In this post, I’ll answer Moadd’s question, review four easy ways to invest in stocks with little money or experience, and tell you the best way to own them. I’ll make it simple, so you can invest confidently and wisely to build wealth for the future.
Free Resource: For a summary of the traditional and Roth retirement account rules, plus the best places to open one up, download the free Retirement Account Comparison Chart.
What Are Stocks?
I recommend that every investor own stocks; however, there’s a right way and a wrong way to buy them. Before I answer Moadd’s question, I’ll explain in plain English what a stock is and pros and cons about owning them that every investor should know.
Companies issue stock to raise money from investors. For instance, maybe Apple wants to fund groundbreaking research, open a new division in a foreign country, or hire a crew of talented designers. If you buy shares of Apple stock, you’re buying a small piece of the company, which is why stocks are also known as equities.
If a company does well, investors buy more of its stock, pushing the price up. Likewise, when a company has lower-than-expected earnings or gets bad press, its stock value can go down quickly as investors sell shares.
There are hundreds of thousands of companies that offer stocks on different marketplaces known as exchanges. The two largest exchanges are the New York Stock Exchange (NYSE) and the NASDAQ. As I’m writing, Apple (AAPL) stock can be purchased on the NASDAQ for $154.12 and Wells Fargo Bank (WFC) stock is on the NYSE at $55.15 per share.
Pros and Cons of Investing in Stocks
The main advantage of investing in stocks is that over time, stocks give you one of the best and most simple opportunities to make money. Although there’s no guarantee that every stock will increase in value, since 1926, the average stock has returned close to 10% a year.
Although there’s no guarantee that every stock will increase in value, since 1926, the average stock has returned close to 10% a year.
If you’re investing for the long-term, which is the only type of investing I recommend, stocks can turbocharge your portfolio and help you build wealth. No other type of common investment, such as bonds or money market funds, outperforms stocks over time.
The main disadvantage of investing in stocks is that prices can be volatile. The value of a stock can change from second to second as trading volume fluctuates. The release of a disappointing quarterly financial statement, news about a product recall, or changes in the global economy are just a few triggers that can cause investors to buy or sell stock shares, which influences price.
Price volatility is the reason stocks are one of the riskiest investments to own in the short term. However, you can greatly minimize risk by adopting a long-term, buy-and-hold strategy. Additionally, being diversified by owning many stocks, instead of just one or two, offsets risk. I’ll tell you easy ways to do that in a moment.
My advice for Moadd is to never pick individual stocks on your own—that’s way too risky. If they perform poorly you could lose your entire investment. So, leave stock picking to professional money managers who research company financials and industry forecasts for a living.
See also: Should You Pay Down Debt or Invest?
4 Ways to Invest in Stocks with Little Money or Experience
Here are four ways to create a diversified stock portfolio even if you don’t have much money or experience with the stock market.
- Buy a stock mutual fund.
- Buy a stock index fun.
- Buy a stock exchange fund.
- Buy a target date fund.
Let's dive deeper into each.
1. Buy a stock mutual fund.
Mutual funds are collections of assets managed by a professional. Shares of mutual funds are bought and sold by a fund family, such as Fidelity, Vanguard, or Charles Schwab. There are different types including stock mutual funds, bond mutual funds, and specialty mutual funds.
A stock mutual fund is an investment made up of hundreds or thousands of different stocks of different companies. It might focus exclusively on international, domestic, large, small, or growing companies. It may only own stocks in certain industries such as utilities, real estate, gold mining, or technology companies.
Having many individual stocks within a single investment gives you instant diversification and minimizes risk over time. Yes, some stocks owned within a fund may go down, but they can be offset by others that go up.
Look for terms like large cap, mid cap, and small cap in the names of stock funds. Cap is short for market capitalization, which is the value of a company’s stock shares. So, a large cap mutual fund means that it only owns shares of big companies, like Apple, Target, or General Electric.
An important tip for buying mutual funds is to look for the lowest fees possible.
All mutual funds charge fees, known as the expense ratio, to pay for costs, such as management, administration, and advertising. An important tip for buying mutual funds is to look for the lowest fees possible.
For instance, an expense ratio of 3% means that each year 3% of a fund’s total assets will be used to pay expenses. The fee comes off your potential annual return and cuts into your earnings. So, if you choose a similar fund that charges just 1% or less, you’ll reap higher returns over time.
See also: Are You Making Investing Too Complicated?
2. Buy a stock index fund.
Index funds are a type of stock mutual fund that attempts to match or outperform a market index, such as the Standard & Poor’s 500 (S&P 500). They own large, diversified portfolios of individual stocks, which generally go up in value over time.
Index funds are managed passively, which means they don’t try to make quick gains by buying and selling underlying investments frequently. Owning index funds gives you an easy way to get broad market exposure. And since they don’t have teams of research analysts or high operating expenses, they charge relatively low fees.
See also: Investment Tips--How and Where to Invest (the Easy Way)
3. Buy a stock exchange-traded fund (ETF).
On the surface, an ETF looks like a mutual fund because both are collections of underlying assets—such as stocks, bonds, real estate, commodities, currencies, or other investments—giving you affordable and convenient diversification.
But unlike a mutual fund, an ETF trades on an exchange (just like a stock), where you can track its price and buy or sell it at any time the market is open. With an ETF, you know the exact companies or assets you own because that information is available daily. With mutual funds, many only reveal their portfolio holdings a few times a year. So, ETFs never leave you guessing about where your money is exactly.
