If you’ve never invested in the stock market before, it can be an intimidating process. Stocks are not like savings accounts, money market funds, or certificates of deposit, in that their principal value can both rise and fall. If you don’t have sufficient knowledge of investing — or emotional control — you can lose most or even all of your investment capital.
Getting started saving for your future doesn’t have to be complicated. In fact, you can being investing with as little as $500.
All you have to do is follow the 10 steps below to jumpstart your retirement and get started with stock market investing.
Step 1. Check Your Financial Luggage
Before you get into investing of any kind, you first have to make sure that your overall financial situation is in a position to accommodate the new activity. This will include everything from income, to debt, to your household budget.
Specific considerations include:
- Employment – make sure that both your job and your income are secure enough to allow you to begin investing.
- Debt – if you have a significant amount of outstanding credit, you may want to pay some debt down before you begin investing; you should never invest money you can’t afford to lose, and that’s the position you’ll be in if you have too much debt.
- Family situation – if you just welcomed a baby into the world, you may need all of your available income to help with the new arrival; family situations should be stable before you begin investing.
- Your household budget – you should have some room in your budget to direct cash into your investment ventures.
Step 2. Build a Cash Reserve
Before you put any of your money at risk, you should first have some put away that will not be subject to any risk whatsoever. A cash reserve equal to at least three months living expenses should be the minimum, and it should sit in nothing more risky than certificates of deposit or money market funds.
The purpose of the cash reserve is twofold: to act as an emergency fund in the event of a temporary income disruption or other financial emergency, and to keep you from panicking should your risk type investments take a sudden dive.
Step 3. Open a Retirement Account
Once you have a well stocked emergency fund set up, the best place to begin investing is in a retirement account. This can be a 401(k) plan (or its equivalent) through your employer, or an Individual Retirement Account (IRA) if there is no employer plan.
Retirement accounts are an excellent start because they represent long-term investing. In addition, they are tax sheltered — and can produce immediate tax savings too — and are typically funded through payroll deductions. You can think of it as patient capital, where you have literally decades to accumulate and grow your money.
One of the best aspects of a retirement account is that you can build up money in the plan without actually investing any money until you’re ready to do so. You can keep it all in a money market account within the plan until you feel comfortable adding stocks and funds to the plan.
Step 4. Open an Account with a Low-Cost Online Broker
Once you have a retirement account up and running, you can open an investment brokerage account for your non-retirement investing needs.
Betterment is an excellent choice for new investors because a) there’s no initial minimum deposit requirement, b) you can build the fund with periodic contributions as low as $100 per month, and c) their fees are among the lowest in the industry.
One disadvantage of a broker like Betterment is that investing in the account is limited. You buy into either a basket of stock-related ETFs, or a basket of bond ETFs. This is excellent when first starting out, but when you are ready to spread your capital around the investment universe, and particularly into individual stocks, you’ll need to look for a full-service broker to meet your needs.
One such full-service broker when you’re ready to trade up is Fidelity. One of the largest financial firms in the world, Fidelity has it all — every conceivable investment choice and a long history of top caliber customer service to support it. For example, Fidelity offers one of the lowest trade commissions in the industry — $7.95 per equity transaction — as well as access to more than 4,700 funds.
Step 5. Start with Mutual Funds or Exchange Traded Funds (ETFs)
When you first begin investing you’ll be far better off with mutual funds and ETFs than plunging right into stocks. Funds are professionally managed, and this will remove the burden of stock selection from your plate. All you need to do is determine how much money you want to put into a given fund, or group of funds, and then you’re free to get on with the rest of your life.
One of the advantages of mutual funds is that you also don’t have to worry about diversification. Since each fund holds numerous stocks, diversification will already be built into the fund.
Step 6. Stay with Index Funds
To make mutual fund investing even more hassle-free, stay with index funds. For example, index funds that track the Standard & Poor’s 500 index are invested in the broad market, so your investment performance will track that index precisely. While you’ll never outperform the market in an index fund, you’ll never under-perform it either. As a new investor, this is as it should be.
Step 7. Use Dollar Cost Averaging
Dollar cost averaging is the process of buying into your investment positions gradually, rather than all at once. For example, rather than investing $5,000 in a single index fund, you can make periodic contributions of say, $100 per month into the fund. By doing this, you remove the possibility of buying at the top of the market. Rather, you’re buying into the fund at all different times and on a continuous basis. This also removes the “when” question, as in when to invest in a given security or fund.
Even better for you, dollar cost averaging works beautifully with payroll contributions, and is a natural fit with mutual funds and ETF’s.
Step 8. Get Some Investment Education
We could have made this step number three, with the intention that you have some understanding of investing before doing anything at all. Fortunately, mutual funds and ETF’s — with the help of index funds and dollar cost averaging — remove that necessity. You can begin investing immediately even if you’re a novice.
But if you want to move beyond funds, payroll contributions, and dollar cost averaging — and into holding individual stocks — you’ll need to learn all that you can about investing before you do.
While you are accumulating money for investments and piling them into mutual funds and ETF’s, you should use this time to educate yourself about the game of investing. Read books, listen to CDs, take a course or two at a brokerage firm or even a community college, join investment forums, and regularly visit investment websites, like InvestorJunkie.com.
In order to become a good investor, you’ll need to surround yourself with investment experts and learn all that you can. The idea is to become “fluent” in investments, before you begin investing with real money.
Still another option is to work with an online broker that offers virtual trading — that is, trading securities on paper only. This provides you with a valuable opportunity to test out investing strategies before actually committing your own money. Several online brokers offer this service, including Scottrade, and OptionsHouse.
The more you know before you begin investing, the lower the amount of risk you’ll be taking on.
Step 9. Invest in Individual Stocks Gradually
When you finally feel comfortable enough to begin investing in stocks, be sure that you do it gradually. You generally don’t have the dollar cost averaging feature when investing in individual stocks, so you’ll have to develop your own method for doing this on a gradual basis.
Since you will already have significant positions in mutual funds and ETF’s, you can begin investing in stocks one at a time as you work toward building a portfolio. The fund positions should prevent overexposure to a single stock, as long as you make sure that your position in the stock represents only a small minority of your total portfolio (generally 10% or less).
Never overload in a single stock. When you are starting out, take a minimal position in one stock — generally 100 shares to take advantage of the best pricing — and then move into another stock. Repeat the process until you have several stock positions in your portfolio, in addition to your mutual funds and ETF’s.
Step 10. Don’t Forget to Diversify!
If you have set up a cash reserve, a retirement plan, and an investment account, and have begun stocking the retirement and investment accounts with mutual funds and ETF’s, you’ve already taken a huge step toward diversifying your portfolio.
Adding individual stocks will further diversify your cash and fund holdings. But while you are building your portfolio, you’ll also need to spread your capital out among various equity sectors.
For example, depending on your age and risk tolerance, you might want to have some of your portfolio invested in bond funds, growth and income funds, and international funds. You may also want to consider high dividend stocks among your individual stock holdings. Income earning securities tend to be less volatile than pure growth stocks, particularly in bear markets. You’ll want to develop a balance between your growth assets, and your income- or growth and income-holdings.
Take these steps, and you’ll have the basic foundation to help you in getting started with stock market investing. Just remember that investing is a process, not a destination, so you need to be learning and experimenting on an ongoing basis.