Mar 8, 2022
How to Invest in Stocks for Beginners
If you’re like a lot of beginning investors, you might think you need thousands of dollars to get started and an economics degree to make good choices. For most people, that’s just not true. While there is plenty of complexity in the stock market, the basic concepts are fairly straightforward, and innovations like fractional shares can bring investing within reach for everyone.
In this article, you’ll learn the key principles you need to know, how to get started in five steps, and how to pick a stock, plus tips for beginners, and a quick overview of tax implications. So if you’re a beginner wondering how to invest in stocks, this guide can help you get started.
Update July 2022: If you’ve been watching the market, you might be feeling a little anxious. Inflation data, the Russia-Ukraine war, and anticipated monetary policy changes are contributing to increased market volatility. It's normal to feel nervous when the market goes down, but panic selling can hurt your portfolio rather than help it. We think it’s best to focus on the long-term, invest in a diversified portfolio and automate investing with Auto-Stash. Staying invested through all parts of a market cycle is key to long term investing success.
How to invest in stocks in 2022: a step-by-step guide
Step 1: Choose how much you’ll invest in stocks
Deciding how much money to invest depends on your circumstances and your goals. If you’re investing for retirement, many experts recommend setting aside 10% to 15% of your income, as a general rule. But there are a few things to think about before you pull out your calculator:
- Do you have a solid budget? If you don’t, or if your financial plan has been gathering dust, it can be a good idea to make sure your bills and living expenses are covered before you start investing.
- Do you have high-interest debt? Facing costly debt or carrying loans that you don’t have a clear plan to pay off? Consider ways to pay it off before investing.
- Do you have an emergency fund? Emergency funds and rainy day funds are liquid assets that can keep you on track when life happens. You may want to ensure you have enough cash squirreled away for emergencies before you start putting money into stocks.
- Do you have a clear goal in mind? For example, IRS rules for 2022 allow you to invest up to $6,000 a year in an individual retirement account (IRA) or up to $7,000 if you’re 50 or older. You might also explore how much you need to save for retirement based on your age.
Once you know how much you can afford to invest and what your goals are, you can pick an investment amount that works for you with more confidence. For example, you might decide to invest a lump sum you can afford to begin with, then add a bit of money every month. Another approach may be to use any lump sums of money you recieve, like tax refunds and bonuses, to boost your investments.
By the way, some brokerages and funds have a minimum investment requirement, though some have very low minimums; you’ll want to consider any minimums when deciding how much money to invest. They may also charge fees, so you’ll want to account for those in your budget. It’s always important to read the fine print before you choose a brokerage or investment product.
Step 2: Open an investment account
Once you know how much you want to invest, it’s time to select a brokerage, which is the firm that actually buys and sells stocks on your behalf.
For the most part, you must work with a brokerage to purchase stocks. The only exception is companies that offer direct stock purchase plans, but that’s much less common than using a brokerage.
Brokerages run the gamut from full-service firms with human advisors, to app-based online brokerages with algorithm-driven robo-advisors, to stripped-down DIY online brokerages. Ultimately, it’s all about what works for you and your money.
Here’s an overview of the accounts, apps, advisors you can choose from:
The what: standard brokerage account vs. retirement account
A standard brokerage account allows you to invest as much as you want in whatever securities you wish (barring minimum investment rules). You can usually withdraw money anytime, and you’ll likely owe taxes on interest and dividends you earn. Buying and selling assets can also have tax consequences.
A retirement amount, in contrast, typically offers tax advantages in exchange for greater restrictions. A traditional IRA, for example, limits annual contributions to $6,000 as of 2022 or $7,000 for those 50 or older. But contributions are tax-deductible, and money grows tax-free until it’s withdrawn. And if you withdraw money prior to retirement, you may owe a penalty, although there are exceptions to the early withdrawal penalty.
Choosing between a standard brokerage account and retirement account is often fairly straightforward. If you’re investing for retirement, the tax advantages of a retirement account could benefit you over the long term. If you’re investing for shorter-term purposes, you may not want the restrictions of a retirement account; a standard brokerage account will allow you to invest as much as you want and take your money out whenever you like.
The where: traditional brokerage vs. online brokerage
Traditional brokerage firms buy and sell stocks and provide a range of other services to account holders. For example, a full-service brokerage might provide investment advice, portfolio management, banking, and more. The greater range of services is often reflected in higher fees. A discount firm, on the other hand, might offer fewer services, but could also have lower fees. If personalized advice or working directly with a person is important to you, a traditional brokerage might feel worth the accompanying fees.
