21 Things to Know Before You Buy Stocks

If you want to be financially secure, saving isn't enough. You also need to invest, and the stock market has historically produced returns that beat most other investments.

Yet before you start buying stocks, there are some things you really ought to know. That way you won't get blindsided by some unexpected aspect of stock investing, and you'll put yourself in the best possible position to generate the long-term gains that will help you reach your financial goals. 

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Stock investing can produce high returns, but in some cases, you can do better. If you owe high-interest debt on credit cards, payday advances, or similar loans, it's almost always smarter to take the money you'd invest in stocks and use it to pay down that debt instead. Once you've gotten that bad debt taken care of, buying stocks makes more sense.

You don't have to know anything about individual stocks to get exposure to the stock market. Mutual funds and exchange-traded funds let you own small stakes in dozens or even hundreds of stocks in a single investment. That gives you diversified exposure to stocks without requiring you to do a lot of research on individual companies.

Many investors make the mistake of treating stock investing like shopping, gravitating to the stocks that have the cheapest share prices. However, these penny stocks are often the riskiest in the market, and some of them are downright fraudulent. You're better off sticking with well-established companies whose products and services you're familiar with and use.

Most people buy stocks using a brokerage company. There are many brokers out there, and each one offers a variety of services to help you invest. By offering company research and a host of investing tools to help you better understand the stocks you're looking at, the right broker can make it far easier to climb the learning curve toward becoming a great stock investor.

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Despite the fact that having a broker can be valuable, it isn't strictly necessary. Some companies offer direct investment plans that let you buy and sell shares directly through the investor relations department. These plans are typically best suited for long-term investors, because they make it more difficult to conduct trades at a moment's notice than most brokers.

Stocks and bonds are two types of investments that you may have heard about, but bonds are a lot different from stocks. Bonds typically pay you interest at regular intervals and then return your initial investment when they mature. They lack the upside that stocks have, but they also tend to be safer -- as long as the company doesn't go bankrupt and become unable to repay bondholders.

Many people treat stock investing like a game, making frequent trades in an effort to make money quickly. Most of those who follow that strategy end up losing their money. The better perspective to have is to focus on stocks of companies with the best business prospects and then hold onto them for the long run. The best-performing stocks can take decades to produce the life-changing wealth they've delivered to shareholders.

With thousands of stocks to choose from, it can be tough to know where to begin. Fortunately, you're familiar with plenty of companies whose shares trade on major U.S. stock exchanges. By looking into the stocks of businesses you know, you'll be more in-tune with their performance and also have a vested interest in seeing them succeed.

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It can be tempting to invest in a company on the cutting edge of some innovative product or technology. Yet if you don't really understand how a company does business, you won't be able to assess whether they're succeeding or failing. Even experienced investors sometimes avoid entire industries, finding their businesses too hard to analyze and therefore not worth the risk. 

Once you start investing, you'll inevitably hear news about your company. Good news will make you excited, while bad news will make you scared about the future. That's why so many investors buy when times are good but then sell at the worst possible time. Only by mastering your emotions will you become a top stock investor.

As anyone who's paid attention to the stock market over the past year knows all too well, the entire market can move up and down wildly. That in turn often hits the share prices of individual stocks -- regardless of whether the reasons the overall market is falling truly apply to a particular company. You'll need to have a tough stomach to stick with your stocks, but adopting a long-term approach is the best way to stay the course.

Many people don't realize that stocks don't just provide return by seeing their share prices go up. Many stocks also pay dividends, which are payments of cash to shareholders. Most dividend-paying stocks make payments four times a year. The amounts are usually relatively small compared to the value of your stock, but over time, they can add up to make a huge difference to your overall investment return.

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There's nothing more frustrating than seeing your stock go down when the broader market is rising, but it still happens. Sometimes, the best stocks win or lose based on very specific conditions that don't apply to other companies. Moreover, event-driven news like a financial report or winning a key piece of business can make share prices move sharply -- and independently of the direction of the stock market as a whole.

Having a portfolio with a lot of stocks protects you from suffering big losses if one of the stocks declines sharply. However, there are downsides to owning too many stocks as well. At some point, it becomes impossible to keep up with what's happening to the businesses of so many different companies. For many, the sweet spot is somewhere in the 10 to 20 stock range, but you'll have to adjust that to meet your own needs.

Many investors get disappointed when a stock they buy loses value. But over time, the stocks you pick whose values multiply manifold will make up for losses on other stocks, and you can even end up ahead with a single huge winner amid a portfolio riddled with stocks that didn't reach their full potential. 

Stocks represent shares of a business, and so it's important to look at that business for warning signs of trouble. High levels of debt, cuts to a dividend, sustained failure to report a profit, or news of an investigation from the U.S. Securities and Exchange Commission or other regulatory agencies are all red flags, and although they don't necessarily mean a stock is in imminent danger, you should still stay abreast of the situation to ensure it doesn't worsen.

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Stocks don't move straight up. Some of the top-performing stocks of all time have still gone through multiple periods during which they lost half or more of their value, and if you sell your shares during such periods, you'll miss out on their huge long-term potential. Locking in profits is always tempting, but it can end up costing you even larger gains that a more disciplined approach would produce.

Owning stocks in a tax-favored account like an IRA can help you improve your overall returns. By holding a stock in an IRA, you can sell it without worrying about paying taxes on any capital gains. Depending on the type of IRA you have, you can also collect dividend income on a tax-deferred or tax-free basis. That's an advantage that can be worth a lot for stock investors.

Just because you own multiple stocks doesn't automatically give you the benefits of diversification. For instance, if you own 10 stocks but they're all in the oil and gas business, then a plunge in crude oil prices will likely cause all 10 of them to drop. Diversification means having different types of stocks, not just a large number of them.

Stocks can be risky, and most investors mix them with other investments in their overall portfolios. Once you've established the right balance, it's essential to keep it. That means rebalancing by selling winning investments and moving money to weaker-performing investments. Doing so can keep your allocations to various asset classes stable, thereby maintaining a level of risk you're comfortable with.

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One of the best things about owning stocks is the tax benefits they have. Dividend income usually gets taxed at a lower rate, and as long as you hold onto a stock, you don't have to pay taxes on the paper gains. Only when you sell do you owe tax, and most stocks qualify for lower long-term capital gains rates if you hold them longer than a year before selling.

Investing in stocks can be scary or intimidating at first. But once you've gained experience with stock investing, you'll realize how useful it is towards helping you become financially independent and secure.

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