Money & Career
Getting Started in the Stock Market: Advice for New Investors
1/1/2020 1:00:00 PM
Getting Started

Many people look for a quick, easy way to riches and happiness. It may be human nature to search for a hidden key or some secret bit of knowledge that suddenly leads to the end of the rainbow or a winning lottery ticket.

While some people do buy winning tickets or a common stock that quadruples in a year, it’s unlikely. In our quest for success, we often overlook the most powerful tools available to us: time and the magic of compounding interest. Investing regularly, avoiding unnecessary financial risk, and letting your money work for you over a period of years and decades is a certain way to grow significant assets. Here’s how:

Handle Basics First

Before making your first investment, take time to learn the basics about the stock market and the individual securities composing the market. Research the internet or read books to familiarize yourself with terms and definitions, stock selection methods, and the various types of investment accounts prior to your first purchase.

Set Long-Term Goals

Before investing, know your purpose and the likely time in the future you may need the funds. If you are likely to need your investment returned within a few years, consider another investment. With its volatility, the stock market provides no certainty that all your capital will be available when you need it. By knowing how much capital you will need and the future point in time when you will need it, you can calculate how much you should invest and what kind of return on your investment will be needed to achieve your goals. The growth of your portfolio depends upon three interdependent factors: the capital you invest, the amount of net annual earnings on your capital, and the time length of your investment. To estimate how much capital you are likely to need for retirement or future college expenses, consult a financial adviser or use one of several free financial calculators available online. Start saving as soon as possible, save as much as you can, and receive the highest return possible consistent with your risk philosophy.

Understand Your Risk Tolerance

Risk tolerance is generally influenced positively by education, income, and wealth (as these increase, risk tolerance appears to increase slightly) and negatively by age (as one gets older, risk tolerance decreases). Your risk tolerance is how you feel about risk and the degree of anxiety you feel when risk is present. In psychological terms, risk tolerance is defined as "the extent to which a person chooses to risk experiencing a less favorable outcome in the pursuit of a more favorable outcome.” All humans vary in their risk tolerance, and there is no "right” balance.

Risk tolerance is also affected by one’s perception of the risk. The idea of perception is important in investing. As you gain more knowledge about investments – for example, how stocks are bought and sold, how much volatility (price change) is usually present, and the difficulty or ease of liquidating an investment – you are likely to consider stock investments to have less risk than you thought before making your first purchase. 

By understanding your risk tolerance, you can avoid those investments which are likely to make you anxious. Generally, you should never own an asset which keeps you from sleeping at night. During periods of financial uncertainty, the investor who can remain calm and follow an analytical decision process invariably comes out ahead.

Control Your Emotions

The biggest obstacle to stock market profits is an inability to control one’s emotions and make logical decisions. In the short-term, the prices of companies reflect the combined emotions of the entire investment community. When most investors worry about a company, its stock price is likely to decline; when a majority feel positive about the company’s future, its stock price tends to rise.

A person who feels negative about the market is called a "bear,” while their positive counterpart is called a "bull.” The constant battle between the bulls and the bears is reflected in the ever-changing price of securities. These short-term movements are driven by rumors, speculations, and hopes rather than logic and a systematic analysis of the company’s assets, management, and prospects.

Stock prices moving contrary to our expectations create tension and insecurity. Should I sell my position and avoid a loss, keep the stock and hope the price will rebound, or buy more? Questions remain even when a stock price has performed as expected: Should I take a profit now before the price falls or keep my position because the price may go higher? These thoughts will flood your mind, especially if you constantly watch the price of a security, eventually building to a point that you will take action. Because emotions are the primary driver of your action, it could potentially be wrong.

Have a good reason for buying a stock and an expectation of what the price will do if the reason is valid. Then establish the point at which you will liquidate your holdings, especially if your reason is proven invalid or if the stock doesn’t react as expected. Have an exit strategy before you buy the security and execute that strategy unemotionally.

Diversify Your Investments

The established way to manage risk is to diversify your exposure. Prudent investors own stocks of different companies in different industries, sometimes in different countries, with the expectation that a single bad event will not affect all their holdings. Financial advisors or robo-advisors can help ensure your investment portfolio stays diversified and balanced over time. 

Investing in the stock market is a great opportunity to build large asset value for those who are willing to be consistent savers, make the necessary time and energy investment to gain experience, appropriately manage their risk, and practice patience, allowing the magic of compounding to work for them. The younger you begin your investing avocation, the greater the final results.

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