How to invest in US stocks will depend on many factors. The best way to invest in US stocks is to follow some simple rules and steps. It is important to understand that by following some simple rules you can do better than many investors, but there are many risks, best to understand these concepts fully before starting to invest. It is also wise to speak with a professional before taking your first investment. Do not get involved in risky transactions. In short, avoid day trading, avoid investing in companies that you are not familiar with and do not get into a short position without understanding the risks and properly protecting your short position. This can be extremely risky, so just avoid it until you are much more advanced.
Steps on How to Invest
Step 1 – Get a broker and Create an Account
The first step is to create an account with a broker. You cannot buy stocks directly you need to have a brokerage account. The broker is the middleman that can buy the stocks for you. This can be an individual, a small company, or a large company that can do this. Generally, you should focus on large companies. One that I commonly use is either Chase Manhattan Bank or TD Ameritrade. Both of them are good and there are many others.
So the first thing you need to do is have brokerage accounts. Go to TD Ameritrade here.
Step 2 – Transfer funds to your account
The next step is to transfer money to that brokerage account. Once you have funds in your account, you can start to invest.
Step 3 – Decided on the Stocks to invest
This step involves many subsets of steps, which will be outlined below, the difference here can be the difference between being successful and being unsuccessful. As a beginner, you should focus on minimizing your risk, but also maximizing your return. It is very interesting how many investors minimize their risk but also do not maximize their returns. By following some simple rules, you can be far ahead of the average investor. Even though they may be investing for years or decades.
Step 4 – Understand the Basics
What is investing? (Download Free Book on Investing)
This is a very important concept, investing is taking some of your money, which has been saved, and buying stocks of a corporation, buying stocks or shares of a corporation with the idea that you would hold it for some time and then you would earn a profit on that transaction. Therefore, the goal of investing is to take your funds, invest in stocks, and earn a profit. That’s the short definition.
Shares versus Stocks
What’s the difference between shares, and stocks? Most of the time these two words will be used interchangeably. For the most part, they are synonymous. But you could think of a share, as a fraction of the company. The stock as being part of the common stock. Generally, when we refer to stock, we mean common shares and not preferred shares. If you own a share or a fraction of the stock of a company, then you will be entitled to both voting rights and earning a share of their profits, according to your pro-rata share of the company. If there are a million share of stocks. The stocks outstanding are 1 million and you own one of those stocks you would own a proportion of the company. You would own one 1,000,000th of the company. That would be your share. The share is the smallest most indivisible ownership fraction of the company. That is one stock divided by the amount of outstanding stock issued. That’s how your share is calculated.
As you can see the two words get commonly mixed, and for the most part that distinction for American English is extremely small. Most of us will use these two words interchangeably. Think of the stock of a company, as the whole amount of the common shares, the whole pool of common shares, and think of the share of a company as being a fraction of that. Ultimately, the two words can be used interchangeably.
Step 5 – Decide what type of Investor or Trader are you?
Before you can fully understand how to invest, you need to decide what type of investor you should be. The next step you need to understand is what type of investor you plan to be. We can divide the different types of investors into two types: one is long term and the second is short term. The short term is called traders and the long term is called investors.
Investing Types
1. Trader – Short Term Investing
2. Investor – Long Term Investing
If you’re an investor, you’re investing for the long term. If you’re a trader, you’re investing for the short term. In finance, the long term is defined as anything over one year, and the short term is defined as anything shorter than one year. There are two main types of traders. The first one is a day trader and the second type is a swing trader. The day trader is the shortest term of all. Their goal is to never hold a position after trading is closed.
Day Trader
By the open of closing the entrance on their trades. By the close of trading, they have exited all their trades. Many times two trades will last hours, and even could last minutes, a swing trader, on the other hand, is someone that’s looking for a little bit longer than one day that could be of over one day to three days and it could be even up to three months, but generally, they’re not there for the long term.
