Investing in Individual Stocks for the First Time

June 9, 2017

If you’re not familiar with investing in individual stocks, there’s a lot to know. Owning them can be more complicated – and risky – than mutual funds, or exchange-traded funds (ETFs). Here are a few things you need to know before investing in individual stocks for the first time.

Make Sure You Know What You’re Investing In Individual Stocks

When investing in individual stocks, you need to be very familiar with the companies you are buying. Stock is merely a paper representation of a company that trades on the financial markets. That’s why it’s important to know a lot about that company. You always need to know more about it than simply the recent performance of its stock.

As a first timer, you should generally stay with companies that are household names. Many of these are referred to as “blue chip stocks” because they are well-known, well-established, and widely owned and traded. Fortunately, there are hundreds of the stocks – just look at the companies that make up the S&P 500 – and plenty of information about each.

You should look for companies that have a good track record on both growth and dividends. Some of the best individual stocks to invest in are the ones that have been paying dividends for a long time and have been steadily increasing their dividend payouts for a decade or more. The stocks tend to be less risky than non-dividend paying stocks, at least in part because so many other investors want to hold them.

Whatever you do don’t gamble on stocks. That means stay away from “hot tips” – those are stocks that you have heard recommended in various places, like TV, financial publications, the web or the golf course. Sometimes such stocks are recommended only because the person doing the recommending owns the stock himself, and wants to generate as much interest in the company as possible. But that’s not an investment, it’s a speculation.

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Understand the Risks of Investing in Stocks

It’s critical to understand that stocks – just about any stock – hold the possibility that you could lose money on your investment. True, when people invest in stocks they’re doing so with the belief that they will rise in value, but that doesn’t always happen. Sometimes there’s bad news affecting that particular company or even its entire industry. Other times the general stock market falls and drags the company’s stock down with it.

The important take away is that investing money in stocks is not like putting money in the bank. Your principal is never guaranteed, and there’s even the possibility that the dividends being paid on the stock could be cut or even eliminated.

Your Time Horizon Matters

Whenever you invest in stocks, it’s important to be a long-term investor. That’s because in the short run stocks tend to go up and down. If you buy a stock hoping to make a quick profit, it’s equally possible that you can simply end up with a quick loss. You should plan on holding any stocks that you buy for at least a few years. Stocks can double, triple or more in price, but it usually takes several years for that to happen, not several months.

You also want to avoid being a trader. That’s someone who moves in and out of stocks in a matter of months, weeks or even days. It’s a very sophisticated level of trading that doesn’t always work. What’s more, since there are trading fees involved every time a stock is bought or sold, you’ll be incurring a lot of expenses through active trading.

Investing in stocks is very much about choosing the right companies, and then be prepared to sit back and give them the time that they need to grow. The desire for action or for quick profits could easily land you in the poor house.

Never Put All Your Eggs in One Basket

Since individual stocks are particularly risky, it’s important that you diversify your holdings. For starters, you should always plan to invest in several companies at a time. Generally speaking, it’s not recommended to have any more than 5% of your total investment portfolio invested in any one company. You should buy stock in one company, and then begin the search for a second, and then a third, and so on.

You should also look to invest in different industry groups. For example, you might want to hold a few stocks in the technology sector, a few in healthcare, and maybe a few in resource stocks. But you should never load up in a single industry. Business sectors have been known to go through hard times, even as the rest of the economy is thriving. If you’re over invested in a sector that’s declining, you can lose a lot of money.

You also should also always invest beyond stocks alone. That means holding some money in fixed income investments, such as bonds, US government securities, and bank assets such as certificates of deposit. These investments will reduce the return on your overall portfolio in rising markets, but they will likewise limit your losses in declining markets. That’s the whole point of diversification, and why you need to use it in creating an investment portfolio.

When in Doubt, Turn it Over to the Professionals

If you have any doubt about your ability to successfully pick individual stocks, there are other options.

You can invest in mutual funds or ETF’s. Each of these funds represents a portfolio of stocks and even other assets, like bonds. You can invest in the general market, such as an index fund that invests in the S&P 500, or you can invest in sector funds. In fact, there are funds that invest in virtually every sector that exists. These can include various industries, such as technology and healthcare, or even geographic sectors, such as emerging markets or global regions.

Each fund represents a portfolio of stocks in either the general market or in a market sector. That will eliminate the need for you to diversify among individual stocks.

Still another possibility is to invest using a managed portfolio. There are online investing platforms, commonly referred to as robo-advisors, that will build a portfolio of stocks and bonds for you, and then manage it. They charge a very low fee for the service, generally well below 1% per year.

With the robo-advisor handling the mechanics of managing your portfolio, your only responsibility will be to fund the account. Examples of robo-advisors include Betterment and Wealthfront.

You can even use a robo-advisor to manage most of your investments, while you maintain a small portfolio of individual stocks in a separate account. That will give you the ability to try your hand at investing in individual stocks, while the majority of your money is professionally managed. That’s the perfect lead into investing for a new investor.

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