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Erik Larson writes about the job market, resume improvement, and career advice

Investing in the Stock Market - Your Questions Answered

Written by Erik Larson, Community Blogger | Mar 9, 2018 5:53 PM

If you want to invest in the stock market, it's important to understand how, why, and where to invest. Investors, including Chart Westcott, COO of Ikarian Capital, have provided answers to a few common recurring questions.

Why is investing a good, long-term strategy to build wealth?

Simply put, because it puts your money to work for you. If you spend some time learning where and how to invest wisely, your money becomes a tool that can create wealth independently of you.

How can a potential investor decide if they want to invest?

Investing is generally a good idea if:

  • You have time to research where you want to invest.

  • You understand the investing principles that can reduce your risk.

  • You have some disposable income that you can put into investing.

  • You can put your money into investments for a minimum of three to five years.

  • You can afford to invest on a regular basis.

When is the best time to invest in the market?

The best time to invest in the market is right now. The financial markets are, and always have been, volatile; it's almost impossible to time or predict the market. Instead of deciding whether to invest today, next week or next year, start investing now and use some simple techniques to reduce the risk of your investments.

What is the best amount to invest?

There are a few simple principles when deciding how much to invest:

  • Start by investing small amounts, so you can get an understanding of how stocks work.

  • Never invest money that you are likely to need in the short term (one to three years).

  • Only invest "disposable income" that you aren't going to use for anything else.

  • Never invest what you can't afford to lose.

A good technique is to work out your budget, based on your income and expenses. Take the money that you have left over at the end of each month and use a small amount of that (10 to 20%) to start investing.

Why do stocks increase and decrease in value so much?

The stock market is unpredictable and volatile. The price of individual stocks and the value of the market as a whole can be impacted by:

  • Major economic and political news.

  • Predictions about growth and the economy.

  • News about individual stocks.

  • News about "sectors" and "industries"--areas a business operates in.

  • Financial reports from a business.

  • Predictions and analysis of the performance of an individual business.

Individual investors have little control over these events. One thing that investors can decide on is to buy stocks in quality businesses.

What are some principles to reduce risk?

There are several key principles that investors can use to reduce risk. They are:

  • Buy stock in high-quality businesses.

  • Diversify their investments.

  • Invest over the medium to long-term.

  • Use dollar cost averaging.

How can investors find good quality businesses to invest in?

There are several factors an investor can use when choosing which businesses to buy stock in. These include:

  • A leader in its sector or industry--recognizable, established companies.

  • Paying a reasonable dividend--interim payments that reward investors for holding stock.

  • A strong financial position--plenty of money in the bank and low amounts of debt.

  • Good historic performance--returns that are in pace with, or ahead of, their competitors and industry.

  • Healthy future performance--good future predictions on how the business is going to perform.

Businesses that meet all of these criteria are generally good places to start investing. If you want to spend more time, it's worth looking deeply at other fundamental and technical factors to help you identify high-quality stocks. These factors include areas such as profit margins, price/earnings ratio (PE) and price/earnings to growth ratio (PEG).

What is diversification?

Diversification is a great way to reduce risk. It means putting money into different types of investments, in different ways. Techniques that can be used to diversify investments include:

  • Invest in stocks across a broad range of sectors and industries.

  • Invest in different types of financial instruments--trackers, individual stocks, bonds, mutual funds, certificates of deposit.

  • Invest over different timescales--medium-, long- and very long-term investments.

Diversification works because it significantly limits your exposure to particular parts of the market. Having a number of investments (your "portfolio") across many different areas means that you spread out your risk.

What's the minimum timescale for investments?

"When you invest, you should expect to hold your investment for a minimum of three to five years. Because of the short-term volatility and unpredictability in the stock market, the longer you can hold an investment, the more likely you are to make money on it," advises Chart Westcott.

This means you should never invest money that you expect to need in the near to medium term; if you sell an investment too soon, you may lose money on it.

What is dollar cost averaging?

Dollar cost averaging is a way of "smoothing out" your risk. It means that you continue to invest regularly as the markets go up and down, so you're buying in over a more extended period. When the market is cheaper, you get to buy more of a particular asset, and when it's more expensive, you buy less.

Over time, because the trend of markets is to increase in value, you'll see a balanced return on your cheaper and more expensive investments.

What's the best way to buy stocks?

Most investors buy stocks through an online broker. There's a large variety of brokers out there, providing services to every kind of investor.

Are there easier ways to invest than buying individual stocks?

Yes. One of the simplest ways to invest is by buying an "index tracker." Trackers invest in the stock market as a whole. They have several advantages over investing in individual stocks:

  • They are easy to setup, and you can invest in index trackers through any broker.

  • They have very low fees, so more money is returned to you.

  • They are diversified across the whole stock market, which means that fluctuations in the price of an individual stock won't have a huge impact.

  • You can regularly invest in a tracker to take advantage of dollar cost averaging.

  • You can start by investing small amounts.

  • About 80% of the time you'll see a better return from an index tracker than through investing in individual stocks.

Are there types of investment or trading that should be avoided?

Yes. There are several different types of "investment" that you should avoid at all costs. These are dangerous approaches and techniques where you can lose significant amounts of money. They are:

  • Penny stocks--very cheap stocks (costing just a few cents each) from low-quality, unproven businesses. These stocks are very easily manipulated, and it's very easy to lose money on them.

  • Day-trading--the practice of buying and selling stocks multiple times in a single day. It's very difficult to predict stock movements, and most day traders end up losing money.

  • Options--these are "all or nothing" investments. You can make (or, more likely, lose) lots of money in a very short period.

Investing is the best way to grow your money over the medium to long-term. Spend some time learning the principles of investing, find some high-quality companies and understand how to reduce your risk. You'll be able to use your money as a tool to build your wealth, see good returns and meet your financial goals.

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