For those new to investing, learning how to start may seem overwhelming. There are so many charts, graphs, and numbers that it could be too much to all absorb at once. Although it seems very complex upon first glance, learning how to invest is not that difficult of a concept to understand. Much of it is very straightforward, especially once everything is explained.
However, many unfortunately are not explained the basic concepts of investing. Unless you major in business or self-teach yourself, you could go your entire life without receiving a proper explanation about investing in the stock market. As a result, many individuals are not properly prepared for their financial future. Knowing the basics of investing can be a significant cornerstone of securing financial freedom in the long-term.
Investing can provide the building blocks to creating generational wealth. But, a number of individuals either do not know or fail to realize how significant the benefits are. As a result, many leave tremendous amounts of money on the table and avoid a simple path to financial security and generational wealth. This also ties into the topics of retirement planning and saving.
If you want to learn the basics of investing and how to start, you’re in luck. This article is going to cover just that.
What is a Stock?
To understand how to invest, you need to know the absolute basics. If you want a more in-depth explanation of what a stock is, then you can check out my other article here. If not, here’s an overview.
Another term you should know is “shares.” Stocks and shares are often used interchangeably, but they mean two different things. When someone says they own two stocks, that person means that they own the stocks of two separate companies. On the other hand, if someone were to say that they own two shares, that person would only own stock in one company. For example, I would say that I own two shares of Coca-Cola, not two stocks of Coca-Cola. To learn more about the difference between these two terms, Investopedia has an excellent article on the topic.
Owning Stock = Owning the Company
Yes, investing in a company’s stock means that you are a partial owner of that company. In the previous example, I would be a partial owner of Coca-Cola. However, owning a single share of a company’s stock does not mean you are a significant owner of that company.
There are millions and millions of outstanding shares of stock for publicly traded companies. For example, there are currently 17.1 billion shares of Apple ($AAPL) stock on the market. That means owning one share of Apple is the equivalent of owning 0.0000000058% of the entire company. So, owning one share of a company is only a tiny drop in the bucket in terms of total ownership of the company.
Why Do Companies Issue Stock?
Companies issue their stock as a means of funding their business. Essentially, the company is selling a portion of its company to investors to receive cash in return. By doing this, the company can raise capital, or funds, and the investor is able to own a piece of a business.
Issuing stock is known as an equity method of funding, as you are selling equity in the company for funds. This differs from a debt method of funding, which includes the company issuing bonds for funding.
What Determines the Price of a Stock?
The price of a stock is the meeting point between a buyer and a seller. To simplify it, if a buyer wants to buy a stock at $5 and a seller wants to sell at $10, the two will meet somewhere in the middle and settle for about $7.50. In this case, the stock price is now $7.50. The bidding price ($5 in this case) is the price a buyer is willing to pay, and the asking price ($10 in this case) is the price a seller is willing to accept.
Stockbrokers conduct millions upon millions of these transactions every day, which is why stock prices fluctuate so often. This constant fluctuation in price is called volatility. Some stocks can be more volatile than others, which means some stocks change in price more rapidly than others. If a stock is more volatile, it typically indicates that the investment is riskier because the price is likely to change tremendously (potentially for a loss).
Importance of the News
The stock market can be very sensitive to news. One headline could really lead to a serious change in stock price. This behavior goes both ways, as both good and bad news can affect stock prices.
This demonstrates that numerous investors were scared about the repercussions the company would face due to the crash. Would they sell fewer planes? Would they face legal consequences? These questions allow for doubt to linger in the minds of investors, which makes them question the company’s future. This would be an example of how news can negatively impact a stock.
News can also positively affect a stock. In 2019, the World Wrestling Entertainment ($WWE) announced that it reached a lucrative television deal with Fox, which equated to $1 billion.
Consequently, the stock peaked at almost $100 per share in April of 2019. In April of 2018, the company’s stock price was around $39 per share. As a result of the television deal, WWE’s experienced an increase of over 150% in stock price. If one had known about the potential of this deal, they may have invested in the company and realized a tremendous return on investment.
