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A suggestion I got when I started this blog, is to provide some insight into how persons with a non-finance background and no prior experience can start investing in Financial Markets. So here goes.
Personally, I have only been investing for approximately three years so please know I am no expert. This is a very lengthy topic and I know for a fact that I would be unable to cover all of the content within this one post, therefore, I aim to provide a brief overview of investing and also recommend some resources that can be utilized for those interested in learning more.
Before we get into the content, I first want to explain some terms used in investing and finance in general.
Stock or Share – Represents an ownership stake or equity in a public company. They are typically traded (bought and sold) on an Exchange (for example the New York Stock Exchange).
Broker – This is a name given to a company that facilitates the platform that allows you to trade stocks on. Banks (e.g. Fidelity, RBC, Scotiabank, Barclays) and other financial companies (e.g. Webull, Robinhood, eToro, Wealthsimple, etc) often offer brokerage services to retail customers. Most brokers offer mobile apps, allowing you to trade on your phone/tablet while some only use Web Portal services.
Bullish – Means increasing in value; effectively the increase in price.
Bearish – Means decreasing in value; effectively a decrease in price.
ETF (Exchange Traded Fund) – Represents a group of stocks or assets bundled together by different categories (sectors, industries, location, direction, asset class etc. I will explain more about ETFs later on).
Blue Chip – This is a term used to describe relatively low-risk companies that have been in existence for a long time and have consistently performed well (some examples are Disney, Coca Cola, Microsoft, Walmart, Apple).
For more explanations of key terms used in investing and finance in general, I encourage you to visit the Nasdaq Glossary (link embedded)
For simplicity, I am targeting this article to “long-only,” retail investors; meaning those people who would only be interested in buying for capital appreciation (the buy low – sell high concept) and/or for dividend income (i.e. monthly, quarterly or annual payments from companies whose stocks you own).
Great now let’s get into the main discussion, “What are the steps I need to take to get invested in stocks?” To follow along with this process, I encourage you to have a piece of paper (or any form of taking notes) whilst reading this article and as I introduce each step, write down your answer/response to it.
STEP 1: Determine your level of Risk!
Firstly, I need to address a critical point that is most times ‘the elephant in the room’ for any form of investing, HOW RISKY IS IT? Now, risk is definitely not something to be taken for granted and with most investments, it should be understood that the level of risk taken is directly related to the return that is to be expected (i.e. if you invest in something high risk, there is a chance for a high return). In this regard, no two investors are the same, everyone has their own risk appetite and tolerance!
So, with step one, I want you to write on a scale of 1-10 what your level of risk is (1 being the least risky and 10 being the most). Now while you do this, please recognize, risk isn’t only about how you feel personally, it is also related to what you can afford at this point in time in your life (i.e. your situation). For example, if you were a young professional, without any major financial obligations and a high risk appetite, having a risk score of >7 would not be unreasonable; but if you were a middle-aged woman with a similar risk appetite but, with an outstanding credit card payment and car loan as well as an unstable job, allocating yourself a high score would definitely not be recommended.
Excellent, now that you have determined your risk level, let’s go ahead and move to step 2:
STEP 2: Deciding how much you are willing to invest.
Simply put, the answer to this question is “as much as you want!” You can start with $5.00 or $1,000 it doesn’t really matter. Of course, the more money you invest, the more you are likely to make, but that’s not exclusive to investing.
Many people often delay the initial plunge into stock market investing due to their belief of ‘needing a lot of money to start investing.’ One thing I can say for certain is the sooner you do it, the better!
Now there are no rules here on amounts (as mentioned above) but, the amount to invest, should be whatever you’re comfortable with risking (at your risk level). Note, you can decide to do an upfront lump-sum investment and see how it goes or you can decide to invest a little each month and slowly build your portfolio. One of the greatest benefits of investing is utilizing the power of compounded interest!
