This article was updated on August 8, 2017, and originally published June 21, 2015.
You're at a party with a bunch of people you don't know, but you manage to strike up a conversation with someone who told you he or she made a fortune trading stocks. This person tells you all about a hot new stock that's sure to take your net worth to a whole new level. You're hanging on this person's every word and can't wait to get home and bet a big chunk of your meager life savings on this next big thing because you want a fortune of your own, and you want it now.
For better or worse, you can do just that. You can hear a tip on some hot stock, go home, and open up an online brokerage account, and with a few clicks of the mouse, you're easily able to invest your hard-earned savings in a company you probably had never heard about until today. In fact, the only research you might be doing on investing is clicking on some internet articles to figure out just how to buy a stock.
Well, you've come to the right place. I'll not only explain to you the process of buying a stock for the first time, but I'll take it a step further and give you some tips to make sure your first stock purchase isn't also your last. All you have to do is follow these five easy steps.
Step 1: Answer this critical question first
Before even opening and funding a brokerage account, any prospective investor must first answer one critical question: Can you afford to invest right now? To answer that question, you need to consider the following three criteria:
- Have you paid off all credit card balances? If not, then pay your credit cards off before investing.
- Do you have an emergency fund with three to six months of basic living expenses? If not, then invest in your financial security first and build up an emergency fund.
- Do you have a little extra cash left over each month that you won't need for the next three to five years? If not, look for ways to cut unnecessary expenses out of your budget, so you have room to invest.
By laying a strong financial foundation, a beginning investor will be able to sleep soundly when times get tough. And I'll warn you now that tough times will happen at some point.
Step 2: Open and fund a brokerage account
If your financial house is in order, the next step is to find an online broker that's suitable for your needs. Not sure which broker to use? We have a handy comparison guide here.
Step 3: Look at businesses, not ticker symbols
While your new friend at that party told a compelling story about a hot new stock poised for greatness, it's best to avoid stock tips. Instead, your mission, should you choose to accept it, is to find a great business that's selling for a fair price, as opposed to buying a hot stock.
It's vitally important to remember that a stock represents a direct investment in a business. Furthermore, to have the greatest chance at success in investing, one should seek out top-notch businesses, which are those that tend to have a sustainable competitive advantage, a strong balance sheet, and great leadership. These businesses are harder to find, but the long-term rewards are well worth it. If you need some help finding great businesses, we've got you covered.
Step 4: Now it's just point and click
With your financial house in order and using money you don't need for the next few years, you're finally ready to buy a great business that you can confidently hold for the next several years. Now all you need to do is hop on your broker's website to enter your order.
Most brokers will have step-by-step instructions that detail how to buy or sell a stock using their website, so be sure to check that out. However, as a general rule of thumb, you'll open up the order page, search for the ticker symbol, and enter the details of your trade. Among the decisions you need to make is how many shares to buy and whether to enter a market or a limit order. My advice is always to use a limit order, which you can set at the current stock price or lower. Taking this step will ensure that the market doesn't take advantage of you by making you pay a higher price for the stock than necessary.
Another valuable piece of advice is to avoid buying a full position at once. Instead, figure out how much you want to invest and divide it by three and then invest that amount on the first purchase. In 30 days buy another third and follow that up 30 days later with that final third.
Step 5: Check in, but not too often
Once your order goes through, you'll be the proud part-owner of a tiny piece of a great business that should reward you through the years. That said, most beginning investors will have the urge to check in on that stock every few seconds or so to see how it's doing. They might even get disappointed when it goes down a few pennies, and depression could set in after it's down a buck or two. That why it's best to keep a long-term mindset, remembering that this is money you don't need for several years, which is why it's best not to check in on your stocks all that often.
Instead of checking the stock price, it's better to check in on the business. Read its quarterly and annual reports, and check out its latest investor presentations to make sure the business is still heading in the right direction. As long as it is doing well, the stock price should follow, assuming the initial purchase price wasn't too rich, although great businesses can outgrow even the richest stock valuations.
Learning to invest the right way will pay dividends down the road
Buying a stock for the first time is almost too easy. What's tricky is learning how to invest correctly, which is where these five easy steps come into play. Follow them closely, and you'll be on your way to a becoming a successful investor.
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