioneers of some sorts, or…all of the above
- Stocks of exciting new technologies or ventures tend to be a crowd favourite
- Growth investors usually don’t feel scary butterflies in their stomach when they see stocks with a super high P/E ratio
- Seen as the arch rival of value investing (or dividend investing), although they are not necessarily exclusive
Technical analysis
- Not an investment philosophy per se
- Used by most professional traders traders to make buy/sell decisions
- Ignores the company’s financial statements
- Identify fancy-sounding patterns in price graphs or trade volumes
- Fancy names include moving averages, Bollinger Bands, correlation coefficients, Klinger Oscillators, inverse head and shoulders, double bottoms, ascending triangles, and cups with handles.
Efficient market hypothesis (EMH)
- Everything that affects the value of the share is already factored into the market price, including news events in real time
- Investors behave rationally and there is no such thing as buying or selling based on emotions
- Arbitrage or deviations between price and value don’t exist, so it is impossible to beat the market
- They usually stick with index funds
Momentum investing
- A strategy of buying only stocks with high returns in the last 3-12 months, then selling stocks with a recent history of poor returns in the past year.
- Like day trading, this sounds like a promiscuous way of investing.
7. Grow and track your portfolio
How often should you invest?
Most investors invest a fixed amount out of their monthly salary into their stock portfolio. This is what I try to do, because it works well with the automated budgeting system I have set up for myself.
Dollar cost averaging (DCA) is a strategy that you can use to reduce the risk of investing in volatile markets. It involves investing a fixed amount of money at regular intervals, regardless of the stock price.
Using this strategy means you are less likely to buy stocks when they are most expensive, but you are also less likely to buy stocks when they are cheapest. This helps you resist the urge to “time the market”.
At the same time, you need to consider balancing out the frequency of your trades compared to investing a lump sum of cash, because brokerage commissions can end up taking a chunk out of your returns.
Why is it important to track your stock portfolio?
Because things change. Including your goals.
Your stocks might deviate from your high-level investment plan and desired asset allocation when the reasons that compelled you to invest in a stock in the first place change.
This could be anything from macroeconomic conditions, competitive landscape or regulatory environment to management taking the company in a different strategic direction or reports exposing poor working conditions and labor rights at the company.
This might also shift the price of your stocks and consequently throw out of proportion your risk exposure and asset types in your overall portfolio.
How often should you check on your investments?
That depends on what your goals are and how long your investment horizon is, but at least once a year. Anything more often than once a week puts you at risk of ‘decision fatigue’ and making buy/sell decisions based on your emotions.
Perhaps reviewing your portfolio every quarter could be the sweet spot. Recurring calendar reminders are a great way to do this.
How to keep automatic tabs on your portfolio
- Set-up watch lists and price alerts. You can do this in your stockbroker app, or via news sites, like Yahoo finance.
- Read the business and market news. The business, economics and finance section will become more interesting. Get your investment news from multiple, reputable sources
- Read your emails you receive on dividends, company announcements, annual report publications, changes in analyst ratings, etc.
At the end of the day…
While it can seem pretty daunting at first, the basic steps on how to invest in stocks are actually straightforward. You don’t need a degree in corporate finance to get started investing in the stock market.
Once you have charted out your own investment plan, all it takes is opening up a stockbroking account, buying some stocks, bonds or funds and checking on them every now and then.
Well, writing this was a marathon. Did you find this helpful? Let me know what you think in the comments below!
