- How do I start investing?
- Isn’t investing in individual stocks like gambling ?
- Which broker should I use ?
- Is there a minimum amount I should start with ?
- What should I know before I start investing ?
- DOs and DON’Ts
Read the section “Build a safety net” in the Beginner’s Guide to Investing to establish an emergency fund.
Once you have this emergency fund in place, start by learning about investing from books, websites and other investors. Finally identify stocks or funds that you think you would like to purchase and put them in a “simulated online portfolio” to see how they perform over the next few months. Yahoo Finance, Seeking Alpha and a bunch of other websites will let you maintain an online portfolio as well.
When have you seen a gambling bet pay a dividend? How often have you seen someone hold on to a gambling bet for over 30 years and hand it over to his or her heirs? Yes, it is entirely possible to trade stocks frequently without any fundamental or technical analysis and that could be comparable to gambling. But investing for the long term after doing due diligence is essential for both wealth preservation (against the forces of inflation) and to grow your net worth towards the goals of financial freedom or retirement.
Lets suppose you wanted to start your own business. Since only one in 5 new businesses survive or in other words 80% of new businesses fail, wouldn’t it be better to invest your money in a business that has already proven that it can survive and can generate free cash flow. Allowing your money to grow with a growing company can be a much safer strategy than attempting to start your own business. Understandably, if your business were to succeed, it will be personally and financially more satisfying than investing in a public company.
Most people start out by using an online “discount” broker such as Ameritrade or Interactive Brokers. Beyond commission fees, also consider order execution and other fees such as those for inactive accounts before deciding on a broker.
Various brokers have various minimum requirements. I would suggest starting with a minimum of at least $5,000 so that trading fees do not have a very big impact on your returns. Many brokers provide free trades to clients who open new accounts and that could help keep your trading costs low. If possible, try to invest money periodically (every month or quarter). If the amount you can save every month or quarter is very small then you can wait until the end of the year to invest your savings for the entire year. Please make sure that you have an emergency fund setup and retain some part of your overall savings in cash or other liquid investments.
It is very important to identify your goals and objectives. It is also important to make an honest assessment about the amount of risk you can afford to take. To figure that out, try to answer the following two questions.
- How long of an investment horizon do you have? 10 years, 20 years, 30 years ?
- Will you have any big expenses in the near future such as buying a house, getting married or having a child?
Risk and reward go hand in hand and if you have a long investment horizon, then you could afford to take greater risk, as you will have more time to recover in case something goes wrong.
Read our Beginner’s Guide to Investing.
These dos and don’ts are meant for long-term investors and some of them may not apply to all investors.
- Try to be patient and avoid trading very often.
- Low dollar value stocks are not necessarily cheap. Sometimes a $100 stock could be much cheaper than a $1 stock. Valuation is determined not by price, but by earnings, underlying assets and the number of outstanding shares. Investors who are just starting out often find it very hard to grasp this concept.
- Keep taxation issues in mind when you buy or sell stocks. Short-term and long-term capital gains and losses are taxed differently. Specifically watch out for the wash sale rule.
- Establish a goal and lay out a strategy to help you reach this goal. Then stick by your strategy.
- Do not use margin to purchase stocks. Margin could do wonders for your portfolio in a bull market (a market where stock prices are rising) but can be totally disastrous during a bear market (a market where stock prices are heading lower). It is extremely hard to time the market and liquidate margin positions before a bear market starts. I have seen too many individual investors get wiped out completely because they used margin.
- Unless you are a professional trader, try to filter out the “daily noise”. According to me “daily noise” refers to the coverage about the financial markets by various media outlets. Watching the Nightly Business Report every night on PBS (or on YouTube) will give you an unbiased and comprehensive yet concise overview of the financial markets. You can also use one of our curated Twitter lists to follow market chatter from insightful investor.
For additional information about things you should NOT do as an investor, check out my article 10 Worst Investor Mistakes.