Stock market investing may seem like rocket science, but it's simpler than you think.
This week’s question concerns investing:
I would like to invest in the stock market, but I don’t know how to do it. Is there like a crash course on investing in the stock market you could point me to? Thanks. — Louise
First lesson: Don’t ever put the words “stock market” and “crash” in the same sentence.
While I’m sure there are courses designed to get you up to speed as a stock investor, I’m going to tell you a lot of what you need to know in this short article. Investing in the stock market looks way more complicated than it actually is.
Let’s start with a video about things beginning investors often don’t know, but should.
Now, let’s add some simple, but important, rules.
Rule No. 1: Long-term money only
When it comes to stocks, the longer your investment horizon, the lower the risk. Day trading, holding stocks for very short amounts of time, is exceedingly risky because nobody knows what’s going to happen at any given hour or day. Investing over decades carries far less risk because quality companies become more valuable over time and so do their shares.
That’s why you should never invest in stocks with money you will need within five years, minimum.
Rule No. 2: Moderation
Because the stock market is risky, it’s not the basket for all your eggs. Here’s the formula I’ve suggested countless times over the years: Start by subtracting your age from 100, then put no more than the resulting percentage of your long-term savings into stocks. So if you’re 25, 100 minus 25 equals 75 percent in stocks. If you’re 75, you’d only use stocks for 25 percent of your savings. Important: That’s just a rule of thumb. If you’re nervous, you’ve invested too much.
Rule No. 3: Use mutual funds
I like buying individual stocks (you can see my online portfolio here) but it’s not necessary or, for most people, advisable. You can do perfectly well with a mutual fund, while at the same time lowering your risk and reducing your hassle.
What’s a mutual fund? A giant pool of investments. It could be a pool of stocks — a stock fund. It could be a pool of bonds — a bond fund. Or it could have both stocks and bonds — a balanced fund.
The appeal of mutual funds is threefold:
- A mutual fund allows you to spread the inherent risk of stock investing by diversifying among a bunch of stocks instead of investing in just a few.
- Mutual funds have professionals who do the buying and selling.
- Mutual funds keep track of a lot of the paperwork for you.
The stock mutual fund that I personally use in my retirement account is one of the lowest cost, and most popular, in the world: Vanguard S&P 500 Index fund. Here’s the way Vanguard describes it:
The fund invests in 500 of the largest U.S. companies, which span many different industries and account for about three-fourths of the U.S. stock market’s value.
Doesn’t that sound like it fits the bill nicely? Funds like this are a simple way to own a slice of the American economy. This fund started in 1976, and its average annual return is just more than 10 percent per year. Not bad. And the cost? Less than 0.2 percent per year, which is way less than most funds charge. The minimum investment is $3,000.
This isn’t a commercial for Vanguard funds, just some insight into how I happened to make the choice. But it’s not the only option. Growing in popularity, and equally good, is another type of mutual fund known as an exchange traded fund or ETF. As the name implies, they’re mutual funds that trade on exchanges like stocks.
How do you learn more? Do a web search for “best sites to research mutual funds.” You’ll get plenty of articles to read, like Best Mutual Funds from US News, and sites that screen funds, like Morningstar. Poke around. There’s tons of free information out there and tons here as well in our investing section.
Rule No. 4: No trying to time the market
Yes, we’d all love to buy at the bottom and sell at the top. But none of us are smart enough to do it consistently.
Try to time the market and you’ll likely find yourself on the sidelines when the market takes off and overinvested when it crashes. The best way to approach stock investing is also the simplest — dollar cost averaging, also known as systematic investing. All you have to do is invest fixed amounts, like $100, at regular intervals, such as monthly.
This method works for a simple reason: It automatically buys more shares when they’re cheap and fewer when they’re not.