Are you interested in investing, but afraid to begin? That's not unjustified. Many financial media outlets post headlines with the aim of stoking fear and greed, putting off many from investing.
Over the past few years especially, market prognosticators have been talking about a possible recession, given the fact that we have been in the longest economic expansion of all time. And memories of the Great Recession and market collapse of 2008 are still fresh in many people's minds.
However, a recession hasn't happened, and these scare tactics shouldn't stop you from investing today, even in the 11th year of this bull market. That's because timing the market is notoriously difficult. Yet over the long run, stocks on average tend to appreciate by a much higher amount than inflation.
In fact, a recent study by JPMorgan Asset Management revealed that in the 20 years between Jan. 4, 1999, and Dec. 31, 2018 (a period that included two nasty market downturns), if you had missed out on just the 10 best market days, your annualized returns would be more than cut in half.
The best option in most cases is to invest regularly, in equal dollar amounts, on a monthly or quarterly basis as savings come in, and not get distracted from that plan. If you're finally leaping into investing this year, here are the initial steps you'll need to take.
Find a broker
If you are wealthy enough to hire a high-touch asset manager from a large bank, that's great. But for most of us, a low-cost online broker that charges low or no commissions is the best way to start. Fortunately for investors, a recent price war among these online brokers has caused many to drop their trading commissions to zero. That's right: zero, as online brokers have other streams of income besides commissions. That means just about every major online broker will allow you to trade stocks, ETFs, and index funds free.
I use Interactive Brokers because it actually has two options for traders: a low-commission option for better execution, as well as a free option that may not get you the best price execution. Interactive Brokers also has the lowest margin loan rates in the industry, which can come in handy if you trade stocks on margin or wish to borrow against your equity holdings at some point. But for beginners, I would not recommend buying stocks on margin. If you do, and the market falls quickly, you can be forced to sell, putting your initial principal at risk.
Most online brokers provide similar services, but there are slight differences among them, such as research, tools and coaching, margin rates, user interface, customer support, and others. Take a bit of time to explore and pick what's best for you, as switching away from one broker to another can be a bit of a headache.
What to buy?
If you aren't familiar with many companies or don't know how to value stocks, that still shouldn't stop you from beginning to invest. You can get exposure to a diversified basket of stocks in several ways: through low-cost index funds, actively managed mutual funds, or sector-specific ETFs.
In fact, the greatest investor of all time, Warren Buffett, actually recommends a low-cost index fund as the best option for most investors. Index funds, as they are named, track an index such as the S&P 500, and usually have minimal fees associated with them.
While index funds are not managed by human beings, many active managers have failed to beat the indexes in recent years, even before management fees. In addition, you won't rack up the trading commissions or generate capital gains taxes that come from buying and selling individual stocks. An index guarantees that you'll do average relative to that index, which, given the S&P 500's long-term annual return of around 8%, isn't so bad.
You can also invest in mutual funds, which are actively managed by a portfolio manager and team of analysts. Some mutual funds are tradeable through your online broker, though some require a minimum investment and aren't as easily accessed. While you have to pay higher management fees for mutual funds, these fees have been coming down in recent years, and mutual funds give you the peace of mind knowing that professional investors are monitoring your holdings and trading on your behalf -- for better or worse. If you do choose mutual funds, you should have conviction that the managers of the fund have the smarts to beat the indexes by more than their management fees. It's not impossible, but it is a taller task these days.
Finally, there are also exchange-traded funds, or ETFs. These are similar to an index fund, but they can also be sector- or theme-specific, such as a technology or healthcare ETF, or an ETF that focuses on growth stocks, value stocks, or dividend stocks. In addition, some ETFs use leverage in order to give investors two, three, or more times the exposure to a certain sector. Other ETFs are short or reverse ETFs, which give investors exposure to the opposite of an index or sector -- a way to bet against that sector or asset.
For beginners, I wouldn't recommend using leveraged or short ETFs because they are really only appropriate for sophisticated investors or those who want to gamble using leverage or make very specific bets. Still, ETFs can be a great way to concentrate on a particular sector. For instance, younger people may benefit from technology-focused ETFs. While technology stocks can be incredibly volatile, the sector has been a long-term winner, and I'd expect that to continue over the longer term as technology becomes a more integral part of our daily lives.
The case for individual stocks
Finally, you may have a particular feeling about certain individual stocks. Famed investor Peter Lynch (who beat the market by leaps and bounds through the 1980s) is known for saying that individuals with specialized knowledge may be able to identify companies with big potential, even before Wall Street. So even if you are new to investing, you may work in a particular industry and have an insight into a great company in the making. If you really love a certain company or product, believe in that company's management, and think the stock is trading at a reasonable price, you can start buying individual stocks today.
Now, individual stocks are riskier than holding a diversified index or ETF, but if you pick right, the long-term returns of certain individual stocks over the indexes can be astounding. If you are interested in picking individual stocks, The Motley Fool is here to support you with Stock Advisor and our other specialized stock-picking newsletters.
The bottom line
With interest rates so low, you probably aren't going to protect the value of your savings by sticking them in a bank. While inflation is also relatively tame today, individuals still need to grow their wealth over time in order to secure their retirement, and investing in stocks is perhaps the best (and most fun) way to do it.
Though investing can be intimidating to newcomers, don't hesitate to begin by following the steps above. If you're still unsure about how to start, you may wish to seek out the advice of a financial adviser, or begin educating yourself about how stocks work. Either way, if you haven't started investing already, make 2020 the year you begin. Your future self is likely to thank you.