As any financial advisor will tell you, owning stocks is one of the surest ways to build your personal wealth in the long run. Investing in the stock market can help you reach major personal finance goals like buying a home, starting a business or securing your retirement.
What’s more, buying stocks is cheaper and easier than ever. With the proliferation of trading apps, you can purchase shares with just a few clicks. And innovations like fractional shares and zero-commission stock trades mean you can invest as much or as little as you want, often for free.
But investing in the stock market can be risky too. While history has shown the stock market almost always goes up in the long run, prices are notoriously volatile. And studies have shown unprepared investors tend to make rash decisions, often selling at the wrong time.
The upshot: In the long run, buying stocks is one of the smartest financial moves you can make. To prepare, read on for our five-step beginner’s guide to investing in stocks.
Step 1. Set your time frame
When you’re ready to invest in stocks, it’s natural to start by looking at how the stock market has performed recently. But investing pros say this gets the process backward. In the short-term, the market’s ups and downs are unpredictable. So instead, you should focus on yourself: What are you saving for? And how long is your time frame?
Your timeline is key. It’s almost impossible to say whether the stock market will go up from one year to the next. But if you can commit to investing for at least five years, your chances of making money are very good.
And if you have 20 years to wait, you are all but guaranteed to come out a winner—the stock market has never posted a negative return in any 20-year period, according to one recent study that looked at stock market returns going back to the 1870s.
If you need the money soon: Skip the stock market
The upshot is, if you are investing for the short-term, say to build an emergency fund or pay for a vacation, the stock market might not be the right place for you. While the stock market has returned about 8% on average a year in the last century and half, in about 1 out of 7 years it has lost 10% or more. “We just don’t even let people put money in stocks if their timeline is less than three to four years,” says David Bahnsen, chief investment officer of the investment company the Bahnsen Group.
Instead, you should consider putting money into investments that may not have as much upside but protect you from losses like CDs or high-yield savings accounts.
If you’re saving for the long-term: Invest in stocks
On the other hand, if you have a long-term financial goal—especially retirement, but any goal a decade or more out—you can afford to invest in the stock market. While you will almost certainly encounter a bear market during the time you invest, you will also have time to ride it out. The average return for the stock market over 20-year periods is about 7% a year, and the worst it’s ever returned is about 0.5% a year.
Of course, even with a long-term time frame, most investors don’t put all their money in stocks. They round out their portfolio with bonds, which can help smooth returns over time, since bonds tend to be less volatile than stocks and often see their prices appreciate when stock prices fall. Owning bonds alongside stocks is especially important as the date of your long-term goal draws near, and you cease to be a long-term investor and become more of a short-term one.
There’s more on ways to get help finding the right mix of stocks and bonds below.
Step 2. Decide how much risk to take
Just because you have time to invest in stocks doesn’t mean you have the stomach. Pullbacks can be sharp—and swift. In fact, the stock market has seen a temporary decline of 10% or more in 10 out the last 20 years, according to stock trading firm Schwab. One time, the notorious “Black Monday” of 1987, stocks fell 23% in just one day.
Needless to say, even if you have the time and understand intellectually that stocks will eventually snap back, you still need to think carefully about how much risk you are really willing to take on.
Historically, bear markets—typically defined as a drop of 20% from a recent market high—last about nine-and-a-half months, and stock prices fall by an average of 36%. While that’s a relatively short time frame, studies have shown that many investors often tend to lose their nerve and sell. Mistakes can be costly, since selling at the bottom of a bear market typically means you will lock in your losses and miss out on the next run-up.
Each year, fund researcher Morningstar tracks the difference between what investors could have made if they ignored the stock market’s ups and downs and invested consistently, and what they actually did. They found that over the past decade, investors have missed out on about 15% of their potential stock market profits by making ill-timed trades.
