Are you curious about the stock market but find it daunting and do not know where to start? Yes? Please keep on reading. This article will attempt to shed some light on the stock market investing basics and, hopefully, inspire you to learn more and start investing.
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This article will cover the following 7 sub-topics:
- Stock Market Basics
- How to buy a stock
- Making money in the stock market
- How to pick a stock
- Taxation on stock market profits
- How to learn more about stock market investing
- Busting common myths about the stock market
STOCK MAREKT BASICS
A stock market or stock exchange is a place where buyers and sellers can trade stocks and other financial instruments. A share of a company’s stock represents partial ownership of the issuing company. So if you buy Apple stock, you then become a partial owner of Apple!
There are many stock exchanges around the world, the most well-known being the New York Stock Exchange (NYSE), NASDAQ, Tokyo Stock Exchange, London Stock Exchange, Toronto Stock Exchange, among many others.
Stock markets have indexes that track the performance of a specific group of stocks. These indexes are powerful indicators for global and country-specific economies. The most widely followed indexes include:
- The Standard & Poor’s 500 (S&P 500): Tracks the performance of 500 large companies listed on various stock exchanges in the United States
- The Dow Jones Industrial Average (DJIA): Tracks the performance of 30 large companies listed on various stock exchanges in the United States
- The Nasdaq Composite Index: Mostly tracks technology stocks as well as many speculative stocks with small market capitalization. It includes some companies not based in the United States
- Nikkei 225: Tracks 225 large and publicly owned companies from a wide range of industry sectors in Japan
- The Financial Times Stock Exchange 100 Index (FTSE 100): Tracks the 100 companies with the highest market capitalization listed on the London Stock Exchange
People buy stocks in companies that they believe will grow in value to earn them a handsome return. Companies, on the other hand, issue stocks to raise capital to finance expansion, research and development, launches, etc.
HOW TO BUY A STOCK
Today, very few trades take place physically on the floor of a stock exchange. Most of the world’s stock market trading takes place on electronic platforms. As such, you would need to open an online brokerage account to buy stocks.
A brokerage account is the means through which you can gain access to the stock market. Through your brokerage account, you can purchase stocks, bonds, mutual funds as well as more complex instruments such as options, futures or forex. There are many licensed brokerage firms in the market. It is often very quick and easy to open a brokerage account.
- Popular online brokerages in Canada include Questrade, Qtrade, Scotia iTrade, TD Direct Investing, BMO InvestorLine Self-Directed, Virtual Brokers, and Wealth Simple.
- Popular online brokerages in the United States of America include TD Ameritrade, Fidelity, Charles Schwab, E*Trade, Interactive Brokers, Merrill Edge, and Trade Station.
MAKING MONEY IN THE STOCK MARKET
There are primarily two ways to make money in the stock market. These include:
1. CAPITAL GAINS
This is the rise in value of a capital asset, such as stocks. Making capital gains is the main reason for investing in the stock market. As a good investor, you typically want to buy when stock prices are low, and sell when the stock prices are high.
Stocks have the highest long-term returns compared to any other asset class. Historically, the average growth rate tends to fall between 7% and 10%. Investing in the stock market will grow your money over the long-term through capital gains (appreciation).
Dividends are simply distribution of profits by a company to its investors. They may be recurring or special (such as a one-time payout after a highly profitable period).
As a rule of thumb, smaller fast-growing companies typically reinvest their profits to further grow their businesses. Therefore, they tend not to pay out dividends. On the other hand, mature slower-growing companies are more likely to pay dividends.
Companies may pay out dividends in the form of cash or company shares. Pay outs in the form of company shares increase the investors’ ownership in the company.
Check out these related articles:
- 5 Reasons to Start Investing Today
- Are you ready to start investing?
- What Style of Investing is Best for you?
HOW TO PICK A STOCK
Investing in the stock market can be immensely rewarding. However, if not done properly it could lead to major disappointments. Below are a few things to keep in mind before investing in individual stocks:
- Never simply rely on gut feelings or free tips and recommendations. You always need to understand the companies that you pick.
- You should only invest your surplus finances.
- Investing is a long-term game and therefore, have patience and do not get flustered by short-term market dips.
One of the most widely used strategies for researching stocks is called Fundamental Analysis. This strategy attempts to determine whether an investment is correctly valued in the stock market. Its goal is to find out whether a company is undervalued or overvalued, and thus helping you to make a good investment decision.
Fundamental analysis considers the qualitative and the quantitative aspects of a company. You need to consider both aspects when picking a stock.
This includes looking at the management and board as they are responsible for the company’s future. Other qualitative factors may include the company’s competitive advantages as these could impact its ability to remain profitable long-term.
This includes looking at the company’s past financial performance, that is the hard facts and numbers. Generally, you want to find out whether the company’s earnings have continued to grow over a long time.
