6 Basics You Must Know Before You Start Investing


So, you wanna be an investor? Like, a real, stock-trading, market-following investor?

It's kind of terrifying, right? You probably have friends who've lost money — or maybe even their shirts. And it's hard not to notice all the news about market crashes and bankruptcies and even fraud.

Sure, you could put your money in a savings account, or some other investment with little or no risk. But here's the thing: A little risk can go long way to increasing your returns. And while portfolio managers tend to quote average returns of 10% per year for the S&P 500, a recent report by LPL Financial's Jeff Kleintop found that the most common rate of return is actually more like 15%-20%. (See also: The Basics of Asset Allocation)

So, does that mean you should throw all your money into the stock market? Don't be stupid. If you're smart about it though, a little stock investing can go a long way. Here are a few tricks about how to ease yourself in, keep your money safe, and emerge with a better net worth.

Get Educated

Learning how the stock market works takes time. Choosing stocks take time. Managing your portfolio to weed out losses and boost returns takes time. Investing safely isn't a get-rich-quick scheme — it's a lifestyle. If it isn't one you're willing to adopt, you should probably stick to set-it-and-forget-it savings and investments. As Warren Buffett once said, "No matter how great the talent or efforts, some things just take time. You can't produce a baby in one month by getting nine women pregnant." He's a multi-billionaire who made most of his money on the stock market. But it took a while. Take it from him. (See also: Investment Secrets of the Rich and Famous)

Need somewhere to start? Consider picking up a copy of Warren Buffett and the Interpretation of Financial Statements by Mary Buffett and David Clark. It's a great starting point for beginning to understand what allows a company to succeed — and how investors can find those stocks. For the most basic info on how the markets and various investments work, check out CNN's Money 101. (See also: 5 Free Killer Investment Resources)

Lose the Fear

It's easy to get emotional about money, and to be fair, the fear of losing it in the market is hardly unfounded. Companies do go out of business. The market does crash. And money does disappear. But often what really costs people in those situations is fear. It's fear that sends people running to sell everything in their portfolios (at a loss) when the market takes a nosedive. It's fear that causes them to trade too much, or too little, or to invest in way too many different things. It's only when you understand what you're doing and are able to make educated decisions about what to buy and when to buy and sell that things stop being so scary. (See also: 4 Quick Ways to Decide of a Company Is Worth Your Investment)

So how can you actually do that? First, learn all you can about the basics. Then, be sure to stick to investments you understand and are comfortable with. Yes, some risk can be a good thing in a portfolio, but only if you can get comfortable with it.

Start Small

OK, so maybe you're reading some books about how to choose stocks, and are doing some research about which stocks you might like to buy, but you don't quite feel ready. What's next? You dive right in. Seriously. The only way you're actually going to be invested (literally) enough to learn the ropes is to put some money in the market. (See also: A Guide to Online Brokers for Newbies)

Open a low-cost trading account, carefully choose a couple of stocks that you think have long-term potential and invest an amount you can afford to lose, and compare prices among brokers. In most cases you can also purchase stocks, mutual funds, and other investments at your regular bank. Note, however, that discount brokerage fees are often less expensive, so it can be worth shopping around. Whatever you deposit, consider it an investment in your financial education, and use it as an opportunity to research, track, and learn about investing.

If you're looking for resources on how to get started on stock picking, try One Up on Wall Street by Peter Lynch or The Intelligent Investor by Benjamin Graham.

Go With Blue Chips

What often draws people to the stock market are tales of once-in-a-lifetime startup stock picks that become the next Microsoft. That does happen, but it is rare. Business is, well, business. It's ruthlessly competitive, very expensive, and requires not only a great concept and good execution, but a whole lot of luck. Depending on who you ask, start-ups fail somewhere between 75% and 90% of the time. That is not good odds.

More established companies, on the other hand, can be virtual cash machines. These so-called "high-market cap" or "Blue Chip" companies have been consistently profitable for many years, have been around for many more, and are so big and well established that it would take quite a blow to take them down. Over the long haul, these types of companies are the best bet for those who want to dip into stocks and limit their exposure to risk. Many of them also pay dividends, which can really help boost what you earn over the long term.

Pay Attention to Fees

When you have your mind on big returns, it's easy to overlook all the little things that can have a huge impact on your net worth. Trading fees, for example; keep them cheap. If you're sticking to a long-term portfolio you shouldn't be trading a lot, but why pay more than you have to? The same goes for management fees, which tend to apply to fund-style investments. A bigger management fee doesn't equal a higher return. It's a fact. Seek out a low one.

The best way to do this is ask what trading fees are on any investment you purchase, then shop around to see how other brokerages — and other types of investments — compare.

Don't Forget Index Funds

Individual stock picking isn't for everyone, but index funds just might be. These are essentially baskets of stocks designed to provide similar returns to the overall market they represent. So, an S&P 500 index will provide a similar return as the 500 stocks represented in the S&P 500 as a whole. You're unlikely to get the high returns you could get if you managed to pick the best of those 500 stocks, but with such broad diversification, you'll also have a lot less risk to contend with. Plus, these investments are very low maintenance and, in most cases, they beat out professionally managed portfolios (such as mutual funds) anyway. (See also: 3 Steps to Getting Started With Index Funds)

I'm not going to say that buying and selling stocks successfully is easy. If it was, everyone would be rich (including me!). But it also isn't as hard as you might think it is. The key is to make sure that your very first investment is in learning to get it right.

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