With new share dealing services and the advances in online brokers, the stock market has become available to almost anyone in the world. More and more people putting their savings to work in the market, realising it is better than using a low yield savings account.
In fact, you might be invested in the stock market and not even realise it… Do you happen to have on of these accounts:
- An ISA or Share Dealing Savings Account
- A Roth IRA, IRA, or 401(K)
- Another Private Pension Account
- Online Trading Account
- Or… A Savings Bond
33% of UK Citizens own shares on the Stock Market, either individually, or through a brokerage account. And 55% of Americans own some kind of stock. When asked why, people stated they were saving for retirement, as regular savings accounts weren’t going to be enough.
It comes down to this. At some point, to secure your financial future, you will need to invest in the stocks market.
When to Start Investing in the Stock Market
Most people think you need a lot of money to even get started investing in the stock market. That is no longer true! With the invention of fractional shares offered by brokers such as eToro & M1 Finance, you can start investing with as little as $100.
Another common opinion of the stock market, is that financial advisors only deal with older people… No matter how old you are, or your bank balance, you can start to invest in the stock market (Or at least plan to).
If you start investing in your 20s, instead of your 40s. You open yourself up to 20 extra years of profit at an average return of 8% (based on the S&P 500 yearly increase). So if you put $1,000 in a mutual fund, or Roth IRA at 40 years old, you would have $4,660 by the time you’re 60! But if you put $1,000 into your investment, starting at 20, you would have $21,724 by the time you’re 60.
Don’t get me wrong, you don’t have to choose a stock market investment, there are, real estate investment, bond investments, you could start your own business, the possibilities are endless. But your time is your most valuable resource, so don’t waste it.
“The best time to plant a tree was 20 years ago. The second best time is now”Unknown Writer – Chinese Proverb
Before You Do Anything!
There are a few things you need to figure out, and a couple of tasks you need to complete before you are ready to invest in the stock market.
What you Need to Figure Out:
- What is your 10 year goal? This is the first question a financial advisor will ask you, but even if you’re going it alone, you want to clearly mark milestones so you can keep track of your progress, to make sure you’re doing well.
- How much time can you realistically commit? If the answer to this to zero, you will have to consult a professional advisor, or mutual fund. To research a potential investment it can take between 5-10 hours.
- What is your financial knowledge limit? You want to learn more, that’s why you’re here. But everyone has their limit, so figure out what yours is at this moment. It will change with the more experience you gain, but don’t stretch yourself, as it can result in poor judgement.
- How much risk can you cope with? Risk is everywhere, but a risk taker can end up with a huge profit, or a huge loss. Risk adverse people tend to choose conservative investments, leading to smaller gains, but very little loss.
- Will you need the money you’re investing in the next 5 years? If the answer is yes, do not invest it. As investors we are looking for upwards of 10 years in one position, this is how we take advantage of compound interest, dividends, and asset appreciation.
Answer these 5 questions and write them down in a notebook, then move onto your tasks below.
What you Need to Do:
These tasks require a bit more thought and planning, I’m going to run through a couple of examples and tips to get them done. The main issue is your patience, you must be patience and stick to the plan until the end.
Pay Off Your Debt
If you have any debt that accrues high amounts of interest, you are not ready to invest in the stock market. Examples of the type of debt I mean are:
- Credit Cards
- Pay Day Loans
- Certain Car Loans
A good rule of thumb is, to pay off any debt that has a higher interest rate than 8%, as this is your baseline rate of return from a stock market investment.
If you have a $1,000 worth of credit card debt at 15% annual interest, and you have $1,000 invested in the stock market with an 8% rate of return. You would lose money!
- Profit from Investment = $80
- Interest Paid on Credit Card = $150
- Total Net Loss on Year = $70
You would have been better off using the $1,000 you had invested to pay off the credit card loan. That way, you would have broken even on the year.
For tips on how to manage your debt and pay it off quicker, I found this fantastic article by Biz Minded: How to Make a Monthly Budget to Pay off your Debt.