Like index mutual funds, the objective for many ETFs is to match an index, like the S&P 500, using a passive investing. As I mentioned, this is different from actively managed funds that aim to beat the market with various investing strategies and must pay management for ongoing research and transaction costs.
To get the job done, ETFs typically don’t buy and sell investments frequently or have as much overhead compared to large mutual fund families. The savings get passed along to investors.
So, when compared to average mutual funds, many ETFs charge lower fees. Additionally, many investment analysts have found that passive funds, such as ETFs and index funds, pay out higher returns over time than actively managed funds.
See also: Investing Tips for College Students and Baby Boomers (Plus Everyone in Between)
4. Buy a target date fund.
Target date funds, also known as lifecycle funds, are one of the newest and most innovative funds available.
Target date funds, also known as lifecycle funds, are one of the newest and most innovative funds available. You’ll see them offered by both mutual fund and exchange-traded fund families.
Target date funds own different types of investments (such as stocks, bonds, real estate, and cash) and the fund manager gradually shifts the allocation according to a selected time frame, such as your estimated retirement date.
You’ll know a target date fund because it typically includes a year in the name, such as Retirement 2030 Fund or Retirement 2055 Fund. The date should correspond to when you believe you’ll want to retire. For instance, if you’re 35 years old and want to retire 30 years from now, in 2047, choose the fund with the closest target date.
What’s so clever about these funds is that they have a “glide path” that slowly owns fewer stocks and more bonds the closer you get to the target date. Since stocks are the riskiest type of investment, it’s wise to own a smaller proportion of them and become more financially conservative as you approach retirement.
Because these target date funds already include a mix of asset classes (stocks, bonds, and cash), you only need to own one of them. The right amount of stocks is baked into the investment, making it an easy, one-size-fits all solution.
See also: How to Invest Money in Your IRA or 401k Retirement Account
How Much Should You Invest?
Let’s get back to Moadd’s question. He said, “I’ve done research about different types of stocks like REITS, Roth IRAs, and mutual funds—but still feel like a rookie. If I invest $10,000, how long will it take to see a profit and how much could I make?”
I want to be clear that none of the investments Moadd mentioned is a stock. He may be using the terms “stock” and “investment” interchangeably, but that’s not correct. There are many other types of investments, such as bonds, real estate, currencies, and precious metals.
REIT stands for real estate investment trust, which is a company that owns real estate. A Roth IRA is a type of retirement account, in which you can own just about any type of investment. And, as I mentioned, mutual funds are a collection of assets, which could include stocks, if you choose one of the four options I reviewed.
Because it’s so risky, I don’t advise investing money for short-term gains. So, asking how long it will take to see a profit isn’t the right question. A better question is, “How much should I invest each year to achieve my long-term goals, such as retirement?” Exactly how much your account will grow depends on many factors including how much you invest over time, the investments you choose, how long you own them, and whether you use a taxable or tax-advantaged account.
If Moadd doesn’t have a retirement fund, such as a 401k or 403b through work, then I’d recommend that he open an IRA and max it out each year. For 2017, you can contribute up to $5,500 to either a traditional or a Roth IRA. If you have a workplace plan, you can contribute up to $18,000 per year.
See also: Is Owning Gold a Smart Investment?
How Much Stock Should You Own?
After you open a retirement account, you’ll need to choose the investments to own inside of it. You’ll have a menu of options to choose from and may also have access to an advisor or custodian who can help. As I mentioned, every investor should own stock through a fund. But how much stock is right for you?
Subtract your age from 100 and use that number as the percentage of stock funds to own in your retirement portfolio.
The answer depends on your appetite for risk, plus other factors like your age and when you want to retire. While there’s no one-size-fits-all asset allocation, in general, the younger you are, the more stock you should own.
Here’s an easy shortcut to figure out how much stock you should own: Subtract your age from 100 and use that number as the percentage of stock funds to own in your retirement portfolio.
For example, if you’re 40, you might consider holding 60% of your portfolio in stocks. If you tend to be more aggressive, subtract your age from 110 instead, which would indicate 70% for stocks. But this is just a rough guideline that you may decide to change.
You might allocate your stock percentage to a variety of stock funds or put it all into one stock fund. The remaining amount would be in other asset classes such as bonds and cash.
Make a goal to invest a minimum of 10% to 15% of your annual gross income for retirement. If you can’t set aside that much, start small. Even investing 1% or 2% is a great start. Then increase your contributions by a percent or two each year.
Having the option to start small is another benefit of owning stock funds. Unlike other types of investments, such as real estate or businesses, you don’t need much money to buy them.
See also: How to Make Money Investing in Stocks
Minimize Risk with a Buy-And-Hold Strategy
One of the most powerful ways to build wealth and financial security is actually pretty boring. Simply choose low-cost funds inside a retirement account and contribute 10% to 15% of your income over a long period of time.
Don’t get fooled into thinking that you need to take a lot of risk to be an investor. If anyone recommends that you buy this or that individual stock, smile politely and say, “thanks for your suggestion,” and never act on the information.
Don’t get fooled into thinking that you need to take a lot of risk to be an investor.
For most investors who don’t want to make a career out of stock picking, buying individual stocks is a bad idea. Trying to find one or two winning stocks is gambling, not smart, strategic investing.
Buying and holding one or more diversified funds minimizes investment risk. If the price of one stock in a fund takes a dive, it’s no big deal because you own hundreds or thousands of other stocks that may be holding steady or going up.
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