The upshot is that most investors will want to own some bonds alongside the stocks they hold to help absorb market shocks. The table below shows how adding bonds to a stock portfolio affects performance.
|Stock and Bond Mix||Avg. Return||Best Year||Worst Year||Years with a loss|
Step 3. Decide your investing style
Getting into the stock market looks different for different people. While some people view “buying stocks” as just that—purchasing one or more shares in a company—choosing what and how to buy is an important step in the process. Picking individual stocks could give you big gains—or big losses. Putting your money in funds is a safer bet, but you have to watch out for fees.
Read more about your options below before you dive in.
Many new investors buy stocks by setting up a brokerage account, which, once the account is funded, will allow you to buy and sell shares of publicly traded companies, such as Apple Inc., Coca-Cola Co. and thousands of smaller concerns.
How to research individual stocks
A lot of investors find stock picking rewarding, but doing it right is a lot of work. People tend to buy stocks of companies whose brand names they recognize or whose values they want to support, but these attributes tell you nothing about how well a business is actually performing.
Take a deeper dive into each company’s quarterly earnings reports, listen to their investor conference calls and explore the other disclosures they’re required to file with the SEC. If this sounds complex, it is. Remember: There are plenty of investment funds with teams of professionals who spend all day doing this.
How to diversify your portfolio of individual stocks
Individual stocks also tend to be risky, unless you own enough of them to essentially hedge your bets, a strategy known as diversification. “The more you diversify, the more you get the risk out of the portfolio,” says Falko Hoernicke, senior portfolio manager at U.S. Bank Private Wealth Management.
It takes 30 to 50 individual holdings to have a well-diversified portfolio, Hoernicke says, because it’s important to get exposure to different industries—such as technology, healthcare or retail—as well as different companies. If you invest in several companies but stick to just one or two sectors, your risk will remain concentrated.
How to invest in fractional shares
If you plan to build a diversified stock portfolio, owning a full share of every company on your investment list might be difficult. While most companies’ shares are under $100, some run into the thousands of dollars. Class A shares of Warren Buffett’s Berkshire Hathaway famously cost more than $400,000 apiece.
With fractional shares, you don’t have to commit to buying a whole share. Instead, you choose either what percentage of a stock share you want to buy or how much money you want to put into that particular stock.
Fractional shares can also make it easier to buy individual stocks with just a small slice of your savings, making it possible to try stock trading as a hobby, without risking your retirement, a strategy many financial planners endorse. “Do that with money you don’t depend on,” Hoernicke says. “Don’t do that with your retirement money.”
For most investors, especially those who don’t have the time or inclination to research individual stocks, mutual funds are the cheapest and easiest way to invest in the market.
You may be familiar with mutual funds already if you have a 401(k)—these are the investment vehicles that dominate most retirement plan investment menus. Mutual funds are essentially buckets of stocks (or another asset like bonds) overseen by a professional money manager and focusing on a particular investment goal or strategy, like picking the next wave of tech winners, generating dividends or simply matching the performance of a market benchmark like the S&P 500.
How to research mutual funds
You can buy mutual funds through a brokerage account or directly from mutual-fund companies themselves. You can start your research by looking at funds’ one- or two-page fact sheets, and get more in-depth information from a fund’s prospectus. Both should be available on the fund company’s website. Alternatively, research firms like Morningstar publish independent, in-depth research and rankings on thousands of funds.
Just remember: Focus on a fund’s investment fees, known as the “expense ratio.” Funds with low investment fees have been shown to regularly outperform more expensive funds in the long run, since fees put a drag on your fund’s investment returns.
How to invest in index funds
Traditionally, mutual funds employed a portfolio manager who aimed to pick just the best-performing stocks, hopefully delivering higher returns than the market as a whole. About a generation ago, a new kind of fund began to gain popularity.
Index funds don’t try to beat the market, but merely try to match its performance—essentially by owning small amounts of every stock available. This strategy of delivering “average” returns, may seem boring, but has a huge advantage: It allows portfolio managers to keep the fund’s operating costs as low as possible, a boon to performance.
In fact, while it may seem counterintuitive, research shows in the long run low-cost index funds tend to outperform most actively managed funds. Although there are plenty of skilled active managers, most stocks are fairly priced, making it hard to reliably find bargains that others have missed. At the same time, researching stocks is expensive, and since a fund’s investment fees are counted against its investment returns, most of these funds struggle to match, much less beat, the average market performance that stock indexes represent.
