- Before you start investing, you need to determine the best way to invest in the stock market and how much money you want to invest.
- After you’ve answered these questions, you’ll need to open an investment account at a brokerage or with a robo-advisor.
- Then you’ll choose your investments and periodically add to them over time
When done well, investing in stocks is among the most effective ways to build long-term wealth.
Here’s a step-by-step guide to investing money in the stock market to help ensure you’re doing it the right way.
- Determine your investing approach
The first thing to consider is how to start investing in stocks the right way for you. Some investors choose to buy individual stocks, while others take a less active approach.
Try this. Which of the following statements best describes you?
- I’m an analytical person and enjoy crunching numbers and doing research.
- I hate math and don’t want to do a ton of “homework.”
- I have several hours each week to dedicate to stock market investing.
- I like to read about the different companies I can invest in, but I don’t have any desire to dive into anything math related.
- I’m a busy professional and don’t have the time to learn how to analyze stocks.
The good news is that regardless of which of these statements you agree with, you’re still a great candidate to become a stock market investor. The only thing that will change is the how.
The different ways to invest in the stock market
Individual stocks
You can invest in individual stocks if — and only if — you have the time and desire to thoroughly research and evaluate stocks on an ongoing basis. If this is the case, we 100% encourage you to do so. It is entirely possible for a smart and patient investor to beat the market over time. On the other hand, if things like quarterly earnings reports and moderate mathematical calculations don’t sound appealing, there’s absolutely nothing wrong with taking a more passive approach.
- Decide how much you will invest in stocks
First, let’s talk about the money you shouldn’t invest in stocks. The stock market is no place for money that you might need within the next five years, at a minimum.
While the stock market will almost certainly rise over the long run, there’s simply too much uncertainty in stock prices in the short term — in fact, a drawdown of 20% in any given year isn’t unusual, and occasional drops of 40% or even more do happen. Stock market volatility is normal and should be expected.
Such sharp drops have happened a couple of times in recent history. During the 2007–09 bear market caused by the financial crisis, the S&P 500 dropped by more than 50% from its previous highs. In 2020, during the early days of the COVID-19 pandemic, the market plunged by more than 40% before it started to recover.
So here’s what you shouldn’t be investing:
- Your emergency fund
- Money you’ll need to make your child’s next few tuition payments
- Next year’s vacation fund
- Money you’re socking away for a down payment, even if you will not be prepared to buy for a few years
Asset allocation
Now let’s talk about what to do with your investable money — that is, the money you won’t likely need within the next five years. How you distribute it is a concept known as asset allocation, and a few factors come into play here. Your age is a major consideration, and so are your particular risk tolerance and investment goals.
Let’s start with your age. The general idea is that as you get older, stocks gradually become a less desirable place to keep your money. If you’re young, you have decades ahead of you to ride out any ups and downs in the market, but this isn’t the case if you’re retired and rely on your investment income.
Here’s a quick rule of thumb that can help you establish a ballpark asset allocation. Subtract your age from 110. This is the approximate percentage of your investable money that should be in stocks (including mutual funds and exchange-traded funds, or ETFs, that are stock-based). The remainder should be in fixed-income investments like bonds or high-yield certificates of deposit (CDs). You can then adjust this ratio up or down depending on your particular risk tolerance.
For example, let’s say that you are 40 years old. This rule suggests that 70% of your investable money should be in stocks, with the other 30% in fixed-income investments like bonds or high-yield CDs. If you’re more of a risk taker or are planning to work past a typical retirement age, you may want to shift this ratio in favor of stocks. On the other hand, if you don’t like big fluctuations in your portfolio, you might want to modify it in the other direction.
Choose your stocks
Now that we’ve answered the question of how you buy stocks, if you’re looking for some great beginner-friendly investment ideas, here is a list of our top stocks to buy and hold this year to help get you started.
Of course, in just a few paragraphs, we can’t go over everything you should consider when selecting and analyzing stocks, but here are the important concepts to master before you get started:
- Diversify your portfolio.
- Invest only in businesses you understand.
- Avoid high-volatility stocks until you get the hang of investing.
- Always avoid penny stocks.
- Learn the basic metrics and concepts for evaluating stocks.
It’s a good idea to learn the concept of diversification, meaning that you should have a variety of different types of companies in your portfolio. However, I’d caution against too much diversification. Stick with businesses you understand — and if it turns out that you’re good at (or comfortable with) evaluating a particular type of stock, there’s nothing wrong with one industry making up a relatively large segment of your portfolio.
Buying flashy, high-growth stocks may seem like a great way to build wealth (and it certainly can be), but I’d caution you to hold off on these until you’re a little more experienced. It’s wiser to create a “base” for your portfolio with rock-solid, established businesses or even with mutual funds or ETFs.
If you want to invest in individual stocks, you should familiarize yourself with some of the basic ways to evaluate them. Our guide to value investing is a great place to start. There we help you find stocks trading for attractive valuations. If you want to add some exciting long-term growth prospects to your portfolio, our guide to growth investing is a great place to begin.
- Continue investing
Here’s one of the biggest secrets of investing, courtesy of the Oracle of Omaha himself, Warren Buffett. You do not need to do extraordinary things to get extraordinary results. (Note: Warren Buffett is not only the most successful long-term investor of all time, but he is also one of the best sources of wisdom for your investment strategy.)
The most surefire way to make money in the stock market is to buy shares of great businesses at reasonable prices and hold on to the shares for as long as the businesses remain great (or until you need the money). If you do this, you’ll experience some volatility along the way, but over time, you’ll enjoy excellent investment returns.
Take charge of your financial journey and invest in stocks today. Whether you’re aiming for growth, dividends, or diversification, stocks offer limitless opportunities to build wealth. Seize the moment, dive into the world of investing, and start growing your portfolio. Your future self will thank you for making the decision to invest in stocks now!”