Everything you need to know, in one place.
When you buy a stock, you basically purchase a tiny bit of ownership in a company and are thus entitled to a portion of its future earnings and, in…
When you buy a stock, you basically purchase a tiny bit of ownership in a company and are thus entitled to a portion of its future earnings and, in most cases, voting rights on important decisions the company is making. As the company grows and increases in value, the bit of ownership you have also becomes more valuable – it is pretty much the underlying principle of any profitable stock market investing. Unlike bonds that are basically loans and give you a fixed return on investment, stocks don't have any guaranteed returns and increase or decrease in value depending on the opinion the market forms of that company.
A stock exchange is basically a place where buyers and sellers get together electronically to buy and sell the shares. The stock price is determined not by some authority but simply represents the last point at which someone was willing to buy and someone was willing to sell. Thus, it is constantly re-priced with each transaction and changes in prices can be seen very quickly based on news, rumors, or quarterly financial statements. That is the reason why news and reports about a company can affect its stock price even before people have a chance to read the full article.
Individual stock investing implies that you pick certain companies on your own, giving yourself the maximum possible opportunity to get a high profit but also the maximum risk. Index funds and ETFs consist of hundreds of stocks and therefore are less risky as they allow you to invest in the market or in a sector instead of a couple of companies. The majority of long-term investors use funds as the basis for their portfolio while considering individual stock investing a supplement.
In order to start, you need to open a brokerage account that is usually easy to do online in just several minutes – all you need is a proof of identity and a bank account linked to your name. You should look for a broker that offers an account with no minimum balance requirements, allows commission-free trading on stocks and ETFs that has recently become an industry norm and that has an intuitive interface. Depending on whether you want to be involved personally or not, you may choose between a full-service broker, discount app or a robo-advisor that assembles a portfolio for you.
With market order you buy or sell stocks instantly at the price that is currently available that works well for a stable and widely-traded stock but gives you a chance to get a bad price during a volatile period. Limit order allows you to specify the exact price at which you are ready to buy or sell so the transaction occurs only at that price or above. For a novice investor it would be better to stick with limit orders on volatile assets and use market orders only for most liquid and stable holdings.
Diversification means not investing all your money in one company or in one sector or even in one country in order not to lose everything in case something goes wrong. The thing is that a broadly-based index fund provides enough diversification by itself which is one of the main reasons why most long-term investors base their portfolio on just one or two funds rather than on tens of different stocks. The right mixture of stocks, bonds and cash depends on your personal timeline and ability to withstand the volatility.
Some companies distribute a part of their profits to shareholders on a regular basis – that is called dividends. Generally speaking, companies that provide such dividends are mature and well-established, and young and growing ones usually keep all the money they earn and distribute no dividends at all. Reinvestment of the dividends is one of the methods to maximize the returns in the long run.
There are situations when stock prices drop significantly and even become lower than your initial investment. The thing is that there is no guarantee that it will ever bounce back and your losses will be minimized. The longer you can keep your investments in stock without needing them, the greater amount of volatility you can withstand – which is one of the reasons why your investment timeline plays a great role. If you need your money in a few years, it is better to keep them away from the stock market no matter how confident you are.
Many investors use a method that is called dollar-cost averaging that means regular investments of a fixed sum of money no matter what is the stock price. In other words, you buy more stock when it is cheap and less when it is expensive. This way is not as effective as buying stocks when the prices are at the lowest possible level, but it helps you avoid the pressure of predicting the market movements that is impossible even for professional investors. Besides, it turns investments into a habit.
Everyday monitoring of the portfolio and reacting emotionally to every change in the prices, chasing the popular stocks and investing the money you'll need in a few years are the surest ways to make a reasonable strategy stressful. Going all-in on one company because of your personal belief is also a frequent mistake that leads to disaster. These mistakes occur because people treat investing as something they can win quickly instead of doing something that is rather boring.
If you sell your stock for a higher price than you bought it, you face a capital gain and depending on how long you hold it, you are taxed accordingly. Positions held longer than one year have a lower tax rate compared to those sold sooner. Dividends you receive are generally taxable for the year when you received them even if you reinvested them. There are special tax-advantaged accounts designed specifically for retirement savings that help you protect your gains from taxes or defer them and that is why many long-term investors use them first and then turn to regular accounts.
The people who make the most profit in stock market over decades are rarely the people who chose the most interesting individual stocks, they are usually the people who started investing in a timely manner, kept their costs low, were diversified and did not panic during downturns. Nothing in investing can guarantee that you won't lose your money, no guide can promise you certain returns, but the strategy with a long history of success is definitely a steady and unglamorous one. It is better to start investing with the money you are comfortable with than wait for the perfect moment.