The advantage of a day trader is the potential to have large gains. The disadvantage is, it’s extremely risky and the fees will eat into your profit. We’ll get into that a little bit later, but with day trading, you’re talking about small margins so if you have some fees, eating into these small margins those small margins got even smaller. This is important to think about with day trading. It’s extremely risky, and it’s very time consuming, you will spend many hours in front of your computer, looking for the right time to execute a trade as well with day trading, you must have extremely up to date data, you’re going to need data that’s not too late by 15 minutes but you’re going to need data. That’s delayed, maximum by a second or two. If you’re trading on data that’s 15 minutes old. You could be trading blind for 15 minutes and that’s not going to work in day trading.
Swing Trader
Swing trading is kind of the in-between from day trading and an investor, but it’s still a lot more similar to day trading. The biggest difference is swing trading has exposed themselves to risk, after the close of the business day. While with the day trader they have not exposed themselves to this risk.
Traders
1. Day Traders – (window is less than one day)
2. Swing Traders (window can last days, weeks, and even months)
Investors
Investors generally could be one year, two years, 10 years, or 20 years, there’s no time limit. Warren Buffett often says when you decide to invest in a company you should plan to hold it for the rest of your life. This is true for the most part, unless something changes in the meantime, that you decide it’s no longer worthwhile holding for life. For example, Warren Buffett recently got rid of some of his shares in the airline industry, and this makes sense, the airline business changed dramatically since the pandemic started.
For Beginners
For beginners, you should choose the least risky option. This would mean that you would not be a day trader, which is the riskiest of all, rather you would be an investor, like Warren Buffett. However, unlike Warren Buffett, you would not focus on value investing but rather on an ETF or Index fund strategy. The advantage here is that you will be investing in many stocks and not only a few. This will reduce your risk greatly.
Investing Strategies
Value Investing
Many different strategies are used by long-term investors. One of the best known is called value investing. The value investing strategy has been made famous by investors such as Warren Buffett, and Benjamin Graham. The idea here is that you calculate the value of the company and then you only buy that company when it’s trading below that value.
The value is the key driver. It doesn’t matter if the stocks are trading at $100, or the stocks are trading at $10. If you value the company is at $20. You will not buy it at any price above this. When the prices are above $20 you’re going to only start to buy. As well, you’re going to look for a premium on your investment. For example, if you value the company at $20, you might not buy at $20 but you might start to invest when the stocks are trading at $17, whatever you decide to put as your premium.
As Warren Buffett says there’s no called strike in investing. What he means by that is, you do not have to swing at every pitch, or you do not have to swing at every investment that’s given to you. You can wait until the timings are right, the situation is right, and most importantly, the price is right. Imagine you value 100 stocks and you have the value of all these 100 stocks, then what you can do is you can wait to see which stocks are now trading below your value price. Then decide to invest in those. If all are trading above your value price, then you would decide not to buy.
Patience is an important thing in investing. Warren Buffett has said the stock market is a device that transfers money from the impatient to the patient. This is critical if you’re looking at value investing and you decide that a company X has an intrinsic value of $20 per share. Then you’re not going to buy it at $30 per share, you’re going to wait until the price drops below $20.
This is why patience is critical to investing and this is why it’s very important to understand that you do not have to swing at every pitch, you can wait for your exact timing. Imagine in baseball, if there was no called strike and you just waited until the pitch was not in the strike zone but in your perfect zone, where you know you can hit it out of the park.
That’s the concept of investing. With value investing you’re looking at investing in a specific company.
Index Strategy – Do not put all your eggs in one basket
Another strategy for long term investing is investing in indexes. This is great for beginners. The advantage of investing in an index is there’s far less risk. Because what you’re doing is you’re investing not in one company but you’re investing in 10’s or hundreds of companies. For example, if you’re investing in the S&P 500 you’re going to be investing in approximately 500 companies. The risk there is far reduced. You are familiar with the saying, “Don’t put all your eggs in one basket.” When you invest in one company that is exactly what you’re doing if you follow the value investing approach.