The 3 main financial statements that you would look at include Balance Sheet, Income Statement, and Statement of Cash Flows. Publicly traded companies are legally required to publish quarterly statements (10-Qs) and annual reports (10-Ks). You can find the financial statements of a publicly traded company on the Investor Relation Page of the company’s website.
Some of the key numbers and ratios that you would need to look into include:
- Earnings per share (EPS): This ratio shows how much money a company makes for each share of its stock. A high EPS indicates high profits.
- Price-earnings ratio (P/E): This ratio measures a company’s stock price relative to its EPS. A price-earnings ratio may indicates that a company is overvalued. It could also indicate that investors expect a high growth rate in the future.
- Debt-equity ratio (D/E): This ratio calculates how much debt a company has relative to its shareholders’ equity. It indicates the company’s ability to cover its debts. Acceptable amounts of debt will vary across different industry groups.
If you have never looked at financial statements before, there will be a bit of a learning curve for you in this step. But with interest and patience, anyone can learn how to quantitatively analyze companies to make good investment decisions.
TAXATION ON STOCK MARKET PROFITS
Tax is an important aspect to consider in your investment strategy. When investing in the stock market, you are typically subject to capital gains tax depending on where you live. Tax applies to stock market capital gains once they have been realized by selling your investment(s).
Generally, if you hold your investment for more than a year before selling, the profits will be taxed at a lower rate. However, if you sell after holding your investment for less than a year, the gain will generally be taxed at your personal tax rate which is typically higher.
You can also minimize and even avoid capital gain taxes by using tax-advantaged accounts. The two most common methods that could enable you to reduce your tax bill include tax deferral and tax exemption.
This allows you to defer paying taxes on capital gains to a future date when withdrawals are made from an account, typically during retirement when most people are in a lower tax bracket. Additionally, this allows you to realize an immediate tax deduction on the amount of your contribution.
The common tax-deferred retirement plan in Canada is the Registered Retirement Savings Plan (RRSP). The common tax-deferred retirement plans in the United States are the Traditional IRAs and 401(k) plans.
This allows your investment to grow tax-free. Any gains realized in such plans are not subject to capital gains taxes. However, there is no immediate tax benefit because contributions are usually after-tax dollars.
The common tax-exempt account in Canada is the Tax-Free Savings Account (TFSA) and in the United States, it is the Roth IRA and Roth 401(k).
HOW TO LEARN MORE ABOUT STOCK MARKET INVESTING
This article covers some of the stock market investing basics, but you can learn a lot more about this subject. Additionally, stock markets are constantly changing based on various micro-economic and macro-economic factors. Below are some of the best ways to further your knowledge to become a good investor:
Books provide a wealth of information and are very inexpensive as compared to attending courses or seminars. Some popular investing books include:
- The Intelligent Investor by Benjamin Graham
- A Random Walk Down Wall Street by Burton G. Malkiel
- The Little Book of Common Sense Investing by John G. Bogle
- One Up on Wall Street by Peter Lynch
- The Little Book that Beats the Market by Joel Greenblatt
Often people will suffer analysis paralysis (i.e., overanalyzing a situation so much that it becomes impossible to take action). Getting right into it is one of the best ways to learn just about anything. Simply, identify and open a good brokerage account, and start getting familiar with the account as you analyze some good investments.
BUSTING SOME COMMON MYTHS ABOUT THE STOCK MARKET
Myth #1: Stock market investing is very risk and it is gambling
The stock market fluctuates up and down daily. However, in the long run, the stock market has historically delivered a consistent and strong performance. The S&P 500 index chart below illustrates this with the upward trending trajectory, despite a few dips along the way.
Yes, you face some are risks by investing in the stock market. However, your odds of losing are much lower if you carefully research and select your stocks. Investing also gives you one of the best chances to grow your money and therefore beat the effects of inflation which leads to increased cost living over time.
Myth #2: Stock Market Investing is for the brokers and the ultra-wealthy individuals
Previously, most financial market information was only privy to the brokers and the more affluent individuals that could have afford to gain access to valuable information. However, access to information has become much easier because of the internet. Today, just as much data that is available to the pros is available to the public as well.
Further, there are many discount brokerage and Robo-advisors that carry out trades at reduced commission rates. Some even allow investors to buy fractional shares giving you access to companies whose full share price may be out of reach for you at the moment.
Myth #3: You need to have a very strong knowledge about finance to invest in the stock market
Warren Buffet, one of the most successful investors of all time, once said, “You do not need to be a rocket scientist. Investing is not a game where the guy with the 160 IQ beats the guy with 130 IQ.”
Many successful investors do not have a formal finance educational background. Instead, they keep on educating themselves, have a long-term view and tend to be very disciplined. All these are skills that anyone can learn to become successful in stock market investing.
Finally, if you have enjoyed this article on stock market investing for beginners or have any questions, please leave them in the comment section below. I would love to hear from you! Also, please spread the word by sharing this post with someone that may benefit from it.
“Magic is believing in yourself. If you can make that happen, you can make anything happen.” – Johann Wolfgang Von Goethe Luther