How to Invest in Stocks: 7 Steps to Get Started

1. Determine your investing approach

The first thing to consider is whether you want to manage your own investments or hand that job to someone else. The honest answer is that both approaches can work well, and the right choice depends on your personality, available time, and interest level.

Do it yourself

If you enjoy researching companies, following business news, and making your own decisions about where to put your money, then managing your own stock portfolio is likely a good fit. Self-directed investing puts you fully in control. You choose which stocks to buy, when to buy them, and when to sell.

This approach does require a meaningful time commitment. You'll need to evaluate companies on an ongoing basis, stay current on earnings reports, and periodically review your portfolio to make sure it still reflects your goals. If that sounds appealing rather than burdensome, you're probably well-suited for the do-it-yourself path.

Use a robo-advisor

If you'd rather not spend time researching individual companies, a robo-advisor may be a better fit. A robo-advisor is an automated investing platform that builds and manages a portfolio of index funds on your behalf, based on your age, risk tolerance, and investing goals. Many will also optimize for tax efficiency and automatically rebalance your portfolio over time.

Robo-advisors have exploded in popularity in recent years because they make investing accessible without requiring deep financial knowledge. You contribute money regularly and the platform handles the rest. The tradeoff is that you give up control over individual investment decisions, and your returns will generally mirror broad market performance rather than outperforming it.

Neither approach is inherently better. The best one is whichever you'll actually stick with over the long term.

2. Decide how much money you will invest in stocks

First, let's talk about the money you shouldn't invest in stocks. In simple terms, the stock market is no place for money you might need within the next five years, at a minimum. Money you need to pay your kids' tuition or pay day-to-day expenses in retirement should be kept in less-volatile investment vehicles.

The stock market is likely to rise over the long term. However, there's simply too much short-term uncertainty in stock prices. In fact, a 20% drawdown in any given year isn't unusual, and occasional drops of 40% or more do occur. Stock market volatility is normal and should be expected. So, here's what money you shouldn't be investing:

• Your emergency fund
• The money you'll need to make your child's next few tuition payments
• Next year's vacation fund
• Money you're saving for a down payment on a home

Asset allocation

How you allocate your investable money is called asset allocation. Several factors come into play here, including your age, risk tolerance, and investment objectives.

The general idea is that as you get older, stocks become a less desirable place to keep your money. If you're young, you have decades ahead of you to ride out any ups and downs in the stock market. That's not the case if you're retired and relying on your investments for income.

A quick guideline called the Rule of 110 can help you establish a ballpark asset allocation. Simply subtract your age from 110. The result is the approximate percentage of your investable money that should be in stocks. The remainder should be in fixed-income investments, such as bonds or high-yield certificates of deposit (CDs).

For example, if you are 40 years old, this rule suggests allocating 70% of your investable money to stocks and 30% to fixed-income investments.

3. Open an investment account

To buy stocks, you'll need a brokerage account. But you're in luck -- Motley Fool Money's actually done the hard part for you already and reviewed dozens of accounts to help you find the right one.

Opening a brokerage account is typically quick and painless, taking only minutes. Most will allow you to invest with play money first to make sure the platform is a good fit for you. You can fund your account via electronic transfer, check, or wire. Before choosing a broker, consider the following:

Type of account

First, determine the type of brokerage account you need. For most people who are just trying to learn stock market investing, this means choosing between a standard brokerage account and an individual retirement account (IRA).

Both account types will allow you to buy stocks, mutual funds, and ETFs. The primary considerations here are why you're investing in stocks and how easily you want to access your money. If you want easy access to your money or are just investing for a rainy day, you'll probably want a standard brokerage account.

On the other hand, if your goal is to build up a retirement nest egg, an IRA is a great way to go. These accounts come in two main varieties -- traditional and Roth IRAs --, and there are some specialized types of IRAs for self-employed people and small business owners, including the SEP-IRA and SIMPLE IRA.

A key point is that IRAs are highly tax-advantaged vehicles for purchasing stocks. However, the downside is that it can be difficult to withdraw your money before a certain age.

There are also specific qualifications for investing in IRAs and taking the tax benefits, such as Roth IRA income limits, so be sure to meet the requirements before investing. One potentially appealing feature of Roth IRAs is the ability to withdraw your contributions (but not your investment profits) at any time and for any reason.

Costs and features

Most online stockbrokers have eliminated trading commissions for standard stock trades, so most are on a level playing field when it comes to costs, unless you're trading options or cryptocurrencies, which often still carry fees. Beyond cost, consider the educational tools on offer, access to investment research, the availability of physical branches if you prefer in-person guidance, and the usability of the trading platform itself. Many brokers let you try a demo version before committing any money, which is worth doing.

