Regular people generally like to play it safe. While everyone is always looking to increase their income or grow their wealth, risk-averse people like to invest in savings accounts, bonds, government-backed securities, and dividend growth stocks. They tend to steer away from directly investing in the stock market as they perceive it to be highly volatile and risky. Preservation of the principal and liquidity of the investment factor high on their priorities.
But it is important to realize that those safe but low return investments will not create wealth, due to reduction caused by inflation. The purchasing power of your returns will significantly reduce over time.
Which is why people need to start investing in the stock market. The earlier they start, the better their returns. The longer they are invested, the more their money grows. This article provides an essential guide for regular people to start investing in the stock market.
Table of Contents
Define Your Financial Goals
Everyone has different financial goals, which keep changing with age. Financial goals should be determined, keeping in mind employment security, current outstanding debt, future financial and family commitments, and current expenses.
Financial goals can be further divided into short term and long-term goals. For example, children’s education, marriage expenses, or a retirement corpus could be long-term goals, while buying a new car could be a short term one. Once you have made an exhaustive list of your goals, set aside the amount of capital that you can comfortably invest in the stock market without affecting any of your goals.
Understanding the Basics of the Stock Market
Start with familiarizing yourself with the basic concepts of the stock market. There are plenty of books and free online information sources available to help you do just that. Clearing concepts on financial metrics, stock valuations, selection & timing, market capitalization, types of stocks, types of trading options, and price fluctuations will help you set your foot firmly in the market.
Understand Your Risk Profile
You could be a risk-taker or a risk-averse person, based on your appetite for risk. Risk is a psychological characteristic generally based on your education, genes, wealth, family culture, and age. You should choose the stocks to invest in, based on your risk profile. For example, an old person who does not understand technology, should not invest in cryptocurrency stocks, as it is a high-risk investment.
Use a Virtual Trading Platform First
A virtual trading platform is just like a stock trading platform which can be used to try your hand at trading, without using any real money. There are now plenty of virtual trading platforms available, which are free or charge very nominal fees. Using a virtual trading platform, you can understand how stock trading works, how to build your portfolio, and also learn about the tools you have at your disposal to execute trades. A good example of this is using the ‘Time in Force’ option, a useful way for traders to keep from accidentally executing trades.
Open an Investment Account
The next step is to open an investment account or a brokerage account. This can be a Do-it-Yourself (DIY) or through a Robo-advisor. A DIY account is the cheapest and quickest way to enter the stock market. However, if you are not confident of investing by yourself, one can use a robo advisor based brokerage advisor. In this account, the robo advisor creates a complete financial profile and invests in your portfolio based on various pre-calculated metrics. Ensure that you follow the day trading rules as applicable.
Diversify Your Portfolio
Based on your risk appetite, it makes sense to diversify your portfolio as much as possible to spread the risk of poorly performing stocks. This is where your research helps you in identifying and quantifying the risk associated with each stock. Prudent investors own multiple stocks in various companies in different industries, reducing their risk from any negative events from a particular industry.
There is no Right Time to Invest
A lot of people give first-time investors the following advice: ‘timing the market correctly is the most important rule of investing in the stock market.’ This is inherently flawed logic, as there is no ‘right time’ to invest. The stock market is cyclical and volatile. Some stocks will rise at the same time, some stocks plummet.
Use Logic Versus Emotions
One of the biggest issues with new investors is that they are prone to think emotionally as compared to rational or logical thinking. Avoid investing based on speculation, rumors, tips, or simply hope. Stick to research and invest in fundamentally strong companies. Look at the company’s assets, management, hiring policies, and market prospects to guide your stock investments. Tension and insecurity created by losses and dashed expectations can ruin your portfolio through incorrect decisions.
Keep an Exit Strategy Ready
Stock prices can move contrary to our assumptions and expectations. It is important to be ready to bear a certain amount of loss, but also to know when to exit a particular stock. New investors can often get stuck in the quagmire of whether to sell, to stay put, or to buy more when there is volatility around a stock price. You need to have a sound exit strategy before you buy a stock and be ready to use it prudentially.
Stock markets have historically provided higher returns than other types of investments. They also provide instant liquidity, no lock-ins, complete visibility, and an instant measure of success.
Investing in stocks is a great way to increase your wealth, provided you take the efforts to be patient, build your knowledge, and keep a long-term horizon. Avoid using the leverage in any form (credit card, loans, financing) to execute your stock market strategy, as this can be devastating.
A profitable outcome in the stock market is not the result of luck, but the disciplined application of a few principles that have come from over a hundred years of stock trading and countless market cycles. Limiting your risk at the start of your investment journey can ensure profits over the long term. The earlier you start investing in the stock market, the higher will be your returns. Just remember to walk before you run.