Being up to date on the news can allow an investor to recognize opportunities in the market. However, never be too focused on headlines, as they only have a short-term effect on the market. If you have a long-term outlook, the daily news cycle should not have too much of an impact on your investments.
Where Are Stocks Traded?
Stocks are traded on exchanges, where brokers buy and sell stocks. There are several exchanges in the United States that serve as a platform for institutions to trade stocks, most notably the NASDAQ and the New York Stock Exchange.
Some foreign companies are not traded on American exchanges; they are traded on foreign ones.
There are some companies that do not even get traded on an exchange. These are traded over-the-counter (OTC). These stocks either do not meet the requirements to be on an exchange or choose not to be on one. An example of an OTC stock is Tencent ($TCEHY), the company that created the game Fortnite.
What are All of Those Numbers?
For a beginner, it might be overwhelming to see all of the numbers associated with a stock. Trust me when I say that it is not as complicated as it may appear.
These numbers are used to give a better understanding of the company before investing. They describe the financials of the company and detail the past performance of the stock.
Although they are easy to learn, knowing what they mean are crucial to understanding how to invest properly.
Earnings Per Share
One significant figure is earnings per share (or the EPS). This number is the calculation of the company’s total earnings divided by the total number of outstanding shares. The higher this number, the better a stock looks. As an investor, you would want to see a company make as much profit as possible, as it shows financial stability.
Formula: EPS = earnings per share = total earnings / total # of shares
Another number to look at is the price-earnings ratio (or the PE ratio). This figure is calculated by dividing the price of the stock by the EPS. This number usually determines whether a stock is overvalued or undervalued.
Formula: PE Ratio = Price of stock / EPS
Usually, the ideal PE ratio is around 20. This number helps determine if the stock is being valued properly.
High PE Ratio
A high PE ratio is typically an indicator that a stock is overvalued, meaning that the earnings report from the company does not justify its stock price. A number higher than around 30 is relatively high.
Usually, a high PE ratio is seen as a red flag not to invest in the company, since the stock price is higher than what the stock should be worth.
However, a high PE ratio is not necessarily a bad sign. For some industries, really high PE ratios may be acceptable. This is evident with most tech stocks. Amazon, for example, has a PE ratio of 85, which does not turn off investors in the slightest. This is because many are expecting the company to have continuously growing earnings, which will eventually lower the PE ratio.
Along with the PE, context helps determine whether or not a company is truly overvalued. This number should not be reviewed in a vacuum, but compared to competitors.
Low PE Ratio
Conversely, a low PE ratio is an indicator that a stock could be undervalued. In this case, the earnings suggest that the stock price should be higher than it currently is. If the stock is truly undervalued, then the PE ratio would hint that the stock is a deal on the market.
A low PE ratio could also mean that a company had unusually high earnings for a period, with expectations of the earnings dropping.
However, typically a low PE ratio is preferable to an investor, not a high PE ratio. Again, context helps to clarify the situation.
Market capitalization is the total value of the company. Typically, a company with a larger market cap is a more conservative investment. Apple and Amazon hit a market cap of $1 trillion last year, the first companies to do so. These companies can be seen as more stable companies, which is evident in its high market cap. Although it is safer, there is less growth potential.
Formula: market cap = shares outstanding x share price
Companies with mid to low sized market caps are less conservative and riskier. Like with all aggressive investments, with greater risk comes greater reward.
Dividends are a portion of the company’s earnings that the company gives to its investors or shareholders.
This figure constantly changes, as it reacts to the company’s success. If a company is doing very well, they might increase their dividend payments. If a company is not doing well, it might decrease it.
These payments are usually quarterly. However, some actually pay semi-annually or even monthly. The number shown is usually the payment for the year, not for one period.
If a company offers no dividend, it does not mean that it is a bad investment. Some successful companies choose not to pay a dividend. Amazon, Facebook, and Netflix all do not pay dividends. These companies do not offer a dividend because they believe the true value of their stock is in their future growth. These are growth stocks. That is why most tech stocks do not offer dividends.
The dividend yield is calculated by dividing the dividend payment by the stock price. This figure is displayed as a percentage; its purpose is to display how much the dividend payment is in relation to the stock price.