Exchange-traded funds are a type of mutual fund that trades on a stock exchange like stock.
For many investors, that makes them more convenient than traditional mutual funds because you can own ETFs in your brokerage account alongside individual stocks, and you can buy and sell them throughout the day. (Traditional mutual fund shares can be traded just once a day.)
Most ETFs are index funds, meaning they merely aim to match the returns of a stock market index, although some target very narrow slices of the market, such as just tech stocks or just energy stocks. Check out Buy Side from WSJ’s picks for Best Dividend ETFs, Best Vanguard ETFs and more.
If you’ve just started on your investing journey and you don’t have a clear sense of your goals and timeline, a robo advisor might be able to help you get started. Robo advisors are algorithm-based investing tools that use automation—and the responses you provide in an online questionnaire—to come up with a mix of investments, typically made up of stock and bond ETFs to meet your individual needs.
They cater to newer investors who might not have the money to hire a professional, or who don’t have the time or the investment knowledge to self-manage a portfolio.
“Robo advisors are very good entry level tools for investment planning,” Hoernicke says, but he adds that the advice is only as good as the quality of the data the program collects. “It should be more than two questions,” he says. “It should be a good set of complex questions to get a good idea of what you’re planning for.”
Buy Side for WSJ’s pick for Best Overall Robo Advisor is Betterment and you can find our full roster of picks here.
Once you reach a point in your life when you have significant wealth and financial obligations to match—such as figuring out how to budget for a child’s college or your own retirement—you may want to seek advice from a professional.
The roughly 200,000 financial advisors in the nation come in many different stripes. While wealth managers tend to cater to affluent investors who have accrued at least seven-figure portfolios, you don’t need to be a millionaire to get personalized financial advice.
One thing to remember: Some professionals who provide advice and sell financial products also receive commissions from those activities, which can create a conflict of interest. Seek out an advisor who is a fiduciary, which means they are legally obligated to work in a client’s best financial interest and not their own, as well as one who is fee-only, meaning that they don’t earn sales commissions on the products they sell. You can find Buy Side from WSJ’s complete guide to finding a financial advisor here.
Step 4. Plan for taxes
Investing in the stock market is a great way to build wealth. But it’s not tax-free.
When you sell a stock for a profit, you can expect to owe capital-gains taxes. If you held the stock for more than one year, the rate is 15% for most middle class investors. If you held the stock for less than one year, you can expect the gain to be taxed just like your other income.
If you receive dividends, you may also end up with a regular tax bill each year you own the stock. Many but not all dividends are taxed like capital gains.
The good news is, there are a number of ways to defer or even avoid some of these taxes, especially if you are planning for retirement. The upshot is you need to think carefully about whether you want to invest through a retirement account like a 401(k) or IRA, or if you want more ready access to your money.
Here are some pros and cons of common tax-advantaged and standard investment accounts:
If you’re new to investing and work for an employer that offers a 401(k) or similar defined-contribution retirement account with an employer match, experts generally agree this is where you should start your journey into the stock market. Investing in a 401(k) is a good way to establish the habit of setting money aside for retirement, and a company match can be a great way to make your contributions go further.
Traditional 401(k)s are tax-deferred: Your contributions come from pretax dollars, and the money invested—whether it is in stocks, bonds, funds or a combination of asset classes—grows tax-deferred until you take distributions in retirement, at which point the money withdrawn is taxed as income.
The IRS limits how much tax-deferred cash you can sock away in a 401(k). In 2023, that limit will be $22,500, up from $20,500 in 2022. (Once you hit the age of 50, the IRS ups those limits to allow people to catch up with additional contributions.)
Individual retirement accounts are another avenue for investing, and plenty of people have IRAs as well as 401(k)s. Since you’re not limited by the administrator chosen by your company and the investments they offer, you might find a broader or more diverse set of options in an IRA.
