Investing in the stock market can be a powerful way to grow your wealth over time. And harnessing the potential of compound interest can help you maximize your financial future. However, making informed decisions about buying and selling stocks requires a clear understanding of how the market works and the strategies that align with your goals. Whether you’re a beginner or looking to refine your approach, we’ll delve into understanding stocks, starting with the basics. For personalized guidance and a tailored investment strategy, consider partnering with a financial advisor who can help you navigate the complexities of the market and optimize your portfolio for long-term success.
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Understanding Stocks
Companies decide to issue stock because they want to raise money. Rather than issuing bonds, which are loans from bondholders to the company, a company might decide to “go public” by issuing stock.
The money a company gets when an investor purchases shares doesn’t have to be paid back. The company can decide whether and when to issue dividends to shareholders. Plus, issuing shares spreads risk to investors rather than keeping it all on the shoulders of the company owners. When you buy stock, you become a partial owner of the company that issued the shares. You have what’s called shareholder’s equity. Like home equity, shareholder’s equity increases your net worth.
How to Buy Stocks
Buying stocks is an excellent way to build wealth over time, but the process can seem intimidating for beginners. Below we’ll cover some of your options, key considerations to make as well as best practices for getting started.
1. Direct Purchase from Companies
Some companies allow investors to buy shares directly through special programs. One popular method is a Dividend Reinvestment Plan (DRIP).
- What is a DRIP? A DRIP lets you purchase company shares directly with your initial investment. Over time, dividends paid by the company are automatically reinvested to buy additional shares. This creates a compounding effect, as your growing number of shares continues to generate more dividends.
- Who is it for? DRIPs are ideal for long-term investors looking to build wealth steadily in companies they trust. However, this option requires you to manage each investment individually, which can be cumbersome for a diversified portfolio.
2. Using a Brokerage
Investing through a brokerage is the most common method of buying stocks.
Platforms like Fidelity, Charles Schwab and Robinhood make it easy to buy and sell shares. These platforms often charge fees, typically on a per-trade basis, though some offer commission-free trading. Some of the benefits of using a brokerage and “DIY” trading include:
- Full control over your investment choices.
- Access to tools, research, and data for informed decision-making.
- Opportunity to implement specific investment strategies.
When managing your own investments, diversification is critical. Here’s how to create a well-balanced portfolio:
- Invest in companies of different sizes (small-cap, mid-cap, and large-cap).
- Diversify across sectors (technology, healthcare, energy, etc.).
- Include both domestic and international stocks.
Even seasoned investors rarely outperform the market. As Warren Buffett advises, “Don’t try to beat the market — buy and hold index funds.” For many, this approach offers better returns with less effort.
3. Investing in Funds
If picking individual stocks feels overwhelming, consider investing in funds. These options let you invest in a diversified portfolio of stocks with minimal effort.
- Mutual Funds: Actively managed by professionals who select stocks based on research and market trends. While promising, they often come with higher fees and don’t always outperform the market.
- Exchange-Traded Funds (ETFs): Like mutual funds but traded on stock exchanges, ETFs offer low-cost and tax-efficient exposure to various sectors or indices.
- Index Funds: These funds mirror the performance of a specific market index, such as the S&P 500. They typically:
- Charge lower fees due to minimal management.
- Outperform actively managed funds over the long term.
- Provide instant diversification.
4. Full-Service Brokers and Financial Advisors
For those who prefer to delegate investment decisions, full-service brokers and money managers offer personalized assistance. Financial advisors can assess your financial goals, risk tolerance and investment timeline, as well as build and manage a portfolio on your behalf. Here’s what to look for:
- Credentials and Experience: Ensure your broker has the appropriate licenses and certifications.
- Fiduciary Duty: Confirm they act in your best interest, avoiding conflicts of interest tied to higher-fee investments.
- Reputation: Research for any history of complaints or misconduct.
Buying stocks can be as hands-on or hands-off as you prefer. By understanding your options and aligning them with your financial goals, you can make smarter investment decisions and grow your wealth over time.
Bottom Line
If you’re risk-averse, buying stock may be intimidating. But unless your salary is very high or you have a big inheritance coming your way, you’re unlikely to save enough for retirement without investing in stocks. Bonds may feel safer, but they don’t offer the same inflation-beating returns as stocks do. That’s why it’s important to find the balance between bonds and stocks that’s appropriate for your goals, as well as the time you have before retirement.
If you’re fortunate enough to have the option of investing pre-tax dollars in a 401(k) through work, look for low-fee places to put those dollars. Fees will eat into your investment gains over time, and who wants that? Ready to branch out from the 401(k)? Consider IRAs and Roth IRAs, which offer different tax advantages. Now that you’ve read our guide to understanding stocks, don’t ignore stocks’ potential to grow your money. Using your 401(k), IRA or Roth IRA to stash all your money in bond funds or money market funds will leave you with sluggish growth. Sluggish growth means more years of work and fewer rounds of golf in your golden years.
Tips for Investing
- However, if you have a more complex financial situation or just prefer talking face-to-face, consider working with a traditional financial advisor. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- As you build your portfolio, you might want some guidance, especially if you find the stock market intimidating. If you don’t have a lot to invest or you’re just starting out, you might want to consider a robo-advisor. Robo-advisors, which are entirely online, offer lower fees and account minimums than traditional financial advisors.
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