If you are a novice to the stock market, investing may seem to be an overwhelming challenge. If you understand these five key principles, you’re ready to dip your toe in the water.
Mutual funds and ETFs (exchange-traded funds) are generally safer ways to invest your money in the stock market. These investment vehicles are professionally managed pools of money that are invested on your behalf. You can choose from a variety of funds, most of which are safer investments — and may have the same prospect for growth — compared with individual stocks.
Investors will generally measure their profits as return on investment — returns for short. Returns on stock investments — including stock funds mentioned above — exceed the returns on most other investments.
The reason that stocks yield better returns than other investments is largely due to the risk of loss. A stock can go to zero. That is a scary thought, but it isn’t just theoretical. Every year some companies with publicly traded stock file for bankruptcy and their stockholders lose everything.
These risks are the reason that you want to invest in a portfolio of stocks and not just one stock. Funds give you the best way to invest in a portfolio of stocks. The best news about stocks is that the company can never force you to pay more than your investment. So if you invest $5,000 in the stock of a company that files for bankruptcy, you don’t have to worry about getting a bill to help repay the creditors.
Some people will try to convince you that you can time investments in the market to earn better returns than the market provides. Most people who try this fail, many fail miserably. Some buy when stocks are down in price only to watch them go lower and then sell in desperation. Others buy when stocks are high in hopes they go still higher only to watch them fall and then sell in disappointment.
Over the long haul, stock prices tend to go up. Buy your stocks for the long haul and then hold them for a long time. The best time to sell a stock is when that stock has gone up so much it represents more than 20 percent of your total portfolio — even then, you may wish only to sell some of your stock.
A stock portfolio should be diversified. It takes about a dozen different companies to create a diverse portfolio. Even then, your portfolio won’t be truly diversified unless the companies are in different industries that are not highly correlated (don’t move in the same direction at the same time for the same reasons).
It is challenging to build such a portfolio. Think of it this way. If you own only stocks related to the automotive industry because you love cars, your portfolio will get crushed when the auto industry struggles. A more diverse portfolio would not suffer so much.
There is a lot more to learn about stock investing, but you’re ready now to start investing. Continue reading to find out how to choose a good mutual fund.
Devin Thorpe, husband, father, author of Your Mark On The World and a popular guest speaker, is a Forbes Contributor. Building on a twenty-five year career in finance and entrepreneurship that included $500 million in completed transactions, he now champions social good full time, seeking to help others succeed in their efforts to make the world a better place.