Online-only or app-based brokerages also offer a range of services. In some cases, you’ll have to do most of the work of managing your money, and you won’t have access to other products like banking. Some online and app-based brokerages, however, offer more support, advice, or companion services than others. Speaking broadly, most online brokerages can help you save on fees, but you’ll have less access to advice and support. This option might be appealing if saving on fees matters more to you than a personal touch.
The who: investment professionals vs. robo-advisors
No matter what type of account or brokerage you choose, someone has to pick your investments. If you want personalized advice from a professional, there’s a smorgasbord of help available, and you’re likely to find advisors at a traditional brokerage, at traditional brokerage prices.
Robo-advisors have become an increasingly popular alternative to human advisors. They gather information about you and your investment goals, then automatically suggest a portfolio for you, usually via an algorithm. They tend to be less expensive than human advisors and are popular among younger investors and new investors. Some human advisors even work with robo-advisors.
When choosing an advisor, you may want to consider your budget, your temperament, and whether you want to be hands-off or hands-on. For example, if you have limited funds, feel confident about investing, and want to be hands-off, you might choose a robo-advisor that can automatically manage your portfolio without much input from you. On the other hand, if you have a bit more disposable income or you’re feeling nervous about market volatility, you might choose a human advisor who can speak directly to your concerns and walk you through your options.
Investing apps and DIY investing
Of course, no one is required to work with an advisor, and you can choose a fully DIY approach. Many brokerages offer investing apps that allow you to decide how to invest in stocks, as well as other securities, at your own discretion. Many people enjoy researching stocks and markets, crafting their own investing strategies, and buying and selling stocks right from their phones.
That said, many investing apps do offer tools to help guide you, like educational resources and automated tools for managing your portfolio.
What, where, and who: putting it all together
Before you open your first brokerage account, it’s helpful to think through your “what, where, and who.” You’ll want to take into account your goals, how you want to interact with your money, your personality, and your wallet. Don’t be afraid to try out a few options to see what works best for you, and expect that your needs may change over your lifetime.
Step 3: Choose what stocks or funds to invest in
Do you know the difference between a mutual fund, an exchange-traded fund (ETF), and an individual stock? Each is a way of investing in stocks, but the pros and cons are different: risk versus reward, impact on diversification, costs, and level of investor involvement.
What is a stock?
Stock is a piece of ownership in a company; those individual pieces are called shares. The values of shares you own rise or fall with the company’s fortunes. Investors hope that the company’s stock price will go up so they can later sell their stock at a higher price than they paid.
Pros of investing in individual stocks
- By handpicking specific companies to invest in, you’re in the driver’s seat of every investment.
- You won’t pay any management fees, although your brokerage may charge fees.
- If you happen to pick the right company, you might find yourself cashing in.
- Some brokerages offer fractional shares, allowing you to start investing with even a small sum.
Cons of investing in individual stocks
- Investing in one stock puts all your eggs in one basket, which can be risky.
- The stock prices of the most highly valued companies are often high, although buying fractional shares can make them more accessible.
A word on over-the-counter stocks
You may come across over-the-counter stocks as you learn about investing. These types of stocks don’t trade on the stock market; they’re bought and sold through specialized traders instead. They’re sometimes called penny stocks because they’re very inexpensive, which can make them seem appealing at first glance. However, according to the Securities and Exchange Commission (SEC), they are “highly speculative.” That’s finance-speak for “a very risky investment.” While the low share prices can be enticing, the chances of losing your principal investment may be much greater.
What is a mutual fund?
These investments pool investors’ money and purchase a basket of securities, like stocks, bonds, and money market funds, in hopes of achieving a particular result. For example, an index fund might own a mix of stocks and aim to match the performance of a stock index, like the S&P 500.
Pros of investing in mutual funds
- Funds tend to create a more diversified portfolio, which can help minimize risk.
- They’re often actively managed by professionals.
- Shares are typically fairly affordable.
- You can earn dividends if stocks in the fund pay them.
Cons of investing in mutual funds
- Funds often have a minimum required investment amount.
- You’ll usually have to pay fees for fund management.
- Diversification in funds varies; for example, a mutual fund that focuses on a single sector could leave your portfolio overly dependent on that sector’s performance.
- Mutual funds only allow trades once per day.
Exchange traded funds (ETFs)
What is an ETF?
Like mutual funds, ETFs pool investors’ money and purchase stocks and other securities. But investors buy shares from one another, rather than from a mutual fund company. The pros and cons of these different types of funds are often similar, but there are a few key differences.
