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The 3 Ways You Can (and Should) Invest in Stocks

Aug 22, 2018 | 3 min read | Karen Kroll

Key Takeaways

  • Consider your time horizon, goals and appetite for risk when investing.
  • Diversify. That is, “Don't put all your eggs in one basket."
  • Watch expenses — they can eat away at your returns.


How do you decide to start investing? Do you know how to invest in stocks? Or how to invest in mutual funds? Or how to invest in index funds?

A first step is thinking through your investment goals, time horizon and ability to take on risk. This is key, as any investment involves some risk.

You'll also want to understand the differences between various investment vehicles, like stocks and mutual and index funds. This article provides a great primer.

 

 

It's also important to keep in mind that how you invest in stocks often is as important as the stocks (or groups of stocks, if you invest through mutual funds) you choose. A key concept is diversification , or the idea that, by investing in different types of stocks, you'll reduce the risk of losing money, should a single stock drop in value.

Here is the lowdown on several approaches.


Investing in stocks

Investing in individual stocks can be tempting. After all, who wouldn't want to own a share of the next highflyer?

The hitch? “Owning an individual company is a huge risk," says James R. Miller, CFP and president of Woodward Advisors in Chapel Hill, North Carolina. “A company can go out of business in the blink of an eye."

As a result, for the average investor, owning large amounts of individual stocks doesn't make a lot of sense, Miller says: “The risk/reward tradeoff just isn't there."

This doesn't mean you can never invest in individual stocks. Perhaps you enjoy supporting local companies or identifying firms you think will succeed. Go ahead, but keep these investments to less than about 5% of your investable assets. Moreover, “it needs to be money you're okay losing," Miller says.
 

Investing in mutual and index funds

Mutual funds can reduce risk through diversification. Even if some companies in a fund decline in value, others could rise, offsetting each other. In addition, mutual funds can be a relatively low-cost and straightforward way to get into the stock market.

Mutual funds come in a range of flavors. One significant difference is whether fund management is active or passive. As this article shows, active managers try to outperform the market. Actively managed funds tend to have higher expenses, as you're paying for the manager's expertise.

Index funds are a subset of mutual funds. Their goal is to mimic a stock index, such as the S&P 500. Because the fund managers aren't trying to beat the market — in other words, they're passive — they don't engage in as much research as active fund managers. As a result, index funds tend to be less expensive than actively managed funds.

“All the academic research suggests index funds outperform actively managed funds after fees and taxes," Miller says.


Investing in a retirement account

A significant goal for most investors is saving for retirement. Common ways to save for retirement are through 401(k) or 403(b) plans, which are offered by employers, and Individual Retirement Accounts, or IRAs.

Your investment options for your 401(k) plan are determined by your employer. Many offer a range of mutual funds. In deciding how to invest, compare the net expense ratio, says Mike Schupak, CFP, with Schupak Financial Advisors in Jersey City, New Jersey. Typically, you'll want to stick with reputable funds with lower expense ratios.

One red flag to look out for is if your employer offers the company's own stock in its 401(k) plan. In most cases, you don't want to invest in your employer through your 401(k). “It's great to believe in the company you're working for, but your future paychecks already are dependent on your employer," Schupak says. If you also invest in your company through your 401(k), you risk both your salary and your retirement savings.

IRAs offer more flexibility than most 401(k) plans, Schupak says. You typically can invest in stocks, bonds, mutual funds and other types of securities. As a result, you should be able to find investments that fit your needs.

 

 

What you can do next

Before investing, consider your goals, time frame and tolerance for risk. This will help you determine how much risk you can take on. Next, research different investment vehicles. Then you'll need to open an investment account. Typically, you'll also need some money to fund the account and start investing. Finally, keep going! Invest small amounts on a regular basis and you will reduce the risk of investing a big lump sum just before a fall in the market. Remember that investing involves risk: you can lose money.

 

Karen Kroll is an experienced freelance writer and editor, with a focus on corporate and consumer finance. Her articles have appeared in AARPBulletin.com, Bankrate.com, Business Finance, CFO, CreditCards.com, Global Finance and many other publications.

 

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