By now you should’ve written down your risk level and initial investment amount, now it’s time to move on to step 3:
STEP 3: Finding a Broker
Now this is a very important step in starting your investment journey because your broker acts as the intermediate between you and the stock market. In most cases they offer custody of your assets and they provide the platform for you to buy or sell stocks on whatever exchanges they support. The reason I say this is an important step is because when selecting your broker, you want to do as much research as possible to understand the services offered and what fees are associated. In some countries (e.g. the USA) brokers offer zero fees for buying and selling stocks, whereas in other countries (e.g. Canada), fees can range from $5.00. to almost $10.00 per trade. Therefore, for simplicity, let break this step down into a checklist that you want to meet when selecting a broker:
- Before anything ensure your broker is legit and not a scam (i.e. do your research!!)
- Ensure to find the broker in your country/region with the lowest fees. Note, some brokers require a minimum deposit so if you’re not looking to invest much, look for a broker no minimum deposit.
- Ensure the broker you select offers the exchanges you wish to trade on. For example, if you live in Brazil but would like to buy US or British stocks, your broker needs to support trading on exchanges in those countries (as a rule of thumb, I recommend finding a broker that supports trading on exchanges in the USA, regardless of what country you are in.)
Once you’ve selected your brokerage account, and before you start investing, we next must address the most important step in investing!!
STEP 4: Deciding your Investment Strategy
As I mentioned earlier, no two people have the same situation or risk tolerance therefore spelling out a universal strategy would be infeasible. Now, I don’t expect you to be an expert by any means when it comes to crafting your portfolio, but I’m also not going to recommend investing blindly in a company without establishing a proper reasoning for doing so. Therefore, I would like to propose four primary objectives which you should cover when crafting your investment strategy. For this step, I suggest writing this up on a new sheet of paper, word document, etc. as this strategy should be considered your mission statement for investing in stocks.
Firstly, you need to clearly identify your time frame for investing – generally I’d break it down into short-term (<3 months), medium-term (3 months – 3 years) and long-term (>3 years). This could imply, when are you likely to make your first withdrawal from your account? In general, your investment timeframe should be in line with your goals and risk level for investing.
Secondly, you need to determine your level of financial knowledge – Are you someone who has a financial inclination, prior financial experience, or no knowledge of capital markets whatsoever? For those who have no financial experience whatsoever, the use of ETFs often provides the best vehicle to invest in as they offer a simple way to invest in a particular sector or group of companies without having to go through the hassle of ‘stock picking.’
Thirdly, you need to decide what method you would use to perform due diligence on your potential investments, this need to be consistent across all investment choices to ensure good decision-making. This objective is related to the second objective above, i.e. your financial literacy. For instance, I wouldn’t expect an investor without financial experience to know how to compare and interpret company financial statements and accounts to make an investing choice. I recommend the use of Investopedia or any books involving financial analysis to help improve your financial knowhow to assist with this process. I will however, discuss this in a later post.
In this analysis there tends to be two primary approaches (which can also be combined):
- A top down approach: Firstly, the analysis of macroeconomic conditions from a global perspective is performed, followed by a narrowing-in on the sectors which perform well during the determined conditions.
- The bottom-up approach: This focuses initially on the microeconomic environment i.e. company specific and uses concepts such as, the supply and demand of the service/product being offered by particular companies as well as the level of competition in specific sectors, then puts this into global perspective.
Finally, you need to decide what types of investments you prefer to and not to make. Now this objective is directly correlated to your risk level and provides the basis for your choice of investments. Persons with a higher risk level, most times choose speculative stocks such as those companies that are yet to generate a profit (e.g. Cannabis and psychedelic focused companies, certain tech companies, etc.). These investments may provide a high return due to the high level of risk involved. Lower risk-oriented individuals may opt for a more defensive selection, such as government bond and blue-chip stocks. These investments offer a much lower return since there is a lower risk associated with it. Most importantly however, this process is done to ensure you manage your risk appropriately, because even if something looks appealing/promising to you, you should only invest if it matches your risk level! I have listed some resources in the last section of this article to help with this process.
