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Learning how to invest is challenging for many people, especially because of the fear of losing money. However, it is important to learn the fundamentals of the stock market when you are young because you can take advantage of compound interest to build a strong investment portfolio and build wealth for yourself.
Before learning to understand the stock market, it is very important to understand who you are as an investor and what you are looking to gain in the stock market. These characteristics and your goals can have a big influence on your investing strategy. Below, we go over three broad investor categories.
If you are relatively young, you probably are in this category as many young investors are looking for growth. Growth investors primarily look for stock price appreciation, meaning strong companies that grow sales or earnings about 15% or more per year. If you’re looking into growth stocks, you should think about what the company is doing over the next 6 to 18 months and how popular it will be then. These are often smaller companies pursuing exciting new products and services, and to that extent, may be more risky than other stocks in the market.
If you love bargain prices and shopping for sales, you might qualify as a value investor. Value investors tend to look for stocks who have stumbled or whose shares are selling at a discount. In down markets, you may be able to find quite a handful of these that fit into this category. While they may be selling at a discount, it does not necessarily mean that the company as a whole is not doing well. Sometimes, the stocks are not doing well, but the company overall is thriving. This could be due to temporary problems within the company, so it is important to do your research on why a stock is selling for such a low price. It’s also necessary to think about anything that may help bring the stock price back up over the next 6-18 months.
Dividend investors typically care more about income, rather than long-term growth. One good definition of a “good” dividend is one that pays higher interest than on a 10-year treasury bond. If you’re in the stock market to make money, a good place to start is by researching companies that have historically increased their dividends every year. Dividend stocks are also worthwhile when the stock market is declining or very volatile, as dividends hold the value of a stock better.
So Which Strategy Should I Try?
These three investor types are a good way to think about how you want to approach the stock market and what you want to get out of it. However, remember that there is no investing strategy that works all the time. In fact, many people decide to include these three types of investments in their portfolios at the same value because your portfolio will be balanced and diversified, which hedges you against risk. After all, one of the first rules of investing is to not place all your eggs into one basket. Once you are more comfortable with the market, you can start shifting more of your investments into either growth, value, or dividend stocks to fit your goals.
Again, many young investors are looking for growth. If this is what you’re looking for, you should focus on ETFs or index funds, sector funds, and individual stocks or growth companies.
ETFs / Index Funds
An exchange-traded fund (ETF) is an investment fund traded on stock exchanges, much like stocks. An ETF holds assets such as stocks, bonds, or commodities. A couple of examples are the Dow Jones Industrial Average and S&P 500. The Dow tracks the value of 30 large, publicly owned companies based in the United States and how they have traded in the stock market. The S&P 500 is based on the 500 largest companies in the world. One of the biggest advantages of ETFs is that you have automatic diversification because the fund includes a variety of stocks in many different industries. On top of that, trading ETFs costs very little.
Both ETFs and Index Funds have low expense ratios (meaning they have low fees), but the primary difference is that index funds can be either a mutual fund or an ETF.
People often use “index fund” and “ETF” interchangeably. That’s due to the fact that most ETFs track an index, and when people refer to ETFs, they’re generally referring to index-tracking ETFs. When people talk about index funds, they could be referring to either an ETF or a mutual fund that tracks an index.
Learn more about index funds here.
Sector funds trade stocks in a specific industry. They also trade just like a stock and provide automatic diversification as it holds a variety of stocks within the one industry. If you have a strong portfolio and are looking to diversify a little more, a targeted sector fund it could be a good way to go. It’s particularly advantageous because you can invest in a specific industry that you expect to outperform, without having to research individual companies within the industry. One important note is that you should still research the industry before investing. You can make a large profit if you predict industry trends correctly, but if you’re wrong and the sector goes down, you’ll be losing money. So before investing, research well and be aware that sectors are generally more volatile than broadly based stock funds.
Investing in individual stocks is riskier than ETFs or sector funds because they do not offer any diversification to your portfolio. But, because it is riskier, you could generate much higher returns by investing in individual stocks. If you’re still determined to try this, it is recommended that you try a stock screener. It’s a great way to see which stocks are performing well and which companies are very robust and expected to grow. Doing solid research is important, it is never a good idea to invest without knowing about the company’s future plans. Many investors are not able to make a profit through individual stocks, so only pursue this if you are willing to do your homework.
One tip is to calculate the PEG ratio, or the Price/ Earnings-to-Growth ratio. You can take the stock’s P/E, or price-to-earnings ratio, which you can lookup easily, and divide it by the growth rate of the company’s earnings for a specific time period. It’s recommended that the PEG ratio is below one, which means that the stock is in a good buying range because it is undervalued. It means that the company’s current market value is currently below the company’s projected earnings growth. While the PEG ratio isn’t right in all situations, it can help you get a better picture of a company’s growth.
When you’re in the stock market, it is very easy for emotions to get in the way. Even though it can be very difficult, these disciplines can help you manage your emotions better and should increase the chances of you succeeding in the stock market.
This means allocating a fixed dollar amount for a fixed time period to invest in shares of a stock, regardless of what the price of the stock is at the time. Many people start to panic when their stock goes down in value and end up pulling out of the market, which can lose you a lot of money. Luckily, dollar-cost averaging is an effective strategy when you are faced in a declining market, and can help you manage your emotions better. Mathematically, you will be buying more shares of stock at a lower price. Think of it as buying your stocks on sale. This strategy is essential for successful long-term investment and works great for ETFs, sector funds, and individual stocks.
Read more about Dollar Cost Averaging here.
Putting all of your eggs in one basket is a huge mistake because you never know when the market will go down. Diversification will substantially lower your risk of losing money. Make sure to spread your investments over different industries or sectors, different sized companies, and different risks and growth rates. In general, it takes 5 stocks across different industries to diversify. No more than 20% of your portfolio should be in any one stock. ETFs like the Dow and the S&P 500 are just a couple of funds that you can invest in that will automatically provide you diversification because it consists of many companies.
Do Your Homework
You are investing with your own money, which you can easily lose. Do your research on stocks in your portfolio, and stocks that you are looking to invest in. Don’t blindly take someone’s opinion as your own, after all it’s your money that you are investing with! A basic rule is to spend one hour each week catching up on with news and information on each fund or stock in your portfolio. It is also recommended that you keep up with economic and financial trends so that you are well-informed of the general market as well.
Disclaimer: The information provided is for informational purposes only, to assist you in managing your own finances and decision-making. Snowball Wealth is not a financial advisor, investment advisor, financial planner, fiduciary, broker, bank or tax advisor. Accordingly, before making any final decisions or implementing any financial strategy, you should consider obtaining additional information and advice from your accountant or other financial advisors who are fully aware of your individual circumstances