The point is, you do not need to be debt free to start investing, you just need to use your common sense to evaluate what you can afford. It does not make sense to borrow money to invest, investing borrowed money is what leads people down to bankruptcy, because there is a chance you could lose it all.
This task is to eliminate your need to borrow money, by having what I call an ’emergency fund’, you can add to your investment portfolio without worrying a surprise expense might come along.
The last thing you want is to sell a losing position, because you need money to pay the bills. This can ruin your portfolio.
This emergency fund is for nothing else except emergencies! Don’t spend it on that new pair of trainers, or an early birthday present.
Saving this first $1,000 will hopefully also prepare you for long term saving goals, it will instill a mindset of holding onto your money.
No one expects to go into debt, but sometimes the washing machine breaks, the car needs a new tire, or you get laid off from work. These are times when you can dip into your emergency fund, as they are directly connected to your living standard. Because no one expects these surprise expenses, no one plans for them… Don’t be like everyone else!
Once you have your first $1,000 it should be easy for you to continue saving alongside building your investment. Ideally, your emergency fund is fully stocked when it is enough to cover 6 months of your expenses. That’s:
- Car payment
- Utility bills
- Food & Water
Everyones emergency fund will have different final total, work out what yours would be, and set a goal.
The last thing I want to mention about emergency funds… This is not money you will ever invest, build this balance in a bank savings account or saving app, then leave it alone until you need it.
Basic Investing Rules
There are a number of basic principles you need to know so you can understand how the market works. When looking at a stock, you should refresh your memory of these principles and see if your chosen company follows them.
Here are 5 sensible rules to follow when investing in stocks.
#1. Buy Low, Sell High
This is the most important rule in investing. Do this, and you’ll become very rich, do the opposite and you’ll become very bankrupt.
Don’t get me wrong, it is not always easy to predict when companies share price will increase, but there are tell tail markers to look out for, which we will go into later.
A great example of this principle is the dot.com bubble of the early 2000s. People thought every online was going to be huge money, so they bought up loads, then when the price dramatically increased, more people thought they were missing out, so they bought shares…
After the price of the entire industry became overvalued, the smart people that got in at the start sold, leaving the late entries with a huge loss after the stock prices plummeted. This leads onto my next rule.
#2. Don’t Follow the Crowd
Everyone and their uncle has a hot new stock tip they want to share with you. Unfortunately, not everyone is a Wall Street analyst.
Following the crowd can only mean one of two things…
- You’ve missed the opportunity to get in on the ground level
- The value of the underlying asset is massively overpriced
Crowd followers are always two steps behind, because they don’t know what makes the company valuable, they just know that others think it is. Crowd investing is what made Bitcoin ballon up in 2017, then crash in 2019, leaving a lot of people out of money.
#3. Don’t Put all your Money on One Horse
As a beginner, you may not have the capital to diversify as much as you should. My rule of thumb is, an account with more than $1,000 invested, should be diverse to minimise risk.
$100 doesn’t stretch that far, so place your investments on one or two companies and start to grow your account. When you build your account to over $1,000 I would look to diversify between different industries, or different securities.
When you reach $10,000 you want to seriously think about your exposure to risk. For an account this size, having more than 20% of your money in one stock is too risky.
#4. Low Share Price Does Not Mean Cheap
Valuing a stock is a very complicated process. People dedicate their lives to finding formulas and techniques for valuing companies. The main thing to consider is… The share price does not mean value.
The share price of a stock has nothing to do with how cheap it is. Amazon’s & Google’s share prices are up in the multi-thousands, whereas there are other companies trading for less than $10.
To find out if the share price is cheap you need to figure out what the company is worth to investors. You do this by completing fundamental & technical analysis.
#5. Stocks are a Long Term Investment
My opinion is, you should hold a stock for as long as possible. If you believe this company to be a solid buy, that will gain you profit, why sell it.
I will admit, I have sold shares for profit in the past, to my disappointment years down the line as they continued to grow. If you want a benchmark for a holding period, it should be 5 years, anything less than that is a speculation you are hoping will turn good.
