Do you want to know more about the stock market and how you can start investing in the stock market?
I will be going through the basic principles, concepts, and jargon used in stock market investment to give you the best possible start to your stock market investing journey.
what is the stock market?
The stock market is like any other market, you have a shop which is the stock exchange bringing together the buyers and sellers known collectively as the investors or traders.
The stock market allows ordinary people like us to invest and own shares of companies or lend out loans to companies or governments in the form of Bonds. In return owners of these shares hope to gain more money in the future from the growth of these companies invested or from the income or dividend payout from these companies.
When you buy or invest in a company share you are effectively one of the thousands of owners of the company Stocks. Equity and Shares mean pretty much the same thing, a slice of ownership of one or more companies.
If you are new to investing I would recommend you read one of my other post on Investing for Beginners to get the general principle of investing such as why invest, goal setting, and investing mindset.
How much can I earn from investing in the stock market?
Let me be clear from the start, the stock investment will not make you a millionaire overnight and not even in just a few years. It will certainly help you make your money work harder and grow faster than keeping it in the bank account.
If you are looking to double your money in a year stock market investment is unlikely to be able to provide you with those returns. The reason I highlighted this from the start is that to be investing in the stock market successfully, you need to have a reasonable expectation and a fairly long-term investment time frame of at least 5 years or more.
Now that we have set our expectations right, let’s dive in.
Is there any risk of investing in the stock market?
The Risk and Return relationship: There is risk in any form of investment the only question is, how much. All investments carry a risk of getting back less than the original money invested and in general, the higher the potential return the higher the level of risk involved, and similarly the lower the risk the lower the expected return.
You need to be aware of the associated risk and decide on the level of risk you are comfortable with when choosing the type of investment. Getting the right balance between your risk tolerance and the potential return is the key to achieving your financial goals.
Taking too little risk is a risk in itself which we will explore in the next section. The risk-return balance is very personal and dependent on your individual experience and knowledge.
In general, how do I gauge the level of acceptable risk for an individual? Essentially if a temporary drop in the value of your stock will keep you up at night then stock investment may not be a great idea for you, as volatility is the name of the game. Meaning swings of stock prices up and down is totally expected in-stock investment
Types of Investment Investing in the stock market?
Let us break down the types of investment you can choose from. In general, you can choose to invest your money in cash, bonds, or shares as the main basic types of stock investments.
Cash is the lowest risk with the expected lowest return, and shares are at the opposite end with the potential of higher return with a higher risk level. Investing in cash usually means money kept in an account with no or minimal interest. Although this form of investment is an extremely low risk of losing all your money altogether it is a sure way of losing the value of your money due to inflation.
For example, if the account provides you with an interest rate of 0.5% and the inflation is 2.5% your money will be losing value at 2.0% every year. So if you take $5,000 invested in this example it will be costing you $100 every year investing your money in cash.
Therefore taking such a low-risk option is a sure way of losing the value of your money gradually over time. To me, that is an even bigger risk than not taking some level of risk by investing in other forms of investment.
Bonds are given out by governments and companies as a form of a loan. When you invest in bonds you are effectively lending money to these companies or governments issuing the bonds. In return, they usually pay out a fixed amount of interest over a fixed amount of time depending on what types of bond you invested in the risk, and the interest payout will differ.
But generally still considered to have a lower risk than investing in individual company shares. Therefore the risk and return level will be classified as low to intermediate. Investing in individual shares is buying some ownership of a publicly listed company.
As mentioned earlier your investment returns will be in the form of company growth or regular payouts in the form of dividend income. As you can imagine the company can continue to grow very well but it can also fall in value or even go bankrupt.
Hence you can see why it is classified as a higher risk but potentially higher returns.
What are Mutual Funds?
Mutual funds are a collection of one or many of the types of investment cash, bonds shares to achieve a defined objective for its investors. Some mutual funds also have exposure to commodities like the investment in metals such as gold, agriculture, and energy.
For example, a mutual fund that has an objective to achieve high potential returns may have 100% shares in an investment portfolio but it will also be a high-risk mutual fund.
A mutual fund for investors with intermediate-risk or return appetite might hold 50% bonds and 50% shares in its funds and for a cautious mutual fund, it may hold mostly bonds and cash in its investment portfolio. So mutual funds are essentially an investment portfolio with a different proportion of types of cash, bonds, commodities, and shares depending on the objective set up by its fund manager.
Mutual funds allow investors to achieve two main things. The first is to enable an investor to get exposure to hundreds of different cash, bonds, shares, or commodities by simply investing in one fund. It will be very time consuming and costly for you to invest in so many individual stocks and shares on your own.
The second advantage of mutual funds is it assists amateur investor and investor who prefers to be more hands-off to invest in many different stocks safely knowing that these stocks have been picked by a professional fund manager.
What are ETFs?
ETFs are exchange-traded funds. It’s basically a very fancy word, it is actually a regular mutual fund with the main difference being that it can be bought and sold throughout the day. Mutual funds can only be bought and sold at a set time of the day otherwise they are pretty much the same thing.
