All throughout history, one of the best ways to make money has been through ownership of a company. But let’s be real – how many of us will ever really have the opportunity or resources to start one?
The good news is that you don’t have to. To become an owner in a company, all you have to do is invest in stocks.
Stocks are simply fractional shares of ownership in a company. And when they make money, you make money!
Here’s what you need to know about how to invest in stocks.
Why Should You Invest In Stocks?
Out of all the financial products available, stocks are the ones that have historically demonstrated the best potential for long-term growth. Meaning, you can definitely make money in stocks.
There have been many examples of stocks that have exploded in value over a relatively short period of time. For example, when shares of Amazon were first issued back in 1997, they sold at an adjusted price of $1.73 per share. As of 2020, Amazon is currently trading at $2,318 per share. That means if you had invested just $1,000 back in 1997, your shares would be worth $1,339,769 today!
Amazon’s story isn’t entirely unique. Over the past few decades, there have been several well-known companies have grown from obscurity: Apple, Google, Netflix, Facebook, and many others.
Risk
While it can be exciting to look at success stories like Amazon, it’s also important to remember that many companies have not been nearly as lucky. When you invest in any stock, you need to understand that you are inherently taking a risk with your money.
How To Find Good Stocks To Invest In
When you’re researching stocks, how do you spot the winners? There are thousands of opinions about what makes for a good stock prospect. But almost universally, what it really comes down to is understanding a few key metrics.
52 Week Price Range
As the name implies, this is the stock price range over the last year (52 weeks). It’s helpful to know this range so that you can gauge if the current price is towards the higher or lower end.
After all, as the old saying goes, you want to “buy low and sell high”. Therefore, stocks closer to the lower end of the range will make potentially better prospects.
Earnings Per Share (EPS)
EPS is the company’s profit (minus any dividend payments) divided by the total number of outstanding shares. This is a measure of the company’s profit.
Generally, a higher EPS is a good sign of a company that’s doing well financially.
Price To Earnings (P/E) Ratio
The P/E Ratio is the stock price divided by the earnings per share. This tells you how much you’re paying for a part of that company’s earnings.
The lower the P/E Ratio, the more attractive the stock is because it implies that you’re paying less for each slice of earnings.
Price-To-Book (P/B) Ratio
The P/B ratio takes the company’s stock price and divides it by its net assets. This is an interesting metric because in terms of value it can reveal how much of the company’s assets you can buy with each share purchased.
Dividend Yield
The dividend yield is the number of dividends the company pays out for the year divided by the price per share. It’s not unusual to make some passive income through dividends. Usually, a high dividend yield is a good thing because it implies that the company has strong financial health and is paying its shareholders generously.
However, beware. Some companies will temporarily increase their dividend payout to make their dividend yield seem high to prospective buyers.
Beta
Stock prices fluctuate all of the time. But how do you know when one is more erratic than another?
Beta is a measurement that compares the fluctuation of a stock price against a market benchmark, such as the S&P 500. A beta of more than 1 indicates that the stock fluctuates more than the index, whereas a beta of less than 1 means the stock is comparatively more stable.
Where To Invest In Stocks
There are a lot of options when it comes to purchasing stocks. Here are some of the most popular ones:
Full-Service Or Discount Broker
Since the beginning of the stock market, brokers have been the ones to facilitate the buying and selling of stocks. Today, most modern brokers conduct nearly all of their business electronically while providing a wealth of stock metrics and guidance to their customers.
Most brokers can be broken up into two main categories:
- Full-service brokers such as Vanguard and Fidelity
- Discount brokers such as E-Trade or TD Ameritrade
Classically, you pay a broker a commission or “fee” every time you trade a stock. However, many of them have now offer commission-free trades.
Robo-Advisors
If you’re feeling anxious about trying to pick your own stocks to invest in, don’t. You can let someone else do it for you!
Robo-advisors have become a favorite among novice investors because of their simplicity and ease of use. Some of the top choices are services like Betterment, Wealthfront, and M1 Finance.
Retirement Funds
If you’d like to invest in stocks and not have to pay any taxes on the capital gains and dividends for years to come, then why not use your retirement plans and invest in retirement at the same time?
For example, you could set up an IRA (individual retirement account) with any financial service provider of your choice (such as a broker or robo-advisor) and buy individual stocks as part of your retirement nest egg.
When it comes to your 401(k), depending on the financial provider your plan is through, you may also be able to purchase individual stocks through your plan.
Note that when saving for retirement, to get these tax benefits, you have to wait until age 59-1/2 before you can start making any withdrawals. Otherwise, you’ll have to pay income taxes and a 10 percent penalty.
Other Ways To Invest In Stocks
For almost a century, investors have been developing creative ways to invest in stocks without having to buy them individually. Today, there are many types of financial products that can help you accomplish this:
Mutual Funds
Mutual funds are pooled collections of assets such as combinations of stocks and bonds. Through simply purchasing shares of mutual funds, you can invest in several hundred companies all at once.
ETFs (Exchange-Traded Funds)
ETFs are financial products which are similar to mutual funds (pooled collections of assets such as stocks and bonds). However, they are traded on the open market so they are free to fluctuate in value (similar to stock prices).
Index Funds
If picking individual stocks seems too complex, then why not buy the whole market?
Today, most investors can do this by buying something called an “index fund”. An index fund is simply a financial asset (usually a mutual fund or ETF) that contains all of the same holdings as a major market benchmark, such as the S&P 500 stock index.
Investing in index funds has become a very popular way for everyone from beginners to professionals to capture the average return of the stock market by making one simple purchase. In fact, even world-famous stock picker Warren Buffett says that most people would be better off buying an index fund rather than trying to pick their own investments.
Currently, the long-term average return of the S&P 500 index is 10 percent.