Formula: dividend yield = dividend / stock price
There is such a thing as having too high of a dividend. A good dividend yield is typically between 3% and 6%. Anything too high is unsafe; unstable companies use a high dividend yield as an incentive for investors. Usually, these companies are not doing well financially, so the only way to attract investors is with their dividend.
Value Stock v. Growth Stock
A value stock is a stock with relatively low volatility that offers consistent dividends. Investors buy these for the dividends and usually not for the stock’s future value. Examples of this would be Coca-Cola ($KO) and AT&T ($T).
As mentioned before, a growth stock is a stock that offers no dividends, but has a good future outlook. Investors buy these for their expected future growth. Tech stocks are great examples of this.
Either stock can be a great investment. It all depends on what you prefer. You could even invest in both!
How to Invest in Dividend Stocks
Investing in dividend stocks is very straightforward. All you would have to do is invest in stocks that pay a dividend. For example, Coca-Cola ($KO) pays dividends to its shareholders. So, by investing in a share of Coca-Cola stock, you would receive a dividend payment on a monthly basis. You would not have to do anything else. Just buy a dividend-paying stock, and let the company pay you on a regular basis.
Every publicly-traded company makes its financial reports available, which can be very beneficial to determine whether or not to invest in the company.
There is a balance sheet, which shows all of the company’s assets and outstanding liabilities. This allows a potential investor to see if the company would be able to pay its debts if necessary. There is the income statement, which outlines the income and expenses of the company. This will display if the company is profitable.
There are also 10Ks, which are very beneficial in analyzing a company. In these documents, the company outlines its business model, explains its financials, and even identifies potential threats for its business. This information can be critical in choosing your investments.
Now that you do understand the numbers, you can now choose your investments. Reading the news helps determine which companies to pick, as you would be able to pick up on trends and recognize opportunities.
In terms of strategy, here is my recommendation to you: be patient, and play the long-game. If you were able to invest in a stock but were unable to touch it for five years, which company would you pick? This is the approach that you should take when choosing an investment. It is how you increase the odds of having a positive return on the market, which has a return of about 10% per year on average.
Also, you should try to start investing as early as possible. The earlier you start, the more you can accumulate over the long-term. To learn more, click here to read Five Reasons Why You Should Start Investing Now.
For those who do not know or just learned how to invest, they make easily avoidable mistakes. Being too emotional or too greedy are common ones made by new investors. A long-term mindset allows you to avoid these mistakes, in addition to numerous others, which you can find here.
No Day Trading, No Penny Stocks
Many people who do not know how to invest typically try to make money as soon as possible. As a result, they engaged in very risky behavior and end up losing significant amounts of money. Two common methods of very risky investing are day trading and penny stock investing.
These two methods bring too much risk and not enough reward. A majority of day traders lose their money in the long-term. Even those who know what they are doing are also likely to have a negative return with these methods. That is just how volatile and unpredictable the market is in the short-term.
Individuals who implement these approaches tend to be speculators more than investors. This behavior can be seen with the erratic behavior on the stock market recently. To learn more about market speculation, click here to read my in-depth article about it.
It is easier to predict long-term performance than short-term performance.
I can understand the appeal for people wanting to trade penny stocks. The Wolf of Wall Street was a popular film, and many saw how successful he was. However, his success also sent him to prison. So, I would not suggest Mr. Jordan Belfort as a role model in that regard.
Investing in penny stocks is a terrible strategy. If a stock were to change in price by a few cents, you could lose everything. The low costs of the stocks deceive many investors into thinking they are good buys, when they really are not. These companies are usually very small with financial instability, making it a risky move.
How to Invest in Stocks
Once you get an idea of how to invest, you need to find a place to start. To start investing, you would use a brokerage. A brokerage is essentially a financial institution that allows you to invest in stocks and other securities. There are a number of reputable brokerages that you definitely have heard about.
The most popular amongst young investors is definitely Robinhood. In another article, I go into depth about Robinhood as a platform. If you want to learn more about the pros and cons of this brokerage, click here to read more.