Active and Passive Funds:
Within mutual funds or ETFs they can also be broken down into actively or passively managed funds. Active funds are funds with a fund manager actively monitoring and changing the mix and amount of each basic type of investment within the funds to try to achieve the objective it has set out to do.
As you would expect higher management fees are incurred which is usually between 1to 2% of your entire investment portfolio in the fund annually.
In passive funds, the funds will have a predetermined objective it has set out to achieve but the difference is that it does not have an active fund manager constantly adjusting the location of the funds.
For example one of the most popular passive funds is the S&P 500 index tracker which has an objective to track or follow the index of the top 500 large companies in the United States.
These passive index funds aim to perform no better and no worse than the average performance of the top 500 companies. Passive funds will have much lower management fees compared to active funds.
We have now gone through the risk and return relationship and the associated risk and potential return with the different types of investments.
Apart from picking between cash, bonds, and shares investing one could also further lower the risk of stock investing by diversification. Diversification means spreading your investment between many different types of investment like what mutual funds offer.
An investor can also choose many different companies from different industries such as technology, property consumer, and even different countries, or parts of the world. You can also invest in mutual funds or ETFs which basically have the pre-packed collection of several types of investments mentioned above such as a mixture of cash, bonds, and shares in different proportions.
Some of these funds will focus on certain industries such as a collection of the top 100 technology companies or the top 100 companies in the United Kingdom like the FTSE 100 index tracker.
Diversification is important for two reasons. When you diversify you lower the risk of your investment. When you buy many different stocks the chances of all of them making a loss is much smaller than if you had just bought one or two individual company stocks.
The second is all companies performance are different significant stock market growth tends to be concentrated on a handful of companies.
Unfortunately to handpick these few companies is difficult even for the experts in the field. Therefore it is generally recommended to spread your investment around to ensure that you have covered the big winners along the way.
We have now pretty much covered the basics of stock investing and all the common jargon used.
When are you ready to invest?
Investing with only your spare cash. Now that you have understood the fundamentals of risk and return in stock investment the next step is to prepare yourself for investing. If you have high-interest loans like credit cards or personal loans do clear them first as on average the interest rate charge will likely be higher than the returns of your stock investments.
Also, ensure that you have already saved up some emergency funds of at least 3 to six months of expenses worth as investment can be risky and require a long-term commitment to maximizing its growth potential.
You should only invest with money you can afford to set aside for at least five years or more.
As you have no control over how your investment performs you need to prepare yourself with the right investment mindset. Huge market price swings and losses are mainly due to investors fear and greed.
Essentially if you learn how to invest by sticking to the plan without any emotional input you will be providing your investment the best chance to grow.
Emotionless investing is vital and if you would like to understand this in more detail do read the post Successful investor’s mindset. why Warren Buffett might be wrong.
Setting investment goals once you’re happy having the right mindset of investing and gathered sufficient knowledge in stock investment.
You have to set clear investment goals setting goals is really the clarity of where you are now, where you want to be financially, and over how long.
For example, whether the investment was to buy a house or retirement and so on. Having a clear goal would help determine how much investment returns, or level of risk you should be taking and over a predetermined time frame.
This will help you choose the types of investment and funds that are appropriate for achieving your goals.
How do you start investing?
Like banks, investment platforms provides investors with a brokerage account for investing. Choosing which platform to invest with is almost like choosing a bank account to use.
They are all pretty much offering the same basic services of buying and selling stocks but have differences in the charges and facilities being offered.
These are some of the more popular brokerage platforms on offer. Most platforms will offer two main options for investing you can pick one of the ready-made portfolio funds on offer or do it yourself option.
The ready-made portfolios are popular for new stock investors who prefer to have a more hands-off approach.
Similar to mutual funds ready-made portfolios are made up of pre-determined locations of different types of investment or mutual funds recommended by the platform.
These portfolios are designed to try to achieve different goals for different investors for example most will have portfolios for investors who are more interested in long-term growth or for investors who are looking for regular monthly or quarterly income payouts.
There are usually portfolios for investors who are more comfortable taking higher risk investment in return for potentially higher growth and portfolios for more risk-averse investors.
The goals of each portfolio are normally obvious from how they are named such as the US growth funds or global income funds or adventurous portfolio.
Every brokerage company will have its portfolio name differently but the basic principle is the same.
The other option is to do it yourself. You choose, pick, and invest in bonds, shares, or funds.
If you know what you’re doing and comfortable with the level of knowledge you have you can effectively make your own investment portfolio.
If you are new to stock investing choosing one of the ready-made portfolios or an index fund tracker is probably the safe place to start.
You should now have a better understanding of how the stock market works what type of investment is on offer, the risk and return relationship, some of the financial jargon used, and how you can prepare yourself to have the best start in stock investing.
From the cautious pension funds to the wealthy individual investors, they invest in stocks and shares to help them grow their money.
The important distinction is their asset allocation or risk appetite may be very different. Hope you have found post useful and Good luck with your stock investment journey.