The IRS also issues regulations around IRA contributions: Next year, you’ll be able to contribute $6,500, up from $6,000 this year (again, older investors get a higher limit for catch-up contributions). Since 401(k)s are tied to your employer, you can also move money from old 401(k)s into an IRA in a process known as a rollover.
Roth IRAs are funded with after-tax dollars, but they also deliver some notable tax benefits. Posttax contributions that you invest grow tax-free, and withdrawals you take in retirement are also not taxed.
But it can be hard to figure out what your tax rate will be in retirement, points out Phil Drudy, tax practice leader for professional services company CBIZ MHM. “You’re making a decision today on something that you’re now going to potentially get the benefit from in 10 or 20 years. You have to have that crystal ball.”
Roth IRAs are subject to the same IRS limits as their traditional counterparts (and if you have more than one IRA, that limit is for all of them combined). Roth IRA contributions limits are also limited by income, phasing out for high—income earners.
Taxable brokerage account
Of course, there is a good chance you will run up against some of your 401(k)’s or IRA’s limits—especially if you are saving for a goal other than retirement. In that case, you will simply invest in a regular brokerage account.
Come spring time, you can expect a slew of tax forms electronically or in the mail, such as the 1099-B, which details capital gains and loss, and the 1099-DIV, outlining your dividends.
Just make sure to plan ahead. A classic beginner mistake new investors make is failing to set aside money to cover the taxes they owe, says Drudy. “I think new investors tend to not think about the taxes,” he says. “Come April 15, they’ll say, ‘Why do I owe?’ ”
Step 5. Open your account
Once you’ve decided how and where to invest, you’re ready to take the plunge, and the next step is setting up and funding your account.
How to open a 401(k)
When it comes to a 401(k) or similar employer-provided plan, there is a good chance you won’t have to do anything. About half of employers automatically enroll workers in 401(k)s, typically putting them in a mutual fund that includes an age-appropriate mix of stocks and bonds, known as target-date funds.
Still, if you are enrolled, you should check the share of your paycheck that is being routed to your retirement plan each month. Many employers set the automatic contribution level at just 3%, while financial planners typically recommend something closer to 10%, in order to build a healthy retirement nest egg.
If you are not automatically enrolled in your company’s 401(k), you should contact human resources to get started. If your employer does not offer a 401(k), read on below about how to open a brokerage account so you can start an IRA or Roth IRA.
How to open a taxable brokerage account
If you plan to trade stocks, you will need to open a stock trading account. This will allow you to buy and sell shares of stocks and ETFs on the market, and should give you access to a wide range of mutual funds.
Many big brokerage firms now offer free stock and ETF trades, as well as access to fractional shares. But there are many other factors to consider, from other types of fees to user-friendliness. Buy Side from WSJ’s pick for Best Overall Stock trading platform is Fidelity. You can see our full list of winners here.
How to open a rob-advisor account
To open a robo advisor account, download the robo advisor’s app or go directly to its website. Because robo advisors are relatively new and operate online only, they tend to have smooth, easy to use interfaces compared with big-name, decades-old brokerages.
What documents do you need to start trading stocks?
Whether you open an account in person or online, you’ll need to provide your name and Social Security number.You might be asked to provide information about your citizenship, employment situation, and you might also have to answer some questions about your investment goals and risk tolerance if you’ve indicated that you might be interested in a robo advisor.
How old do you have to be to buy stocks?
In general, 18 is the youngest age you can be if you want to start investing in stocks, but there are a few exceptions: A number of big brokerage companies promote investing in stocks for beginners through custodial accounts.
A parent or guardian can open a custodial account on behalf of a minor so they can learn the ropes of trading stocks under supervision. When the teen reaches an age of between 18 and 25 (depending on the institution and the state), he or she takes control of the account. With a custodial account, you can hold or trade most common investible assets the financial institution offers, although speculative activities like trading on margin are liable to be prohibited.
One caveat: Since custodial accounts are in the minor’s name, this can reduce the amount of college financial aid for which they might otherwise be eligible.
The advice, recommendations or rankings expressed in this article are those of the Buy Side from WSJ editorial team, and have not been reviewed or endorsed by our commercial partners.