4. Choose your stocks

Once your account is open, it's time to start choosing what stocks to buy. Here are the most important concepts to master before you get started:

• Diversify your portfolio across companies and industries.
• Invest only in businesses you understand.
• Avoid high-volatility stocks until you get the hang of investing.
• Always avoid penny stocks.
• Learn the basic metrics and concepts for evaluating stocks.

Diversification means owning a variety of different types of companies, though too much diversification can dilute your returns. Stick with businesses you understand, and if you find you're comfortable evaluating a particular type of stock, there's nothing wrong with one industry making up a meaningful portion of your portfolio.

If you want to buy individual stocks, familiarize yourself with basic methods for evaluating them. Learning the fundamentals of value investing is a great starting point, as it helps you identify stocks trading at attractive valuations.

5. Choose an order type

There are different types of orders for stock purchases. For our purposes, there are two types of orders you should know about.

• A market order, which instructs your broker to buy the stock immediately and at the best available price, is typically the best order type for buy-and-hold investors.
• On the other hand, you may want to place a limit order, which indicates to your broker the maximum price you're willing to pay for a stock.

For example, let's say a stock is currently trading for $20.50 per share. You want to buy it only when the price is less than $20, so you place a limit order. Your broker then buys shares on your behalf only if the stock's price dips below $20.

6. Place the stock order with your brokerage

To place a stock order, go to the appropriate section of your online broker's platform and enter the required information. You will enter the company name or stock ticker, and whether you want to buy or sell shares (the exact process varies slightly). You'll also enter either the dollar amount you want to spend or the number of shares you want to buy.

After you tap the button to place your order, your stock purchase should be executed in seconds (if you've made a market order).

7. Continue investing

Here's one of the biggest secrets of investing, courtesy of Warren Buffett: you don't need to do extraordinary things to achieve extraordinary results.

The most reliable way to make money in the stock market is to buy shares of great businesses at reasonable prices and hold them for as long as those businesses remain great. If you do this, you'll experience some volatility along the way. But over time, you'll most likely enjoy excellent investment returns.

Potential benefits and risks of buying stocks

Over several decades, major stock market averages have consistently produced returns of between 9% and 10% annually. Based on an expected 10% long-term rate of return, if you invest $5,000 in stocks every year for 30 years, you would have a nest egg worth more than $900,000. Other benefits include:

• Inflation protection: The stock market has historically been an excellent hedge against inflation.
• Income: Many stocks pay dividends, and dividend stocks can be a great source of passive income.
• Liquidity: Stocks are highly liquid assets that you can buy and sell at full market value whenever the market is open.

The primary risks are associated with short-term volatility. Swings of 10% are relatively common, occurring roughly once a year, and declines of 20% or more are rarer but do happen. When investing in individual companies, you can also lose money due to competitors taking market share, interest rate changes, political headwinds, inflation, geopolitical tensions, or negative news about a specific business.

Stock investing mistakes to avoid

There are many potential mistakes new stock investors can make, and here are some of the most common. Avoiding these can save you a lot of money and aggravation as you build your investment portfolio:

• Don't make emotional investing decisions. Our instincts tell us to put our money into stocks when they're going up, and we see everyone else making money, and to sell before things get any worse when stocks are going down. This is literally the opposite of the buy low, sell high principle, the central goal of investing.
• Don't day trade or try to buy stocks because you think prices are about to go up. Leave short-term trading to professionals.
• Don't invest on margin (borrowed money). Not only will you pay interest on the money you borrow, but if your stocks fall, this can also magnify your losses.
• Don't use options to invest. Options should be left to those with more experience, at least until you really know what you're doing.

Stock investing strategies

To be clear, different strategies work for different investors, and there are too many potential stock investing strategies to list them all here. But in addition to the general strategy of buy-and-hold, which is the best way to create long-term wealth, here are some that are pretty universal:

• Dollar-cost averaging: The practice of investing a set amount of money over time. For example, instead of buying $5,000 worth of a stock today, maybe you'll buy $500 per month for the next 10 months. This helps you get a mathematically favorable share price over time.
• Tax optimization: By using a combination of retirement accounts and standard (taxable) brokerage accounts, investors can optimize their investments to minimize taxes. For example, dividend stocks are best suited for retirement accounts where your income can grow tax-deferred, while growth stocks or non-dividend stocks can be best for taxable accounts.
• Diversification: Diversification is the practice of spreading your money across many different investments. While you don't necessarily need to own stocks from every sector, it can be a smart idea to make sure you aren't too reliant on any single company's performance.
• Rebalancing: Over time, different investments perform differently, and it can be a smart idea to periodically check whether your asset allocation is out of balance. For example, if one of your stocks triples in value, it could make up an uncomfortably large percentage of your portfolio.

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