The stock market can be confusing; investing in it even more so. Spencer Platt/Getty Images

Let’s break down investing

Katherine Wiles Sep 26, 2019
The stock market can be confusing; investing in it even more so. Spencer Platt/Getty Images

“Buy low, sell high.” We’ve all heard the adage before. But investing in the stock market can be a big step. It can be confusing — even daunting — and the terms can make it feel like inside baseball. So here are some basics to know about investing in the stock market before jumping in feet first.  

First, before investing in any stock, Lisa Cook, a professor of economics at Michigan State University, recommends having a clear plan detailing all your financial goals.

“One needs to know what one is investing for [and] what one’s risk appetite is,” Cook said. “When marrying those two objectives — and there could be others — you can come up with a financial plan.”

You don’t need a lot of money to invest in the stock market. While you should make sure your finances are healthy before investing, William Michael Cunningham, an investment adviser and CEO of Creative Investment Research, said directly purchasing stock from a company can be done with as little as $25 by buying a fractional share.

But both Cunningham and Cook said that investing in funds, as opposed to individual stocks, is a good way for beginners to get started. 

A mutual fund is a collection of investments in one portfolio account. The mutual fund takes investors’ money and places it in different types of securities. There are different types of mutual funds. A stock fund is a mutual fund that invests primarily in corporate stock. Index funds invest in company stocks that match those in a particular stock index, like the S&P 500. 

Money market funds invest in short-term debt and usually provide a modest return. A bond fund invests in bonds and typically aims to produce greater returns than a money market fund. 

Mutual funds have a few advantages over individual stock for new investors. First, they tend to be more liquid

“You should be able to come in and out of those funds easier than you can come into and out of an individual stock or an individual bond,” Cunningham said.

They are also thought to be more secure because they are inherently diverse investments. Diversification is the idea that you’re not putting all your eggs into one basket.

“If you invest in one company, then your investment is wholly dependent on the performance of that single entity,” Cunningham said.

If you are going to buy stock in an individual company, Cook and Cunningham both said to invest in what you know. For example, if you fly a lot and know about the types of planes that are being ordered, it might be good to invest in that company. It’s important to be familiar with the company and its goals, and reading its prospectus is a good way to do that. 

It’s important to think long term when investing in the stock market. A common pitfall, Cunninham said, is chasing returns, which is switching investments based solely on earning the highest return.

“The reason why this is so bad is — in addition to not being diversified — you’re going to pay these fees that the brokers charge, and you’re going to pay them repeatedly,” he said. “Your gains are going to the brokers as opposed to going into your pocket.”

Cook said patience is key, especially if you are far from retirement. Don’t get spooked over some bad economic news, and remember that the stock market is not the economy. 

Dividends are company earnings that are given back to the shareholders. They are classified as qualified or nonqualified, depending on how they are taxed. Nonqualified dividends are typically taxed as income. Qualified dividends are ones that meet certain criteria, including owning them for a length of time known as a holding period. Qualified dividends are taxed at the capital gains rate, which is typically lower than income tax. Cunningham noted that these laws can change frequently, so be sure to check with your tax adviser. 

It’s important to be prudent when investing in the stock market, especially when you’re starting out. Saving money in the bank typically yields less profit than investments, but it’s also more secure. 

“There should be an acknowledgement that these investments are not [Federal Deposit Insurance Corp.] insured,” Cook said. “So if investors lose their money, they lose their money.”

Important terms

Beta

Measures the relationship between the stock price and movement in the whole stock market; basically, a measure of volatility.

Bear market

When share prices decline on the stock market for a sustained time.

Bull market

When share prices rise on the stock market for a sustained time.

Blue chip

Large, industry-leading companies that are financially sound.

Bonds

A loan to a company, country or local government that pays a stated interest rate.

Capital appreciation/capital gain

How much an investment has increased in value.

Diversification

The strategy of having a mix of different types of investments to reduce the risk of any one holding.

Dividends

Payments made to shareholders from company earnings.

Earnings per share

A company’s profit divided by the number of common outstanding shares; an indicator of a company’s profitability.

Liquidity

How fast or easily securities can be converted into cash.

Margin

The money borrowed from a broker to buy an investment.

Money market fund

By law, funds that can only invest in certain “high-quality, short-term investments issued by U.S. corporations, and federal, state and local governments.”

Mutual fund

When a company pools investors and invests their money in securities like stocks, bonds or short-term debt.

Net asset value

The total value of a fund or company’s assets minus the total value of its liabilities.

Penny stocks

Stocks traded at under $5, typically traded over the counter and not on a stock exchange.

Portfolio

The collection of securities that a mutual fund is invested in.

Prospectus

A legal document required by the Securities and Exchange Commission that provides details of an investment.

Risk appetite

How much risk you’re willing to take in order to achieve a goal — in this case, making money.

Securities and Exchange Commission

A government body that was created to protect investors and maintain fair markets.

Volume

The number of shares traded over a certain period of time, typically measured over the course of a day.

Clarification (Sept. 26, 2019): This story has been updated to clarify how stock can be purchased for as little as $25.

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