This is why reducing your risk is very important and why having an index strategy is critical. The other thing that’s important to understand is the difference between an index fund a mutual fund and an ETF.
Index Fund, ETF, and Mutual Fund
An index fund and an ETF, basically the two of them follow a specific index. It could be the S&P 500, Dow Jones, or NASDAQ. Their goal is to follow that index and mirror the results of that index. This has many advantages for you. You invest in one investment, but you’re investing in hundreds of companies. The other thing is you don’t do not have to make 500 trades and you do not have to pay fees of 500 times. The cost to you is reduced greatly. Your risk is also reduced greatly. The reality is, of course, index funds do not get the same rate of return as specific individual stocks, but they do not share the same risk. It’s a bit of a trade-off. In the beginning, it’s wise to reduce your risk.
As a beginner, I would advise sticking with indices.
What about Mutual Funds?
A mutual fund is a type of vehicle for holding the shares. There are two types of mutual funds, there are your passive mutual funds and there are active mutual funds. Passive mutual funds are those funds that follow an index or follow a specific set of procedures. The advantage of passive funds is the fees are extremely low. An index fund is by nature, passive funds.
When we say mutual funds, for the most part, we generally mean an active mutual fund. Although some people may refer to passive funds in that way so you have to understand. What are they talking about, but generally speaking, a mutual fund without any connotation is talking about an active mutual fund? The disadvantage of an active mutual fund is there are a lot of fees. The active mutual fund has a goal to beat the market. The goal of the passive fund is to meet the market.
To beat the market, the active fund must make a lot more trades. They incur more costs, and they have to hire a hedge fund manager. The person who is in charge to execute these trades which can be quite costly. All of these fees have to be passed off to the consumer, which is you the buyer. These fees can range from 1% to 2%. If we compare it to passive funds, these fees can be as low as 0.1% or lower. If you have a 2% fee and you compare it to a 0.1% fee, that’s 20 times the amount of fees.
The goal here is with an active fund is that they should beat the market. The amount that they beat the market will compensate for those increased fees. Here’s the problem. Most of the active funds do not even meet the market. They generally underperform compared to the market. When you add the fees on top of that, you’re getting a double hit. You’re getting hit because you’re not performing as well as the market and you are getting more fees. For example, let’s say the S&P 500 market earned 10% in the year, so the S&P 500 index earned 10% since they meet the market. And you paid a small fee of 0.1%. You earned 9.9% for the year. Let’s compare that to an active fund that underperformed by 1%. Let’s also assume there was a 1% fee. Now, instead of earning 10%, they earned 9% plus your fee is costing you 1%, now your actual return is 8%.
This is why active funds are not the way to go right now, some make sense, but most do not.
The difference between an ETF and an index fund. The index fund is in the form or vehicle of a mutual fund. You cannot trade on an index fund or mutual fund during trading, you must wait until the end of the day. With ETFs, they are intraday so you can buy stocks in the middle of the day. It’s traded like stocks. That has a slight advantage, but the reality is, you’re looking at being a long term investor. This does not have that much of an effect.
As a beginner, your best strategy between all of these strategies is to avoid anything to do with day trading for the beginning. After you get some experience with investing you could start to think about day trading but do understand it’s the riskiest. Then what you should focus on, for the most part, is choosing one or two or three indices that you think are good and focus on either index funds or ETFs that match those indices. Three good indices to consider are the S&P 500, NASDAQ, and Dow Jones. Those are the three to focus on if you’re only going to focus on, we recommend starting with the S&P 500, the number of stocks there is significant and the risk is lower. Also understand that NASDAQ has much higher risk, but also has higher returns, or potentially higher returns.
Step 6 – Decide When to Invest
You must ascertain whether the market is currently overpriced or underpriced, and then decide to invest primarily when underpriced. There are tactics one can take when they are overpriced, but these all have some risk associated with them.
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