Once your strategy is finalized, keep it in a place that would be fully visible along with the paper that you have used to write Steps 1 and 2! These documents provide a framework for final step in investing:
STEP 5: Let’s actually get INVESTING!
FINALLY, it’s time! By now you should have determined your risk level, decided how much you are willing to invest, selected a broker and crafted an investment strategy. Now remember, although this is the step that involves you taking action, the four-steps above are CRUCIAL to the entire investing process! You must adhere to your decisions for these steps and know that they’re not mutually exclusive. This means, if for example, you feel as though you are willing to invest more money or you have a different situation and would like to update your risk level, ALL four steps should be revised simultaneously not just one! (in most cases the choice of broker is the one decision that remains constant)
Now let’s talk investing and choosing your portfolio. First, the holy grail of Investing 101 – The Law of DIVERSIFICATION. No matter how bullish or bearish you feel on the market or what sectors or companies you prefer, it is imperative to always keep a diversified portfolio. Now why do we do this? As with every investment you make, there is a risk involved (in finance this is broken down into an unsystematic risk (company specific) and a systematic risk (general market). Now in order to lower your overall risk, diversification is essential. Have a look at this graph below:
Diversifying into a broad range of companies allows you to remove the company specific risk. This works by taking advantage of correlations (also called beta) between stocks. This is best explained through an example:
For example, the stock of Exxon Mobil (Symbol: XOM) within the energy sector has a strong correlation (high beta) to the stock of BP (Symbol: BP) due to both companies being in the same line of business and in the same sector. However, the stock of Exxon Mobil would have a weaker correlation to the stock of a company like Coca Cola (Symbol: KO) because they have very different business operation activities. So, in a hypothetical situation where an oil spill occurs, all stocks related to companies in the energy sector (e.g. Exxon Mobil and BP) would be negatively impacted however, it is possible that while this happens, stocks in the Consumer Discretionary sector (e.g. Coca Cola) would actual increase, as money flows out of energy stocks and into other sectors. Therefore in this situation, instead of investing in Exxon Mobil and BP, it would have been wiser to diversify by investing in Exxon Mobil and Coca Cola, thereby reducing the risk.
Now that you understand the basics of getting into investing, it’s time to have a go yourself. As a rule of thumb, it is widely recommended for newbie investors to first invest in a general market ETF before trying to pick and choose sectors or companies. ETFs such as SPY or VOO track the S&P 500 index in the US stock market and as such, offer a great, diversified vehicle for your first investment. After you feel confident enough to make your own decision, with due diligence of course, you can then start selecting stocks that stand out to you as investable.
Personally, I am in two minds about the common phrase “invest in what you know” because while considering an investment in a company that you are familiar with would be helpful, it should NOT be the primary basis for making an investment! Nevertheless, these steps should provide you with a guide to investing and hopefully would allow you to start sooner rather than later!
Some Additional Tools and Resources:
I definitely recommend setting up a spreadsheet of some sort in order to keep track of all your investments for learning and tax purposes. Additionally, having a printed or written version of your strategy on your desk at all times helps you to mention a good grasp of your emotions while making decisions.
I would also encourage you to read books such as “The Intelligent Investor” and “The Little Book of. Common Sense Investing” (links embedded) as well as read articles posted by The Economist, The Wall Street Journal or Bloomberg. If you’re a more visual learner, I would recommend subscribing to the CNBC Television or Yahoo Finance channels on YouTube (links embedded) to get market updates/news and learn more about how to select companies and sectors to invest in.
I hope this post was informative and easy to digest for you. I know it is a lot of information to take in, therefore I encourage you to save and reread this article to better understand the steps outlined! I will be posting some more content soon explain some areas of this article in more detail.
DISCLAIMER: Please note this article does NOT represent Financial Advice and is intended only for educational purposes! The Investing Virtuoso is NOT responsible for any losses on investments made after reading this article. Invest at your own risk!