Given the stock market’s strong performance up until the COVID-19 pandemic, combined with the extra attention towards the market and the quick rebound over the past few weeks… it’s safe to say A LOT of people have expressed interest in learning how to invest and get started.
While investing isn’t necessarily a hard thing to do, it does require a bit of basic knowledge, a strategy, and a plan. Otherwise, it can feel super confusing and intimidating, leading people to avoid investing all together. I’m here to share some basic concepts about investing, because it doesn’t need to be scary! However, it is critical to make sure that you understand what the stock market is, as well as your strategy, risk tolerance, and budget to get started.
This article is not financial advice and based on my own knowledge and experience. Any decisions you make as a result of reading this article are at your own risk.
What Exactly IS the Stock Market?
The stock market is a group of buyers and sellers of stock. Stock is simply just a piece of ownership in a company; when you purchase a stock, you become a partial owner of that company. A company will issue stock in order to raise money to fund their business. Each purchase gives the company money to invest in itself, and gives each purchaser (investor) a piece of the business, and ultimately a share in the businesses earnings.
The value of a stock will rise and fall depending on how well the company is performing. If a company is really popular and their business is doing well, the stock price will rise because more people want to buy the limited amount of shares in the market. The same goes if the company isn’t doing well; investors may want to sell their shares to avoid losing money when the share value decreases.
The bottom line is that the stock market serves as a place for investors (shareholders) to buy and sell shares of stock. They trade shares based on anticipation of prices rising and falling, with the ultimate goal to buy a stock when the value is lower in the hopes that it will become more valuable over time.
When it comes to investing, you need to have a strategy. While there are many different types of strategies investors follow, there are a few main strategies that beginners can focus on to get started:
Buy and Hold (Long-Term)
A buy-and-hold strategy is simply what it’s name is; you buy an investment, and you hold it for as long as possible (think anywhere from 10-40 years). This strategy is great for long-term investing because the goal is that the investment you purchase will appreciate and grow over a long period of time, ultimately becoming much more valuable than it was when you purchased it. While this strategy requires some thought and evaluation up front, it is simple to maintain and add money to over time with little to no extra effort. However, it is important to know that when you invest in a specific fund or stock over a long period of time, you will likely need to sustain some fluctuations in value.
This strategy focuses on investing in companies that are growing very rapidly. An investor will purchase stock in a company that is either new or small, or pre-IPO (meaning they haven’t gone public into the market yet but plan to), with the hope that purchasing the stock early will result in big gains down the line as the company grows. Often these types of investments will grow rapidly, resulting in your money growing pretty rapidly as well. However, this growth may not always be sustained and can be quite volatile, so there is a higher risk of losing money.
Value investing is comparable to buy-and-hold investing, however it is focused on purchasing shares of stock that seem to be selling for less than what they may actually be worth, also called “below market” value. Think of it as buying something for cheap right now, knowing that in 10 years you can sell it for way more than what you bought it for. While this strategy can lead to long-term success, it does require you to keep up to date with events, company news, and specific industry trends, which can be challenging.
Keep in mind, as an investor you can incorporate all 3 of these strategies into your overall investment strategy. You are not required to choose one strategy and only follow it specifically; it is actually a great idea to combine different strategies for overall wealth maximization over time. As you begin investing and start learning more about different types of investments, you’ll become more confident to make decisions using different investment strategies.
Risk is an integral investing concept; simply put, risk is the volatility of a specific investment. An investment that sees many large fluctuations in value is considered riskier compared to an investment that holds fairly steady over time. As a result, an investment that is riskier can bring a higher return in value compared to a more steady, lower risk investment. This concept is called the risk-return tradeoff, and will ultimately determine your risk tolerance as an investor.
Risk tolerance is how much risk you’re willing to take on, and it has a huge impact on the types of investments you’re willing to take on, as well as your investment strategy. Risk tolerance is generally classified into 3 main categories:
Conservative: Focused on steady-eddy style investments. Willing to take on smaller returns in order to maintain a steady value in the portfolio and minimize any losses over a given period of time.
Moderate: Willing to take on some more risk than a conservative investor in order to reap higher returns on their money. Focused on steady investment growth with periods of fluctuation that eventually even out.
Risky: This investor is willing to take on a lot of risk, invest in volatile stocks in order to reap high rewards. This investor isn’t worried about losing money as much as they are focused on maximizing return.
Your risk tolerance is individual, however many investors are some combination of 2 tolerances. Keep in mind, your risk tolerance can and will change over time. Your age and current financial situation are huge determinants in how much risk you can tolerate. Generally, younger investors are willing to take on more risk, because they have a longer period of time to re-gain any losses they may incur.
Knowing how much to invest is one of my most commonly asked questions. Generally speaking, it is important to have an emergency fund set aside before you start investing. This fund should contain 3-6 months of living expenses so that if your investments lose value due to market fluctuations, you have other funds available. Remember, investing is an additional form of saving, it is not the only way you should be setting money aside.
Determining how much you need to invest first requires you to determine a GOAL! You can’t give directions without having an end point in mind, right? This goal can be fluid, but it will give you a starting point to figure out what it is going to take to get there. For example, say you’re 25 and want to save $1.5 million for retirement. To figure out how much to start saving, you would need to do some pretty complex backward math. However, there is a sneaky tool that is widely available and FREE online for you to use to get an idea of how much you need to invest monthly (or annually) to reach that goal.
The tool is an online compound interest calculator, and you can use it to determine how much you need to invest to reach a certain goal. You simply enter the how much you think you need to set aside each month, how long you plan to save (in this case, 40 years) an assumed interest rate (generally speaking, the historic rate is ~7%, so that is a good place to start), as well as your compound frequency, which is how often you’ll contribute (either monthly, or annually). Plug those numbers in and hit “Calculate” and a graph will appear showing how much you’re investment will look like at the end of the time you entered! If the number is lower than you want, you’ll need to increase your contributions or length of time. So for example, if you wanted to save $1.5 million dollars in 40 years assuming a 7% return, you’d need to invest $575 per month; that is about $150 a week.
This is a fun tool to play around with because it will help you determine how much to set aside, but also can show you how much you’re investment can grow over time!
Investing doesn’t have to be scary or intimidating, but it does require some basic understanding and confidence to get started! While this guide is just the beginning, I hope it has given you some points to think about and research further based on your individual financial situation. Please keep in mind, this post is for educational purposes only. I am not a financial advisor and no part of this blog post is intended as financial advice in any form. Any action taken is at your own risk; be sure to contact a financial professional for tailored advice.
Part 2 coming soon!