How to Invest in Stocks Smartly
Investing in stocks is a smart way to build wealth, but it’s important to do your research before you dive into the market.
Stock investing can be intimidating, but it doesn't have to be. In this guide, we'll cover the basics of stock investing and talk about the types of stocks you can invest in. We'll also discuss how to buy and sell stocks, as well as how to choose an account for your investments.
Know the Different Types of Investments
Before you can start investing in stocks, it's important to understand the different types of investments. When you invest your money in the stock market, you're essentially lending it to companies and hoping that they will use it wisely and grow as a result. When this happens, your investment grows in value as well.
Stocks are shares of ownership in a company; for example, if you owned 100 shares of Google stock at $1 each (called "100 shares"), then Google would owe you 10 cents per share ($10) if they paid out their profits quarterly or annually. Because stocks go up or down based on how well the company does financially — or how much its stock price fluctuates — there's always potential risk involved with buying them.
Think Long Term
One of the biggest mistakes that investors make is trying to time the market. That is, they buy low and sell high in an attempt to maximize their returns. The problem with this strategy is that it's nearly impossible to predict exactly when those fluctuations will happen, so it's best to avoid them altogether.
Instead of focusing on short-term movements in your portfolio (or even medium-term ones), think about investing for the long haul — 10 years or more. With that kind of time frame in mind, it doesn't matter if you buy stocks at $5/share or $50/share; either way, you'll be able to ride out any downturns and reap the benefits once things start heading back up again.
If you don't know anything about a particular stock before buying it (or if you're only familiar with one aspect of its business), consider looking for more information before making an investment decision: read company reports from third parties like Morningstar or Standard & Poor's; attend company presentations at conferences; talk with other investors who have experience working with this type of company, etc.
Consider the Liquidity of Your Investment
Liquidity is the ability to convert your investment into cash quickly. It’s important to consider liquidity because it allows you to access your money when you need it. You may want access to cash for an emergency, such as sudden medical bills or a job loss. Liquidity is also important if you plan on selling your investments at some point in the future. If they are not liquid enough, then it could be difficult or impossible for you to sell them when necessary.
When evaluating how liquid an investment is, think about how long it would take before it could be converted into cash and transferred back into your bank account.
Take Your Risk Tolerance Into Account
Risk tolerance is the degree of uncertainty or variability in returns that an investor is willing to accept in exchange for the possibility of a greater return. It’s important to understand your risk tolerance when investing because it will determine how much risk you can handle and how much money you should invest at any given time. Each individual has his or her own unique risk tolerance, which depends on your age, your financial situation (e.g., do you have enough cash reserves?), and any goals that may be motivating your investment decisions.
Stick to Your Plan
If you’re reading this and thinking, “I know all this stuff already! I don’t need to read anymore,” then you might be one of those investors who are prone to making poor decisions. The reason is simple: If you know what not to do, it doesn't mean that you're going to follow through on your knowledge every time. So-called "experts" in investing are often just as susceptible as anyone else when it comes down to making emotional decisions or over-trading (which ultimately costs them money). Whether it's because they're afraid of missing out on a potential opportunity for growth or because they've had a loss recently and want their pain back by acting quickly, they make unwise decisions based on whatever is happening at the moment.
The most important thing to do? Don't trade out of fear or greed. When markets go down (and sometimes even when they go up), people get scared and rush into action — often doing something like selling stocks at a loss just so they can say "I'm not losing anymore." Or conversely, after seeing how much money some people have made in recent years, mainly due to their stock portfolios growing exponentially faster than anyone ever expected them to, others may decide now's finally the time to join in on those gains while still feeling confident that things won't turn around anytime soon, so there's no risk involved here whatsoever.
Don't Try to Time the Market
We know what you're thinking, and the answer is no. You should not try to time the market. You will never be able to predict when a stock price will rise or fall — and even if you could, it's probably not worth trying to do so.
Instead of focusing on short-term gains and losses in your portfolio, keep an eye on long-term trends. If you're saving up for retirement or investing in stocks right now because you plan on selling them later down the road anyway (even if it's set aside money for college), then don't worry about whether they're going up or down today or tomorrow. Focus instead on making wise decisions that are good for your overall financial health over time.
Understand That Past Performance is Not Always Indicative of Future Results
You should never invest in anything based on past performance. The reason is simple: The future is unknown, and there are no guarantees that the past will repeat itself. Let’s say you invest in 20 companies over a period, and all 20 of those companies go out of business before you can sell them for any profit at all. Maybe one or two have made profits for several years — but that doesn't mean anything about their future performance.
Past results are not necessarily indicative of future results; it's a fact that people have ignored for centuries but one that is well understood by economists today (and therefore should be well understood by investors). The best way to make money in stocks is by buying low and selling high — but how do you know when something has hit its peak? If this were easy, everyone would be rich off trading stocks.
Investing in Stocks is a Smart Way to Build Wealth, But You Have to Make Sure You Do it Right
Stocks are an excellent way to diversify your portfolio as well as build passive income. They allow you to invest in companies that you believe in and understand. If a stock is doing well, it can be quite lucrative for its shareholders, but if a company struggles or goes bankrupt (and some do), then its share price will drop and shareholders' capital will decrease accordingly. Yes, investing in stocks is a smart way to build wealth, but you have to make sure that you do it right. You’ll need to consider the type of investment and its liquidity, as well as your risk tolerance so that you know how much money you can afford to lose if things don't go as planned.