Pros of investing in ETFs
- ETFs often have lower fees because they’re usually passively managed, e.g., set up to track a market index.
- Buying and selling ETF shares is more flexible; you can make trades any time during trading hours and know the market price at the time you initiate the trade.
- They may offer some tax advantages over mutual funds because they generally don’t pass capital gains tax on to investors.
- Because many ETFs disclose their holdings daily, you might have access to more up-to-date information compared to mutual funds, which only have to disclose holdings quarterly.
Cons of investing in ETFs
- Like mutual funds, the actual level of investment diversification varies.
- They generally do charge some fees. That might include brokerage fees, which you may encounter in some circumstances, like when working directly with a broker.
- If the fund is passively managed, there’s little involvement from a fund manager; some people see this as a downside.
- Investment strategies differ among funds, and some, like leveraged ETFs, use approaches that may be riskier than others.
Step 4: Choose an investing schedule and continue to invest
Once you have clear goals in mind, you can create an investing plan and schedule. Many people like to invest monthly or set aside a certain amount of each paycheck; this approach allows you to build your investments over time, even if you don’t have a lot to invest upfront. You might also participate in a dividend reinvestment program or DRIP, so that any dividends you earn are automatically invested in more securities.
Whatever cadence you choose, regular and early investment gives your money time to grow and compound. Including a line item in your monthly budget for investing can help you stay on track with your investing goals. Automating your investment by using an app or payroll deduction can help you stay on target without having to transfer money manually.
Step 5: Monitor and track your portfolio
Once you have a portfolio, check in on it regularly; about once a month can be a good frequency to start with. You can expect that your portfolio value will change from day to day, and stock investments are likely to see some peaks and valleys. Don’t panic if the value of your investments decreases sometimes; the whole idea of investing for the long term is to allow for inevitable ups and downs.
Periodically, you may want to rebalance your portfolio. Many experts suggest doing so once or twice a year or if an asset class exceeds the ceiling you’ve set. Your brokerage may do it automatically, or you might have to take a more active role. There can be tax consequences to rebalancing, and you may want to check in with a tax professional to understand your options.
Finally, it’s a good idea to rethink your investment strategy every so often, especially when you have a major change in your life. You’ll likely find that your risk profile and investment goals change over the course of your life, and your portfolio can evolve with you.
Why should you invest in stocks?
Investing approaches are personal, so hard-and-fast “shoulds” may be less helpful than understanding the potential pros and cons. Remember that all investing involves risk, including the risk that you could lose money.
That said, stocks are frequently part of a well-balanced, diversified portfolio. That’s because over the long term, stocks may offer a greater return on investment than other securities, like bonds. At the same time, stocks present more risk than bonds because stocks may be more volatile, meaning stock values often swing up and down more dramatically than bonds.
Finding your stock-investing sweet spot, or what percentage of your portfolio you’re comfortable investing in stocks, can help you thread the needle between risk and reward. And with the power of compounding, the earlier you invest, the greater your earning potential.
Here’s a hypothetical example of how investing over the long term can pay off. Say you invested $1,000 in an index fund 25 years ago. If that investment earned an annual compounded rate of return of 8%, your portfolio would be worth $7,340 today.1 And that’s without putting any additional money into your investments. To see how investing could pay off for you, experiment with a compounding calculator.
Things to consider before you start investing in stocks
While all investors hope to earn a return, any investment has the potential to lose value. The great news is that there’s a lot you can do to mitigate the risk and understand the approach that’s right for you. Here’s how to invest in stocks while managing risk:
- Understand risk and reward. Investment accounts aren’t savings accounts, and they aren’t insured against loss. You might earn a lot, a little, or even lose your initial investment. That said, not all investments are created equal, and understanding relative risk can help you make choices that are right for you.
- Know your risk profile. Your risk profile means the amount of risk you want to accept. It can be influenced by your age, investment goals, temperament, and more. And it will probably change over time.
- Allocate your assets. Once you know your risk profile, you can distribute your investments, which is known as your asset allocation, among asset classes, including stocks. For example, if your risk profile is moderate, you might invest 40% in bonds and 60% in stocks. With that allocation, the higher risk, higher reward stocks may be balanced out by lower risk, lower reward bonds.
- Diversify your portfolio. Putting all your eggs in one basket is usually risky. But if you diversify your investments among asset classes, sectors, geographical areas, and more, a drop in one part of the market may have less impact on your portfolio.