If you want a cliff notes version, here is a summary. Robinhood has disrupted the entire brokerage industry, as it eliminated commission fees. Originally, investors would have to pay a fee for every stock they purchase. Now, most brokerages no longer have fees. Robinhood also offers interesting features, such as fractional shares, which lowers the barrier to investing for younger people. With this platform, your limited amounts of cash can go a very long way.
If you choose this method, you will receive one free stock when you create an account. To open a Robinhood account and collect that free stock, click here.
There are other platforms out there that are very similar to Robinhood. WeBull is another online brokerage that provides commission-free trading. They also offer two free stocks when you sign up and deposit $100. If you are interested in creating an IRA and collecting two free stocks with WeBull, click here to sign up.
Betterment is another brokerage you could use. The platform also offers a high-interest savings account, which could also be an interesting option for an emergency fund. It should be noted that, while Betterment is commission-free, they do charge a yearly fee of 0.25%. If you are interested in creating an account with Betterment, click here.
If you do not want to use any of these online brokerages, there are other many options available. Brokerages, such as Fidelity and Charles Schwab, are more traditional platforms. They are both very reputable and have very good track records. So, feel free to do your own exploring to see with which brokerage you’re most comfortable.
How to Invest with a Brokerage
Investing with one of these brokerages is much simpler than you would imagine. You could simply go onto any of their websites and sign up there. Note that you will need to have some personal information at hand to create an account. This information includes your Social Security Number and your address.
Do not be alarmed if you are asked for these, as this is common for brokerages to ask. I would just advise you to select a reputable brokerage and not to give this information to just any platform.
Time to Invest in the Stock Market!
Now that you know how to invest, it is time for you to invest. Do not be nervous; there is nothing to fear. Study as much as you can, then choose safe, reputable companies. This will increase your odds of success.
Again, always look to the long-term. Do not be worried about short-term trends or dips. If you truly love the company’s business model, then you should believe that it will perform well over the long-term, which it will.
Good luck, and happy investing!
How can I start investing with little money?
There is no such thing as not having enough money to invest, especially nowadays. With brokerages like Robinhood, you could now buy fractional shares of your favorite company’s stock. So, for as little as $1, you can buy stock in Apple, Tesla, Amazon, or any other company of your choosing. You could also utilize index funds, which would allow you to get a little piece of the entire market for a low cost.
Can you get rich by investing?
The stock market is probably the best way to generate wealth in the long-term. You just need to have a long-term outlook. Most people lose money trying to get rich quick. Instead, consider holding stocks of very reputable, stable companies for the long-term.
How can I start investing with $500?
Although you may not think so, you could do a lot with $500 on the stock market. With Robinhood, you now are able to buy fractional shares of stock, meaning you could buy shares for as little as $1. Build positions in companies that you like and are financially sound using fractional shares. Also, consider buying index funds, as they are safe investments and allow you to buy a piece of the entire market for a low cost.
What are the 4 types of investments?
There are various different investments that you could make, not just on the stock market. The four main types of investments are cash, fixed interest, property, and shares. Cash is self-explanatory. Fixed interest assets are assets that pay a fixed return, such as bonds. Property investments are essentially investments into the real estate. Share investments are the ones you are probably most familiar with. They are investments on the stock market, either through stocks, ETFs, options, etc.
What should a beginner invest in?
For beginning investors, many advise to look into index funds. Investing in index funds really requires no research or heavy lifting. Further, they add diversification to the account and tend to outperform individually picked stocks on a consistent basis. On average, they have a return of 10%, which is great for anyone on the market.
What do rich people invest in?
Very wealthy individuals have different goals when investing than middle- and lower-class individuals. For the very rich, they look to preserve wealth, not create it. To do so, they invest in things like artwork and gold, which are uncommon investments for non-wealthy individuals. While they definitely do hold stock positions, they do not do so significantly. However, to become a wealthy individual, many are involved in real estate investing, both privately and commercially. Real estate appears to be the best means for individuals to become very wealthy because it is less volatile than stocks. This would allow them to continue generating income and preserve their existing wealth.
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