Over 90% of traders lose 90% of their starting capital in the first 90 days trading stocks. Don’t be a short term traders, be a long term investor. The success rate of short term trades is very low, there is no way to predict which way the share price will move in the short term, because share price does not equal value.
How do you Make Money
There are two main ways you can make money investing in stocks. Asset appreciation & dividends.
When you purchase a stock, you are hoping the share price will increase, so you make money. With this in mind, you want to invest in companies you understand, so you can predict when the business is doing well.
This appreciation can take years to come through. Traders look for quick wins, so they might be speculating on a very volatile stock, looking for minor price movements to score a profit.
Dividends are a distribution of profit that a company rewards it’s investors with. Companies with solid cash flow often pay dividends for years and years.
Although dividends are never guaranteed, some blue chip companies such as Coca-Cola, AbbVie, and AT&T are what is known as dividend aristocrats, meaning they have consistently paid a dividend for over 60 years.
We have comprised some of the best dividend paying stocks to hold forever. By investing in dividend paying companies, you can take advantage of compound interest.
The Wonder of Compound Interest
Compound interest is a way of growing your money exponentially by reinvesting your dividends. Warren Buffett calls compound interest ‘the 8th wonder of the world’ and also attributes a lot of his success to compound interest.
By reinvesting your dividends across your portfolio, you increase your share-hold in the companies. This alongside asset appreciation will grow your money faster.
Take a look at this graph:
At an average market return of 5%, $1,000 doesn’t go far in 40 years. However, when you reinvest dividends you’ve earned at the same yearly return, generating more asset appreciation, it boosts your retirement income dramatically. Here is a Free Compound Interest Calculator for you to experiment with.
Why does the Stock Price Change?
As soon as you purchase a stock, the share price begins to change. Unless there is some breaking news, it will move quite slowly.
There are more than a few reasons why the share price changes, I will try to run over the major 9. It can be a mixture of these reasons, or just one, but keep your ear to the pavement because sometimes it’s hard to tell when a change is coming.
#1. Earnings Reports
A common catalyst for price changes, earnings reports show if the company in question has performed well or poorly over the last quarter. Normally they will be accompanied with analysts predictions, which is a baseline to judge the company’s performance against.
When you see that a company has beat earnings, it means the actual figures were better than Wall Street estimations.
Is a company has missed earnings, it means the figures were worse than Wall Street estimations.
As you can imagine, when the figures are better than estimates, the share price increases, and the opposite if the earnings miss. Companies will offer guidance to investors, which are predictions made by the company managers.
#2. Dividend Changes
Dividend investors get very anxious about their payments, making dividend changes one of the most common reasons for price changes in stocks.
Remember that dividends are not always guaranteed, so reductions or voided payments can have a massive affect on the share price. Generally companies will give plenty notice when reducing dividends, so you will have loads of time to decide to sell or not.
As you can imagine, a reduction in dividend can cause the share price to nosedive. But an increase in dividend can have the opposite effect.
You also need to figure out if your dividend is safe.
Unemployment is never a good thing for the overall market, but if one company suddenly sacks employees it could be a bad sign.
Either the company is expecting less output, meaning less profit. Or they are automating processes. One is obviously worse than the other.
Sacking employees, historically has a negative effect on the share price, bringing it down. But if the company has created an automated way to perform a task, making the employees an unneeded expense, it may be a sign of increasing profits.
It is down to your judgement, and the news stories to determine whether layoffs are a good or bad thing.
#4. Acquisitions or Mergers
If a company acquires another, either through a purchase of assets, or controlling share-hold, it almost always causes a change in share price.
AT&T acquired Walt Disney in 2018, which caused AT&T stock to take a hit because investors didn’t like the company taking on more debt. I give this example because, the complicated financial implications of acquiring another company can swing the share price in both ways, depending on the acquisition.
Mergers are very similar in the way of price movement. You need to read up on the companies involved and make a judgement call about the health of the investment. Is this acquisition/merger going to benefit the company?
