An Introduction to Investing in Stocks
We at MoneyMio think it is important for most people to be familiar with stocks and the available options to invest in them. With the right approach, stocks can be a nice way to supplement your income and can create a more comfortable future for you and your family. For the last three years, I have supplemented my income significantly by investing in stocks. My educational background and experience in finance have facilitated this, but any person with the right guidance or access to educational resources can also achieve the same result.
Prior to my experience in the finance world, I grew up in Colombia during a time when the financial markets were in early developments. I did not receive sufficient financial education on investing as it wasn’t yet part of the culture. While I did not gain that knowledge until later in my life, I will make sure I pass down the knowledge that I have to my children—that way they can benefit from starting to invest early on in their lives and create a very comfortable financial future. I would probably begin that conversation with some simple questions and answers to give them a general introduction to investing in stocks.
People don’t need a financial background similar to mine to be successful in investment, but they should be careful, do their research, and stay informed when putting their hard-earned money to work.
Simply put, investing is putting your money to work for you. Investing allows you to buy something that ideally will increase in value, provide you with additional income, or both. If you’ve worked hard and saved your money, why not create more financial security for yourself through investing? Incremental financial security will allow you to reach certain lifestyle goals: whether you want to feel more comfortable with your financial responsibilities or you want to buy a new laptop. There are many ways to invest, and this article will discuss one of the most predominant methods: investing in stocks.
What Are Stocks?
A stock is a share in the ownership of a company: it legally entitles you to be a part owner of that business. You can be a stock owner of a private or public company, but this article will focus mainly in public stocks.
Public stocks are widely traded in public stock exchanges all around the world. A public stock exchange, like the NYSE or IBOV, is a marketplace where stocks are exchanged by buyers and sellers. Stocks can be great vehicles to invest in, given their low transaction costs and wide availability, which allow you to buy or sell with relative ease when compared to other investments.
For example, investing in real estate, although less volatile, has high transaction costs. Generally these costs are 5% of the value of the property when sold. These costs are generally significantly lower with public stocks. Also, with real estate and other investments, you cannot immediately sell a property if there is an unforeseen situation where you truly need to do so. But with public stocks, you can.
The ability to readily sell or buy an asset with ease is referred to as liquidity. When assets are liquid, like public stocks of large corporations, you can buy and sell without much trouble, which is an advantage that stocks have over other investment types.
Is Investing in Stocks Risky?
Yes, investing in stocks can be very risky given their volatility and given the high probability you will get nothing in return if the company goes belly up. But carefully selecting a company, investing in the long run, and buying when stocks are inexpensive (the price of a stock is not an indicator whether a stock is cheap or not), can significantly reduce risk and position you to reap rewards. There is a reason why very wealthy individuals and institutions usually have a portion of their money invested in stocks.
How Can I Invest in Stocks?
There are two main ways to invest in stocks. A common form for experienced individuals is to open a trading account with a reputable broker online and do it yourself. We recommend that investing on your own should only be done when you have a good understanding of investing in stocks and financial analysis. You will be surprised how anyone that is motivated can gain the necessary financial knowledge to in order to do so. Once you open a trading account—which generally only takes minutes—and you transfer funds to your account, you are free to trade within a day or so. In a following article we will provide a top list of brokers and steps to open the account.
The other way to invest in stocks is to find a reputable investment professional to do it for you. For those of you that are new to investing in stocks, this is the prefered method we recommend until you have sufficient financial knowledge or experience to do it yourself. Many people opt to “invest” with very little knowledge of finance which equates to speculating, not investing. Investing in stocks without sufficient knowledge and experience is the same as gambling and can result in material losses.
There are several investment professionals that can assist you with investment advice. We would suggest you take time to research the available options in your community and get recommendations from trusted people or advisors that have a very strong track record. At MoneyMio, we aim to provide these services in the future as we scale our business with the best talent we can find and at much more affordable fees than what is available out there.
What Is Diversification?
Diversification is simply not putting all of your eggs in one basket. When investing in stocks, a common theme discussed is diversification. Whether done through an investment professional or on your own, you should always ask for or seek diversification.
You can do this by creating a portfolio of assorted stocks: different industries, company sizes, and geographic locations. Investment professionals should generally recommend diversification as a tool to minimize risk and prevent large losses. They will be able to recommend how you can achieve diversification even by investing in companies that have exposure to other types of investments, like real estate or bonds. Yes, there are companies that are set up to buy bonds or other investments of which you can buy stocks. Many of these come in the forms of mutual funds, close-end funds, ETFs, etc., which are financial products available to everyone.
What Strategy Should I Use When Investing in Stocks?
Whether you invest on your own or through an investment advisor, we suggest you do so in the long term and not try to time the market.
Although there are many approaches to investing, we like to learn from the ones that have done it best: Warren Buffett, Seth Klarman, and other value investors. These investors have incredible track records, and they have mainly accomplished that by investing with a longer term time frame.
Long-term investing is when you hold an investment for more than one year (typically from three to five years) which has a lot of clear positives:
- It takes you away from putting too much attention on daily fluctuations of the market and takes you away from market timing
- It’s beneficial for your taxes
- It reduces trading commissions
Having a long-term focus is very important and deserves its own article, but, out of these three points, I would like to emphasize the importance of not timing the market and to avoid putting too much attention on daily fluctuations.
Market timing is extremely difficult, if not nearly impossible, and trying to predict when a stock is going to go up or down in the short term is nothing short of speculating. Short-term trading, given the volatility of stocks, can lead to significant losses. For example, assume an individual buys a stock that has been on an uptrend, and it falls a big amount shortly after due to unforeseen events. A short-term-focused investor might not have the patience to wait until the stock turns around and reaches the initial target price but sells the stock and locks in the losses. A long term investor knows that in the long term, the stock will likely appreciate to its target price based on the work he or she has done and will not worry about the drop in price.
If anything, after carefully reviewing the situation he or she might use the drop as an opportunity to buy more. In that way, the loss is avoided, and the person likely benefits down the road without having to worry about the stock going up or down. Of course, there are situations where you should still sell a stock after it drops, but a qualified financial advisor, or a person with sufficient financial investment knowledge, can determine that.
With a little work and financial fitness over time, you, too, will be able to create a significant change in your financial future. This has been my experience, and if it was not for that, I would not be writing this article to share my experience with you, nor could I have afforded to resign from my job and create a company to help others with their personal finances. Stocks are risky, but they can be great investment vehicles and can provide you with strong returns when done with the right approach and balance of discipline and patience.