- Rebalance from time to time. Over time, your asset allocation will likely drift. Hypothetically, let’s say you started out with an investment of $1,000 and want to put 60% of your entire portfolio in stocks and 40% in bonds. In that case, you’d invest $600 in stocks and $400 in bonds. If your stocks’ values increased to $800 and your bonds didn’t change in value, you’d have 66% in stocks and 33% in bonds, so your desired asset allocation would have changed. Rebalancing your portfolio periodically can help you stay on track with your investing strategy.
How to know what stocks to buy
Choosing stocks can often be more of an art than a science, so think about the various factors that matter to you when deciding how to invest in stocks. For example, do you hope to earn dividends? What sectors interest you? How might you spread your cash around to diversify your portfolio?
Once you’ve got a direction in mind, you can start researching. With mutual funds and ETFs, you can look into the funds’ prospectus, shareholder reports, and investment advisors. While past performance doesn’t necessarily predict future results, knowing an investment’s history can be a useful piece of the puzzle.
You might also consider searching for news stories, following investing experts on social media, and studying companies’ and/or funds’ websites before investing. And, of course, you can work with a human or robo-advisor.
Stocks and taxes
Do you have to pay tax on your investment returns? The short answer is yes. For example, you’ll likely owe tax on dividends and, potentially, the money you earn on your investments when you sell them, which is called capital gains. You may also be able to deduct capital losses, or money you lose on investments. Retirement accounts, including IRAs and 401(k)s, offer tax advantages.
Top 5 tips on investing in stocks for beginners
Many beginner investors feel a bit overwhelmed by choices and logistics involved in investing, to say nothing of the acronyms. Be patient with yourself and start slow. Here are five top tips for beginners:
- Understand risk and your risk profile
- Pick a brokerage that offers the level of advice you need
- Make a budget and a schedule for regular advising
- Diversify your investments
- Keep tabs on your portfolio
Investing in stocks can seem complicated, but getting started doesn’t have to be. Once you know the basics of how to invest in stocks and understand that all investing involves the risk that you could lose money, you can take steps to make informed decisions. There’s a brokerage and an advisor out there for everyone, and the earlier you start, the more your money could grow.
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Investment advisory services offered by Stash Investments LLC, an SEC registered investment adviser. Investing involves risk and investments may lose value.
1Hypothetical Projection: All investments involve risk, including loss of principal. This projection illustrates hypothetically, how factors such as recurring investments (amount and frequency) may impact the long-term value of investing given an 8% hypothetical rate of return (compounded annually). Please note, your account may be different for many reasons including, but not limited to, market fluctuations and volatility, changes in your recurring investments, withdrawals and additional investments, time horizon, taxes and fees, including your Subscription fees. This projection does not represent the actual performance of any client nor does it reflect the performance of any of the underlying investments therin. Diversification, asset allocation, and dollar cost averaging does not ensure a profit or guarantee against loss. Your actual investment return and principal value may fluctuate, so you may realize a gain or loss when shares are redeemed or sold. Please consider your objectives before investing. Investment outcomes and projections are forward-looking statements and hypothetical in nature. Your account balance may be more or less than your original investment. This example is for illustrative purposes only and is not indicative of the performance of any actual investment.
Hypothetical values shown in this tool assume the following factors: 1.) Initial investment of $1,000 2.) a 25 year time horizon 3.) No other account deposits, investments, fees, or dividend reinvestment 4.) No withdrawals taken from this account. “Retirement Portfolio” is an IRA (Traditional or Roth) and is a non-discretionary managed account. Stash does not monitor whether a customer is eligible for a particular type of IRA, or a tax deduction, or if a reduced contribution limit applies to a customer. These are based on a customer’s individual circumstances. You should consult with a tax advisor.
Traditional IRA: Withdrawing prior to age 59½, generally means you’re subject to income tax and a 10% penalty. Withdrawals after age 59½ are only subject to income tax but no penalty.
Please note: IRA eligibility rules apply. Please note, for 2019, if you’re 70 (½) or older, you can’t make a regular contribution to a traditional IRA. However, you can still contribute to a Roth IRA and make rollover contributions to a Roth or traditional regardless of your age. For 2020 and later, there is no age limit on making regular contributions to traditional or Roth IRAs.
This should not be construed as tax advice. Please consult a tax professional for additional questions.
Remember, not all stocks pay out dividends. And there’s no guarantee any stock will pay dividends in a quarter or year. Dividends may be subject to additional taxes, and are considered taxable income. Please refer to the IRS for additional information.