Many Americans' first investing vehicle is an employer-sponsored 401(k), with 65 per cent of U.S. workers offered one or a similar plan. However, you may desire or need to invest outside of that plan to develop wealth.
Here are five investment methods for novices to get started in the stock market:
1. Create an IRA (Individual Retirement Account):
Following an employer-sponsored retirement plan, any stock market strategy should invest in other tax-advantaged funds, such as a standard or Roth individual retirement account.
You can start an IRA using an online broker - many brokerages don't have a minimum account balance, and you won't be investing any money until you're ready. Brokerages are now very comparable to banks. The main distinction is that when you're prepared to invest, you'll have access to the stock market through brokers.
You can contribute up to $6,000 per year to an IRA ($7,000 if you are 50 or older), either to one account or to both types of IRAs. Each has various tax benefits, so choose which IRA is best for you.
Suppose you exhaust your IRA contributions for the year. In that case, you can always continue investing in a taxable brokerage account, which can likewise be formed via an online broker but does not provide the tax benefits of an IRA.
2. Only invest money that you won't need in five years:
One significant disadvantage of regular and Roth IRAs is that if you withdraw funds before 59 ½, you may face penalties and tax consequences. Roth IRAs are more lenient when it comes to early withdrawals – you can withdraw contributions at any time, but you may be penalized or taxed if you withdraw investment returns too soon.
However, such restriction may be acceptable because there is an essential rule of thumb to remember with any stock market strategy: Don't invest money you will need in the next five years.
When it comes to investing, patience pays off - you need to allow your assets time to weather the market's ups and downs.
"A key rule of thumb to remember with any stock market trading strategy: Don't invest money you won't need in five years."
If 59 ½ feels too far away, a taxable brokerage account will not penalize early withdrawals. Still, it will not provide an IRA or employer-sponsored account (most brokers offer both taxable and tax-advantaged accounts).
If you've already maxed out your 401(k) and IRA and have funds languishing in your bank account, opening a taxable brokerage account may be the next step. On the other hand, the following tactics can be used for retirement and brokerage accounts.
3. Look into index funds that are handled passively.
Ideally, you want to build a well-balanced portfolio while reducing costs to a minimum. Most investors use mutual funds, index funds, and exchange-traded funds. These funds mix several equities rather than betting on a single stock, balancing the inevitable losers and winnings.
These funds are also based on passive management methodologies. Passive investing strives solely to match broad market gains, as opposed to active investing, which seeks to outperform the market by purchasing and selling stocks regularly.
While having a professional pick and choose stocks for you may sound enticing, 80 per cent of large-cap funds underperformed the S& P 500 in the five years running up to Dec. 31, 2019. In other words, if you had invested in a low-cost index fund that closely tracks the S& P 500, you would have likely seen better returns than the average mutual fund.
Passive investing also results in lower costs, diminishing long-term investment growth. In 2019, the average asset-weighted expense ratio for passively managed funds was 0.13 per cent, compared to 0.66 per cent for actively managed funds.
This cost disparity has given rise to many robo-advisors that automate portfolio management, allowing these firms to charge significantly cheaper costs than actively managed accounts.
4. Keep current stock trades to no more than 10% of a portfolio's total value:
Suppose you wish to acquire stocks and attempt to limit them to 10% of your whole investing portfolio. Again, actively managed stock market strategies that consistently strive to outperform the market underperform passive methods.Suppose you put all of your money into one or a few companies. In that case, you're betting on a speedy success that could be derailed by a single regulatory issue, new competitor, or public relations disaster.
Suppose you still want to trade actively with a percentage of your portfolio. In that case, several stockbrokers provide instructional tools and simulators that allow you to practice trading before you dive in. (Would you want some pointers? Check out our ranking of the year's best-performing stocks.)
5. Make use of dollar-cost averaging:
Active investors compete to buy low and sell high, but this is easier said than done. According to experts, a preferable technique is making new investments at regular intervals; a practice is known as dollar-cost averaging.
It is more important to give a diverse portfolio of investments the time it requires to grow than to time the market. Unlike the frantic impression you may have of stock market trading, slow and steady usually wins the race when investing.