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Editor’s Note: This post was originally published in July 2022 and has been updated to include additional insights and improved clarity.
Investing in stocks is one of the essential parts of building wealth over time. Diversification is the primary key to wealth building (we’ll discuss later in this post), so you wouldn’t want to risk all your money on just a few investments! Allow this post to be a tool to help you invest in stocks efficiently and intelligently.
What is a Stock?
“A stock (or equity) is a share of ownership in a company. It represents a portion of the company’s assets. Companies issue stocks when they raise capital by selling new shares of stock to investors. Investors purchase those shares, hoping the company’s value will rise. If the company does well, its stock price rises, and vice versa.”
I have actively participated in the stock market for over 10 years, and I must tell you that money has been made. I’m not saying I’ve made millions, but I have seen a solid return through regular contributions. It doesn’t take much to get started, and since I didn’t have much, it is also simple. Let’s get into it!
What Are The Risk Of Stocks
Firstly, let’s note that we all have varying levels of risk, and the number of stocks we hold dramatically depends on our stage of life. For example, a portfolio with only stocks for people in their 20s may sound reasonable since they have more time ahead. Still, a portfolio such as this for an individual in their 80s would display ATROCIOUS!
A young person fresh out of high school or college has a longer time horizon (the time until retirement) to deal with the market’s ups and downs. As such, they would most likely not need to live on these funds at this point. That said, a retiree shouldn’t put their near-fragile heart at risk from seeing a possible 30% drop in their stock value overnight!
Why should you Invest in Stocks?
Investing in stocks is a great way to build wealth over time. An index is a portfolio of stocks that measures a section of the market. Many indexes track the stock market, but I’ll use the most well-known, the S&P 500, which is comprised of the 500 largest publicly traded companies in the US.
According to a Berkshire Hathaway Study, the S&P 500 returned an average annual return of 10.5% between 1956-2021. Even better, over the last ten years of the study, 2011-2021, the average yearly return was a whopping 14.7%!!!
When we put into perspective compounding returns of $1,000 at an annual 10.5%, this would be $2,714 in 10 years! That’s almost triple your original investment. Of course, this level of return isn’t guaranteed due to years when the market can perform better or worse.
I know this doesn’t seem like much in 10 years, but when investing correctly, you must remember that it is a marathon, not a sprint. I would certainly say it’s a better alternative to the average bank account or Las Vegas slot machine.
Ready to start building your wealth? Open a brokerage account today and start with a low-cost ETF like VTI or SCHB to gain exposure to the US stock market. It only takes a few minutes to begin your investment journey!
Why is diversification important? (Risk Management)
Diversification means spreading your investments across various assets to reduce risk. Think of it as not putting all your eggs in one basket. For instance, if one industry struggles (e.g., tech), gains in another (e.g., healthcare) can balance your portfolio. Diversification can be achieved by investing in mutual funds, ETFs, or even stocks from different industries and countries.
In my opinion, this Forbes article does an excellent job of solidifying the importance of diversification!
What are some easy ways to invest in Stocks?
Different types of investment vehicles offer varying levels of risk. Some are safer than others, as the stock market can be volatile!
Assuming you’ve already opened your brokerage account. Let’s discuss a few investment vehicle options so you can start investing in stocks today!
- Mutual Funds
- Exchange Traded Funds
- Individual Stocks
- Options
| Investment Type | Pros | Cons | Best For |
|---|---|---|---|
| Mutual Funds | Professional management, diversified | Higher fees, minimum investment required | Passive investors |
| ETFs | Low fees, trades like a stock | Requires a brokerage account | Beginners and passive investors |
| Individual Stocks | Potential high returns | High risk, requires research | Experienced investors with time |
| Options | Potential for high profits | Very risky, complex | Advanced investors |
Mutual Funds
Above all, A mutual fund is a type of investment vehicle that pools money from investors and invests it into different securities (stocks, bonds, etc.) based on what the fund manager thinks will do well. This means that when you invest in a mutual fund, you’re not putting your money directly into individual companies; instead, you’re investing in a group of companies the fund manager has chosen.
Look, I get it… this is probably not the sexiest way to invest, I know.
I’m not making risky bets or personally picking the next Apple, Tesla, or Google, but in my opinion, this is an easy way to invest in stocks and ETFs. I’ve also seen tremendous growth doing so. My approach is the classic ‘buy-and-hold strategy’ (buying stocks and holding on for the long term until you’re ready to retire or use those funds), which Investopedia has proven to work!
Many investment brokerages offer a selection of mutual funds, and they are the best way to invest if you want to do so passively. Even target-date mutual funds will automatically risk-adjust over time based on the year you plan to retire. For more info, check out FINRAs explanation on Target-Date Funds!
Here are a few significant brokerages and their mutual fund listings: Vanguard, Charles Schwab, and Fidelity. I want to note that there can be minimums of $500-$5,000 to enter a mutual fund, which could initially limit this option. But have no fear. There are ETFs!
Exchange Traded Funds (ETF)
ETFs are similar to mutual funds because they pool money from investors and invest it into different securities. However, unlike mutual funds, ETFs trade on exchanges just like shares of stock. They can also offer great diversification benefits! They allow investors to buy a basket of assets rather than choose one purchase at a time.
This vehicle can be very similar to a mutual fund; there is more of a tax advantage when dealing with ETFs versus mutual funds. This is because when investors enter and leave the mutual funds, the fund managers must buy and sell assets in the fund. This can cause you to pay capital gains tax on the assets sold.
Some ETFs track the same indexes as mutual funds, which can be a good alternative. This is an easy way to invest in stocks and is my primary way of investing. If you want to quickly get exposure to the entire US stock market for the absolute most diversification, there are ETFs such as VTI, SCHB, and ITOT.
ETFs are a great starting point for new investors! Explore funds like VTI or SCHB and begin diversifying your portfolio with as little as $50.
Individual Stocks
Most people think this is the best way to invest in the stock market. But, unfortunately, I am here to tell you this is not where it is! This is not a good first step into the stock market. As we discussed earlier, you shouldn’t base an investment decision solely on one company alone. This exposes you to tons of risks that could be company-specific, industry-specific, and sector-specific.
To diversify this risk, you must purchase many stocks in many different sectors, which costs you major moola. However, you can eliminate many potential dangers by balancing them with other stocks in the market. You would also benefit from more cost-efficient diversification in an ETF or Mutual Fund.
Stock Options
An option gives you the right to buy or sell a certain number of shares at a specified time. You can make money by trading options instead of buying the shares.
These can be complex investments, especially since it is a bet on the underlying asset’s direction (which, in this case, is a stock). However, individual investors who can make consistent profits from them are not the norm.
Options trading is an active approach to investing and requires strategy and discipline! This is not an easy way to invest in stocks! Based on the long-term probability of success with this strategy, I do not advocate this being the intro for a beginner.
In Summary
For those who don’t want to read all that (because I know you’re out there), stocks are an excellent tool for long-term wealth creation. Mutual Funds and ETFs are a great way to get into stocks and gain diversification quickly. Individual Stocks and Options can also be adequate for long-term wealth creation but will require much more research, effort, and luck to maintain consistent success. Remember, slow and steady wins the race when it comes to investing. But I guarantee you’ll see a payoff if you stick with it!
Start today! Open a brokerage account and begin your investing journey. Remember: It’s a marathon, not a sprint. Stick with it, and the results will come.
DISCLAIMER: The above references an opinion and is for informational purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice. Do your research; this content is designed to be used and must be used for informational purposes. It is essential to do your own analysis before making any investment based on your circumstances.
