If you have saved some money or come into an inheritance you probably want to invest. Over the long run the stock market outperforms investments such as real estate or money in the bank. And stocks are a liquid investment in that you can buy and sell much more easily than with real estate. Investopedia compares the stock market and real estate as investment vehicles.
For the 38 years between 1975 and 2013 a $100 investment in the average home (as tracked by the Home Price Index from the Federal Housing Finance Agency (FHFA)) in 1975 would have grown to about $500 by 2013. A similar $100 investment in the S&P 500 over that time frame would have grown to approximately $1,600.
If you are interested in making your money work for you over the long term, how do you start investing in the stock market? The first step is to take a look at your finances and your expenses. In fact how to start investing in stocks is to get your financial house in order first and then start picking stocks.
Pay off Your Credit Cards!
If you have credit card debt you are paying between 13% and 20% a year on what you own the credit card company. It is difficult for an investor to routinely make this kind of a return on stocks so your first move should be to pay off your credit card debt.
You Need a Place to Live
It will cost you less over the long term to own your home than to rent. And the interest on your mortgage is tax deductible.
A Rainy Day Fund
It is all too common get trapped in a job with no future because you have no cash reserve. And it is all too common to lose a job and not be able to find one for six months to a year. Regarding investments you do not want to have to pull money out of a stock investment just as the market retreated. So, before picking stocks it is wise to have six months-worth of living expenses in the bank.
Now It Is Time to Pick Stocks
As you start investing in the stock market think about you goals. Do you want to save for retirement? Are you putting money aside to pay for your child’s college education? Are you looking to make lots and lots of money and are you willing to take on the risk that goes with aggressive investing?
Last week we wrote about how to pick dividend stocks. These are stocks that you will buy and probably hold until retirement and after. They will appreciate some in value and they will pay you a dividend every quarter. A conservative investor will load up on these stocks whenever they have money to invest.
The ideal growth stock is in a new market. The classic example is Microsoft. Paul Allen and Bill Gates founded the company in 1975 and took it public in 1986. If you had purchased 100 shares at $21 each at that time you would now have 28,800 shares after nine stock splits. Today the stock sells for $53 a share making your total holdings worth $1,526,400. And you would be receiving $40,320 in dividends every year. The obvious choice if you want to make tons of money is to pick the next Microsoft. Your best bet for doing this is to invest in stocks of companies that you know something about. Look for low price to earnings ratios of solid companies. And invest in a sufficient number of startups so that you increase your chances of hitting a home run while seeing several of your start up bets go out of business. In the end the best approach is to diversify your investment portfolio with a mix of conservative and aggressive stock picks.