It’s time to lift the veil on investing in stocks. This simple guide takes you through the simple steps you must take to invest in stocks.
Investing in stocks is not as hard as it sounds - it just requires some understanding of the basic principles to get started. BUT it is not to be taken lightly, the confidence to invest properly only comes from knowledge about what you’re doing- so take the time to make sure you’re comfortable.
For those just getting started with investing, we recommend to first read our guide on How to start investing in 5 simple steps.
Contents: How to invest in stocks
- Investing vs trading stocks
- Back to basics of stocks
- How do beginners buy stocks? (7 Steps)
- Stock investing ideas
Investing vs trading stocks
It’s important to make the distinction between these two very different approaches to the stock market.
Day trading takes a very active approach by buying stocks on a regular basis to capture short term moves in the stock pricev with good market timing using either the latest news or by using technical analysis of price charts. This typically involves extended-hours trading. Day traders will even go short stocks in a bet that the share price will go lower.
Investing is all about growing wealth for the long term and requires much less active involvement. If your investing portfolio is setup right, you will not need to change it often and can simply keep investing into it over time.
Back to basics of stocks
What is a stock?
Owning a stock means you are a part of the company. The reason for taking ownership is that you believe the company will grow in value and the price of the stocks you own will rise over time.
Why own stocks?
Stocks tend to be the pillar of most investing portfolios because of their ease of access and because ownership requires no active involvement in the running of the business. This compares with buying a private businesses where your intent might be to take over the day-today operations of the company to help it grow and earn more profits.
As the charts below show, in recent years more of the wealthiest people own stocks and at the same time their share of all wealth has been growing. Like it or not, the reality is that owning shares goes hand-in-hand with growing wealth.
How do you make money from stocks?
The traditional investing approach is to “buy and hold” stocks over the long term in time for important life events like paying for your children’s education and retirement. The idea is that by then, a growing economy and strong business which is growing its sales and profits will mean the stocks are worth more than when you bought them. i.e. buy low and sell high !
Is investing in stocks risky?
It’s very important to understand that investing in stocks is riskier than keeping your money in a savings account or government bonds. On the whole, established companies tend to grow and the stock market rises over time, but individual companies can lose value and even go bankrupt. If you invest in of a company that goes bust, your stocks will be worth zero. The way to address this individual stock risk is through diversification, which we discuss more of below under portfolio construction.
How do beginners buy stocks?
We will get to the process of picking stocks in just a moment but don’t rush through the other important steps towards deploying your investor funds - without those your chance of investing success is greatly reduced.
Here are the steps you must take to invest in stocks:
STEP 1: Arrange your funds
The fancy name for this is ‘asset allocation’. It’s the question of how much of your wealth you will put into stocks, bonds, savings accounts etc. The very first consideration for new investors is how much to save vs invest.
How much should you invest in stocks first time? Write down the value of your savings and the extra money available to invest each month or each quarter (income - expenses) and decide how much you will put into the stock market. Never invest money that you will need soon to cover expenses!
The 80:20 rule suggests aiming to preserve 80% of your wealth, while actively trying to grow the other 20%. So roughly speaking, 20% can go towards investing in stocks and other 80% can go into a savings account or relatively safe investments like bonds.
STEP 2: Investing style
This article is intended for those who want to invest for themselves. If this is not something you’re completely committed to you - try reading our blogs: Active vs Passive investing & Do I need a financial advisor? These explain the pros and cons of investing through investment funds managed by professionals and hiring a professional to help choose your stock market investments.
NOTE: This isn’t a binary choice- you can invest in mutual funds, have a financial advisor and do you own DIY stock investing.
STEP 3: Investing goals
Stop there - yes of course you want to make money with stocks! The question is how and when this money will be earned and how much risk will be taken to earn it.
Risk vs reward: Think of it like this, if you want to buy a stock that could double in value in a year, you must accept the increased risk that this same stock could fall in value by a half. Likewise a stock that might only go up 10% in the next year might only fall by 5% if things go wrong. The reason for this is that fast growing companies are generally smaller and more likely to fail than larger, slow growing companies. This is the concept to risk to reward in investing.
