Wondering how to start investing in stocks? Well, you’re not alone.
You probably have a lot of questions, including:
- How much money do you need to start investing?
- What are the best stocks to buy?
- What are mutual funds, and how are they different than stocks?
Thankfully, learning about how to start investing in stocks isn’t as difficult as it seems. In fact, anyone can start investing in the stock market — even with as little as $1,000 or less.
That’s because the best investing strategies aren’t about aggressive trading, where you put a ton of money into a risky stock and then quickly sell it for a profit. While that investing strategy is sexy, it just isn’t realistic.
But instead of trying to triple your money overnight, when you think about how to start investing in stocks, you actually should be thinking about more achievable goals … like how to reduce expenses and reduce complexity.
Here’s how you do it:
How to Start Investing – Buy an Index Fund … and Forget It!
To be a successful investor, you obviously have to buy things that go up in value. But simply picking the right direction on a stock or mutual fund isn’t enough — because that investment has to go up enough to offset taxes, fees and any other expenses.
Let’s say you buy 100 shares of Stock XYZ at $5, for a $500 investment; tomorrow, it rises to $10. You’ve doubled your money, right?
Well, not really.
First, you bought the stock via a stock broker who charges you $7 per transaction — once to buy, and once to sell. That shaves $14 off your $500 in profits. Then, you have to pay short-term capital gains, which can be as high as 39.6%.
So instead of $500, it’s possible you’ve actually netted out as little as $293 … which means that 100% gain is actually more like 60%.
That’s not bad, except it deals with the unlikely scenario of investing in a pick that doubles your money. Still, it illustrates the big bite that expenses and taxes take out of your profits.
But there are ways to combat this when you start investing in stocks.
First, pay attention to transaction fees. If your broker is charging you per transaction, you should try to trade less — particularly if you don’t have a lot of cash to spend on those buy and sell orders.
Consider mutual funds and ETFs. Of course, building out a diversified portfolio that spreads your risk around several different investments can be hard if you’re afraid to buy anything. That’s where mutual funds and ETFs — or exchange-traded funds — come in. These vehicles are a basket of other investments that spread out your cash for you. For instance, the SPDR S&P 500 ETF (SPY) owns the stocks in the benchmark S&P 500 Index … so rather than buy 500 individual companies, you can just buy this one fund and achieve the same goal.
Watch fund and ETF expenses, too. Of course, a fund like the SPDR S&P 500 ETF isn’t run out of charity; fund managers charge expense fees for overseeing your money. However, while some mutual funds can charge 1% or 2% of your nest egg, there are a ton of cheap options out there, too. For instance, the SPDR S&P 500 ETF charges just 0.11%, or $1.10 for every $1,000 you invest … pretty cheap, and pretty valuable for investors who want diversification without paying out the nose for it.
Watch your taxes. When you consider how to start investing in stocks, you shouldn’t overthink things. Investing in a 401k or an IRA gives you exposure to the stock market — and frequently does so in a tax-efficient manner. If you want to branch out into a taxable account, that’s fine … but also remember the burden of capital gains on any transaction, and consider holding stocks for the long term to reduce taxes. Consider that the top rate for long-term gains is just 15% while the top rate for short-term gains is 39.6% … that’s a big difference and leaves more in your pocket.
Be patient. Trading too much racks up expenses and taxes, and also can cause a lot of stress and move you out of a good investment too soon. Particularly if you’re just figuring out how to start investing in stocks, it pays to sit back and watch for a while instead of frantically trading. You can do much more harm than good.
For more tips, read my article on how to invest $1,000 now.
Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks. As of this writing, he did not hold a position in any of the aforementioned securities. Write him at firstname.lastname@example.org or follow him on Twitter via @JeffReevesIP.