How to invest in stocks

In a nutshell

For many investors, owning stocks is a key financial instrument for building wealth.

• Stock is a share of ownership in a company.
• If the shares are publicly traded, you can buy and sell them with a brokerage account.
• People can invest in stocks for the short or long term, either to gain capital appreciation or dividend income or both.

Decide on your investing approach

There are two main ways to invest in stocks: by purchasing shares of individual stocks or by investing in professionally managed funds like mutual funds and ETFs.

Investing in individual stocks directly or investing in stocks through a fund is not an “either or” decision. A lot of investors combine the two approaches, and certainly you can too. Some things to consider in deciding which is the better approach for you include:

• Do you enjoy researching investments? Are you comfortable researching individual stocks?
• Are you comfortable with math, and do you have good analytical skills?
• Do you have several hours each week to research and monitor your investments?

Your answers to these questions and other considerations will help you decide on the best way to invest in stocks for your situation.

Individual stocks

If you have the time, interest and ability to do it, investing in individual stocks can not only be profitable, it can be enjoyable. Investing in stocks takes a lot of patience, however. You have to analyze and review your holdings on a regular basis.

ETFs and mutual funds

Another way to invest in stocks is through ETFs and mutual funds. These funds are professionally managed and invest in a number of stocks held inside the fund. Stock mutual funds and ETFs can track broad indexes, various asset classes of stocks, and specific sectors such as technology and a host of others.

Some mutual funds and ETFs track stock-based indexes, for example, the S&P 500, and the Russell 2000. There are also funds that track the total U.S. stock market and the total non-U.S. stock market. These funds are called “passively managed” funds because their managers don’t pick stocks or have an investment thesis.

There are also actively managed stock funds. At these funds, the fund manager actively decides which stocks to hold in the fund and which to exclude based on their investment thesis – an argument that some group of stocks within a sector or a sector of the market broadly will outperform the rest of the market.

Set a budget

It’s important to establish a budget for investing in stocks. You will want to be sure that the money you dedicate to investing in stocks is money that you will not need in the short term. The stock market is not the place to invest money you have set aside as your emergency fund or for near-term expenses like an upcoming vacation or projected house renovation.

Open an investment account

In order to invest in stocks, you will need a brokerage account. There are a number of options to consider. The broker you choose should offer a good experience and lots of help if you need it.

Online brokers make it easy to open an account online. Brokers such as Robinhood, TradeStation, and others have streamlined the process to allow you to get started investing quickly. These firms may vary in the services offered, the types of accounts available, and other aspects, so be sure to do your homework to find an online broker that matches your needs. Also, be sure to understand any and all fees the firm charges for accounts and services.

Charles Schwab, Fidelity, Merrill Lynch, and other firms tend to offer a full line of trading services and access to a wide range of investments and account types.

Many firms have reduced or eliminated trading commissions on stocks, but there may be other transaction costs at a brokerage you are considering. For example, you will want to check on any fees or expenses for trading mutual funds that you might be interested in. Different brokers will offer certain mutual funds with no transaction fees while charging a transaction fee on others.

Beyond the ability to trade stocks, you should consider the types of accounts you may need based on your situation. These might include an IRA, a self-employed retirement account such as a Solo 401(k) or SEP-IRA, or other types of accounts, including a trust. IRAs and 401(k)s are “tax-advantaged” accounts, so different rules apply to how you can contribute to and deduct money from them.

Account minimums

Some types of online and traditional brokerage accounts may require a minimum amount to open an account. This can vary widely and may be higher at a more traditional brokerage firm. In contrast, many online brokers allow investors to open accounts with very low or even no minimum investment.

Some brokers may reduce transaction fees and other costs for investors whose accounts reach a certain minimum level of assets.

Commissions and fees

Commissions and fees for trading stocks vary widely among brokers. In some cases, commissions and transaction fees have been drastically reduced or eliminated altogether.

Even if your broker offers low- or no-fee trades, it's important to understand that you are still paying the broker in some fashion. Research and understand all fees that any brokerage firm you are considering charges. As they say, there is no free lunch.

Asset allocation

One of the most important steps as an investor is your asset allocation. This is about how you divide your investments between broad asset classes like stocks, bonds, and cash.

In terms of stocks, investors might divide their allocation among large-cap, mid-cap, and small-cap stocks. They may also want to allocate money between growth and value stocks, as well as between U.S. and international stocks.

Ideally, your asset allocation will be done across all types of accounts, including a workplace retirement account like a 401(k), your taxable brokerage account, and any IRAs you might have.

Your asset allocation should be a function of your age, your risk tolerance, and the timing of your financial goals for the money. Ideally, you will set a target percentage for the asset classes that comprise your asset allocation and rebalance your portfolio back to these target allocations at regular intervals as needed.

There is a place for both individual stocks as well as stock mutual funds and ETFs in your asset allocation.

Selecting the best stocks to own

If you are a beginning investor or at least one who is new to investing in individual stocks, here are some things to consider in selecting the best stocks to own.

• Diversify your portfolio. Be sure that you diversify not only among the types of individual stocks you choose but also look at how these stocks fit in with your overall asset allocation if you have money invested in mutual funds and ETFs elsewhere in your portfolio.
• When looking at individual stocks, only invest in companies whose business you understand. If you can’t explain what the company does, your money probably should not be invested in that stock.
• Be sure to understand the volatility of any stock you are considering. If a stock is highly volatile during periods of market upheaval (the price goes up and down a lot), be sure you are comfortable with that to avoid selling the shares at the first sign of trouble.
• Avoid penny stocks. While some of these stocks may be good investments, often, these stocks represent companies without solid balance sheets and income statements. They are often quite risky investments.
• Spend some time before investing to understand how stocks are valued and how to use valuation models to do your own analysis.

Research the stocks you are interested in

When looking at stocks you are considering investing in, do your research first. You might start by looking at companies that you are familiar with as a consumer of their product or service. Another place to start is with companies that you are familiar with through your work or from the industry you are involved in.

When researching companies, look at publicly available documents like their annual report and SEC filings. These are often available on your broker’s website. You can also research stocks at independent research sites like Morningstar and Zacks.

Decide how many shares to purchase

This will vary by the investor and their situation. New investors might consider buying a few shares at first and perhaps adding more over time. A number of brokers offer the ability to buy fractional shares, making it easier to purchase shares of companies whose share price is high.

Understand stock order types

It’s common for investors to buy shares of stock using a market order. This is an order that is entered during the trading day for a set number of shares. The order is filled at the next available price. For companies whose shares are widely traded, this will generally happen quickly and at a price close to what you expect.

Some investors might use a limit order, especially for shares that are not as widely traded. A limit order specifies a range between which shares can be purchased or sold.