Growth vs income: Do you want to take a regular income from your investing? Some companies pay dividends, which is a certain value per share that you own. You can use these stockholders dividend payouts for spending or reinvest them back into the company by buying more stock. This is income investing.
For example, a stock worth $100 might have a cash dividend of $3 per quarter. This means you will earn $12 per year for your investment, meaning a dividend yield of 12%.
Companies that do not offer dividends are usually using their profits to reinvest into the business instead, which if well invested by the company management, will mean a higher share price. This is growth investing.
STEP 4: Dip your toe in the water
Some people never gather the courage to start investing in stocks. To get over the hurdle of just getting started with investing, it’s good just to buy a small amount of a stock that you like. You can always sell it later and if it’s a small investment, the winnings or losses probably won’t make much difference to you financially.
Is it worth buying 10 shares of a stock? To determine the size of your investment, you will multiply the number of shares by the share price. 10 shares x $10 stock price = $100 investment. 10 shares x $1000 stock price = $10,000 investment.
STEP 5: Build a stock portfolio
What is a portfolio? A portfolio is a collection of financial assets.
Individual share prices go up and down and it’s impossible to invest in stocks that only go up, some will turn lower and all of them will turn lower for at least short periods of time. The way to make money by investing is to grow the value of your portfolio, which will hopefully have more stocks that are rising in it than stocks that are falling over time.
There are different ways of categorising stocks, and each category will go in and out of favour among investors, so it pays to have some allocation to the major categories. This is what’s termed a balanced portfolio.
The main ways to diversify an equity portfolio are as follows:
- Large cap vs small cap = big companies and little ones
- Domestic vs international = stocks from your national stock exchange and from abroad
- Growth vs value = stocks that do and don’t pay dividends
- Sectors = e.g. technology vs healthcare or financials
The below charts give three examples of how you can model your portfolio to be conservative, moderate or aggressive.
Source: Charles Schwab
STEP 6: Stock picking
There are literally thousands of books written on how to best pick stocks so summarising it is not so easy, but we will do our best. There are really three factors to look at for analysing a stock.
- The story
This is likely will capture your initial interest in the stock, a good story for why it might grow in the coming years. The best example in recent years is Tesla and the expected growth of electric vehicles (EVs). But it can be as something as simple as this company produces a wide variety of consumer staples and should be able to maintain its market share and keep paying the dividend.
- Financial metrics
This is where you need to check the health of the company. Are sales rising or falling? Are costs rising or falling? Does it have a lot of debt? Fortunately you don’t need to pour through company income statements and balance sheets (unless you enjoy that kind of thing!).
Public companies are required to provide certain financial information, which is handily converted into financial ratios on any finance website. When reading a stock quote, you will typically find information showing the company name, ticker symbol, market capitalization, Dividend yield and the highest and lowest the price has been in the past 52-weeks (one year).
This is how investors measure what the company should be worth versus its current share price to determine whether the shares are cheap, expensive, or fairly-priced. The classic measurement of value is the price-earnings ratio (P/E ratio).
STEP 7: Keep investing
As time passes, it pays to buy new stocks and add to your current positions in your portfolio. Because of the power of compound interest, investing more into your portfolio, including reinvesting dividends will make an almost exponentially large difference to the value of your portfolio over time.
If you believe in the long term performance of the stocks in your portfolio, it is generally best to add to those positions when the share price falls. This is called ‘buying on weakness’ or ‘buying the dip’ and conforms to the idea of buying low and selling high. Of course, when the share price falls it is for a reason and you must determine whether it affects the reason you are buying the stock in the first place.
Stock investing ideas
Hopefully this overview has broken down the steps you need to go through for how to invest in stocks. There are of course thousands of stocks to choose from. To help learn about some of the latest and greatest stocks, you can read the FlowBank Market Research blog
To get started investing today with the possibility to invest in over 50,000 products with the secutiy of a Swiss bank account, register with FlowBank.