Over the first eight months of 2020, the stock market whipsawed from huge loses to outsized gains, taking some to the poorhouse and others to an early retirement. Many quality stocks went “on sale” with the drop in the market, and others just kept plugging along. You might be itching to join the party. However, before you start trading stocks on your own, look closely at your personal situation, your desire to spend time choosing stocks, and your propensity for risk.
Am I doing everything else?
Most financial planners suggest you have three to six months of expenses saved as an emergency fund in case you lose your job or have a large unexpected bill. They also say you should be saving for retirement either through your workplace plan or through tax-advantaged retirement accounts. And if you have kids, consider saving for their college expenses in a 529 plan.
But don’t forget the debt side of the equation. In addition to investing, you need to be paying off your credit cards in full every month. Also there should be no other onerous loans (high interest rate car or home loans, etc.) that you are paying down. Most financial advisors suggest you work to get the interest rates as low as possible for any loan you’re carrying.
Spend time learning
Make sure you understand the basics of money management and investing, such as asset allocation, dollar-cost averaging, common investing options, etc. Did you know there are different ways to buy a stock (market order vs. limit order)? Are you familiar with margin accounts or the dangers of trying to time the market? Spend some time learning about technical analysis of stock vs fundamental analysis. Finally, it never hurts to understand the tax implications of selling stock (whether you make money or lose money).
Play the game
While you’re researching the basics, find a site or brokerage where you can buy and sell on paper. In other words, you make the trades but no money changes hands, similar to the stock market game many middle schoolers play every year. Spend some time deciding what types of stocks you want to invest in. Practice using stock screeners and play around with the inputs to see how the listed results differ. Practice several buy and sell strategies, seeing which one might be most profitable (and comfortable) for you.
Risk tolerance
Take some time to see how you react to these paper losses and gains. How do you feel when something you bought tanks? Are you willing to buy more in a good company that is having temporary difficulties? Would it keep you up at night if this was real money? Understanding your risk tolerance isn’t easy. There are quizzes, but honestly until you are losing real money it doesn’t truly hit home. Still, if you’re very uncomfortable with paper trading, this might not be the best plan for you.
Notice how much time this is taking
Learning about stocks and investing, determining the strength of a particular stock, and keeping up with changes to the company and sector all take large amounts of time. Most of us aren’t stock traders. Will you be happy continuing to spend this amount of time investing in individual stocks?
Research brokerage options
With most online brokers now offering no commission trades, it’s possible to develop a portfolio of stocks with no added fees or expenses. But there’s more to the right online brokerage than just low or no fees. Spend some time looking into the different options to see which fits most closely with your needs.
Money you can afford to lose
Start with money you won’t need for your house payment or to put food on the table. Think of it like Vegas: invest only what you can lose. Maybe that’s 1% of your pay per month, maybe it’s an extra amount you’ve saved, maybe it’s 5% of your total portfolio. There’s nothing wrong with starting off small and increasing the amount over time. This lets you make mistakes when the dollars are lower versus when there’s more money in play. And watch the amount you have in one particular stock. Consider selling if it reaches an uncomfortable amount of your portfolio.
Note: Investing in your employer’s stock can be a great way to make some money but it can also be the worst of both worlds. While you may have a chance to buy discount shares, watch the amount you put in. If the company experiences financial difficulties, not only could your investment lose money but you might be out of a job.
Dollar-cost averaging
If you have a hard time deciding when to buy, consider putting the same amount into your investment at the same interval. In other words, if you want to invest $5,000 in AAA Company, you might put $1,000 in for five months in a row, or $500 for ten instead of trying to find the perfect moment to invest all of it. Results may vary. If you are investing in a stock that goes up and down during your investing period, you will have the chance to buy some shares at lower prices, which could make your cost basis lower. If you invest in a company that only climbs during your investing period, it would have been better to put all your money in at once. But again, knowing that one perfect moment is a challenge.
Brother-in-law advice
People love to talk about hot stock tips. And while I’ve received some good ideas about stocks, I’ve also been advised to buy some real stinkers. Don’t dismiss outright what people tell you, but don’t trade only on tips. Do your research. Make sure it’s a quality company that fits into your plan. If so, thank them for the advice.
Stock watchlist
Maybe your brother-in-law’s recommendation is a quality stock but too pricey right now. Consider creating a stock watchlist, which you can set up online through your broker or many financial sites. Narrowing the world of stocks down to several you’re interested in will help you learn about the stock, keep up with news affecting it, and follow the price changes over time. If stocks go on sale you have an idea of what a fair trading price has been and can move quickly with more confidence to buy that stock.
Against the crowd
I’ve been through several major recessions and corrections. In each instance, there were quality stocks on sale that just got caught up in the sell momentum. Yet when the news is screaming every day about the economy and huge numbers of people out of work, it’s hard to buck the tide. Buying when everyone else is selling is one of the toughest traits to master.
Selling
Investing in stocks isn’t like buying shoes. You don’t want to keep these around the closet floor without thought to selling them. It’s hard to sell a stock that you have an emotional attachment toward, whether it’s gone up or down in value. You might think that losing stock will come back if I give it more time or believe that there’s no reason another stock should fall in value. If you haven’t already, develop a plan for selling the stock just as you did for buying it.
Long-term investment
Finally, don’t forget that investing in the stock market is for long-term goals. While you might make money immediately on an investment, you might also lose or just skim along. That’s why it’s so important to go into this with a plan for where you want to be and an understanding of how stocks can get you there.
Photo by Jack Moreh