#5. Stock Splits or Reverse Splits
A stock split is something a company does to increase the outstanding shares on offer, it is generally a good sign when a company performs a split.
When the share price becomes unreachable for retail investors, a company will normally do either a 2 in 1, 3 in 1, or 4 in 1 split, where the value of 1 share becomes the split value. Apple performed a stock split in 2014 at 7 in 1, so each outstanding share of Apple stock became 7. Stock splits tend to drive the share price up.
Reverse splits on the other hand have the opposite effect. This is where a company will merge shares, so if a company performs a 1 in 3 reverse split, if you own 3 shares, they will become 1 share. This is very rare, but it is a bad sign.
Stock splits don’t change the value of your investment, just the number of shares you own. So if you own 1 share at $70 per share, then the company performs a split of 2 in 1, you will own 2 shares at $35 per share.
#6. Management & Board Changes
Changes in members at the management level can result in a change in share price. All depending on why, and who is replacing them.
Most management changes are pre-determined, so replacements can be researched properly, to see if they fit the company values and what goals they want to achieve. However if a board member leaves without warning, it can be a sign of a scandal, which Wall Street will react negatively to.
Most of the time management changes are a good sign of growth, but research the new member. Their past will tell you whether or not they are likely to do a good job.
Politics have a huge impact on the stock market. When Donald Trump was elected president, the U.S. stock market went into a mass selloff because of the news.
Depending on the political agenda of the member in office, Wall Street can react in different ways. For example, when Trump announced a corporate tax cut, it had a positive impact on the market as earnings went up.
However, when the U.S. was in the middle of a trade war with China, which had the U.S. buying from other venders. This caused the Chinese stock market to go into decline in late 2018.
#8. Interest Rates
Changes in Federal interest rates always affect the stock market.
When the overall economy is in a slump, the Government and the Federal Reserve will normally lower interest rates, to kick start the economy.
Lower interest rates are passed onto the consumer and corporations, who are able to borrow money at cheaper rates. As a result, spending increases and the economy moves forward.
To contrast, when the economy and inflation becomes out of control, the FED will increase interest rates to slow growth, so it is maintained.
Lower interest rates tend to lead to higher growth overall in the stock market.
#9. Scandals, Illegal Activity, Accounting Errors or Data Breaches
All scandals or illegal activities cause share prices to plummet, only one in a million accounting errors lead to increased stock price, and data breaches are never good.
A few examples of scandals that lead to a reduction in share price are:
- JD(.)com CEO arrested for sexual harassment charges
- Equifax data breach in 2017
- General Electric SEC investigation of accounting practices
What Are You Buying?
When investing in a stock you are buying a share in the company, which might mean you have certain rights as a shareholder.
- Vote on business decisions
- Receive a share of company profits as dividends
- Receive certain documentation such as earnings reports
- The ability to inspect books & constitutional documents
Not all shares come with these rights, so you will have to read the company agreement which can be found through the investor relations section of the companies website.
A good example of this is Snapchat. Snapchat offers 3 kinds of shares, Class A, Class B, Class C.
Class C shares are reserved for company owners, Class B are reserved for company executives and early investors in the company, and Class A are widely available on the stock market.
Unfortunately, Class A shares do not come with voting rights or dividend payments, but Class B & C shares do.
Choosing Your First Investment
Just like horse racing, all the research in the world cannot guarantee success.
When you choose a company to invest in, you need to be confident in your decision, so you perform the necessary research… You need to safe, so you diversify to manage your risk… And you need to have the potential to grow, so you pick companies that are likely to increase in value.
All of this is a good way to start, you don’t need to be a financial expert, you just need to have a basic understanding of the market, and a good grasp of what makes a good company.
Warren Buffett actually advises people just to invest in a low cost S&P 500 index fund to get started. This will help you gain experience in the market.
We’ve covered a lot of ground in this article, so feel free to come back to it for a refresher course when you’re feeling overwhelmed.
Investing is a marathon, not a sprint, so take your time. In the first 6 months of your investing career I would aim to build your emergency fund, open your free brokerage account, then start with simple companies you understand.