Investing for the future is an important part of any effective financial plan, but the stock market can be intimidating for beginners. Finding the right stocks, doing the research to determine if you should buy them, and at what valuations, and then building a strong portfolio can be complicated matters -- even more so if you're a novice.
For many investors, that means stress as they worry that they are taking on too much risk or missing out on the best opportunities. For others, those fears can lead to not investing at all.
If you have fears about putting some of your hard-earned money into stocks, the following advice should help you get more comfortable with the idea and allow you to set yourself up for a lifetime of capital growth.
1. Educate yourself
Familiarity is a great step toward comfort. Start by learning the basics of stock market jargon, understanding the forces that influence share prices, learning about the relevant macroeconomic issues of the moment, and learning about how to actually buy and sell shares. It's all part of the process of getting a feel for investing.
Fortunately, all of this can be accomplished by consuming some business media and placing a few small trades. There are vast numbers of cable channels, online video channels, podcasts, periodicals, blogs, and reputable websites that offer resources on investing for beginners. Dedicating some free time to reading, watching, or listening to stock market coverage will make you better-informed -- and less worried.
2. Start small
There's no substitute for experience. To really become familiar with how investing works, you'll have to put some cash on the line. Start with an amount that you wouldn't miss if you lost it -- something that won't impact your lifestyle and doesn't sap your emergency fund. I recommend starting by either purchasing an ETF or fractional shares of a handful of stocks.
Then, periodically keep up with important updates from the companies you own, and over time, you'll become more comfortable with the whole investment process. You'll see that it might be hectic, but with the right mindset (more on that below), it's not actually scary. Eventually, you'll be ready to accept stocks as a part of your overall financial plan.
3. Think long term
Tip No. 2 mentioned "the right mindset," and an important part of that is to avoid making buy or sell decisions based on everyday, short-term changes in the prices of your shares. In fact, the best strategy is precisely the opposite.
Maintaining a long-term approach will actually simplify things for new investors. The S&P 500 has never lost value over any 15-year span, and it has almost always been higher over any 10-year span as well. However, strange things can and do happen over shorter time frames. The U.S. stock market may cycle through bull markets and bear markets, but its long-term trend has always been upward. If you can prepare yourself (mentally, emotionally, and financially) for the inevitable market downturns and commit to keeping your money invested for the long haul, then history suggests that the value of your portfolio will recover from any declines and grow.
Stock prices are ultimately determined by the financial performances of the underlying businesses. Those businesses, by and large, grow along with the global economy. If the global economy expands, the stock market is very likely to follow. This is especially relevant for young people who are saving for retirement. If you won't be accessing the funds in your 401(k) or Roth IRA for a few decades, then you don't really need to worry about short- or medium-term market fluctuations that occur along the way.
One of the classic ways to limit your investment risk is to diversify your portfolio. If you own a basket of stocks, then you reduce the likelihood any single holding can ruin the performance of your entire portfolio, regardless of how badly things go for that company.
To diversify, you should purchase an assortment of stocks across various industries, or take the simpler route of purchasing an index fund in the form of either an ETF or mutual fund. Diversification transforms the nature of the risk you are taking -- instead of betting your future prosperity on whether or not one stock does well, you'll be betting on industries or the broad economy.
5. Use experts
If you don't want to purchase index funds, and you don't trust your own portfolio-building skills, you can also lean on professionals. Actively-managed mutual funds and ETFs are allocated based on the investment strategies and research of the fund manager. Target-date funds are another option -- each one is rebalanced regularly over time to gradually shift the allocation of stocks, funds, and bonds to reduce the level of risk the closer one gets to that fund's target date. Ideally, investors using these tools should pick a fund with a target date that coincides with their expected retirement.
A word of caution before opting for active management -- a lot of solid research indicates that the vast majority of active managers are unable to reliably outperform the market over the long term. Furthermore, those hands-on strategies require much more labor from the management team, leading to higher expense ratios that erode your returns every single year. Make sure that any additional expenses you incur are actually justified by the extra value created for your portfolio.