If you want to grow your wealth, or even just save for a secure retirement, investing in the stock market is one of the smartest moves you can make.
Stocks represent a small share of ownership over a corporation. That means when you buy a stock, you have a chance to own a small slice of one of the world’s best-known brands, such as Apple or Tesla — as well as hundreds of others making everything from medical devices to oil rigs to burritos.
Companies sell their shares to the public in order to raise cash to invest and grow. Afterwards the value of the shares rise and fall based on the corporation’s business prospects. That means when the company grows, so too does the value of your investment — if you are lucky, to the point where your stock is worth many times what you initially paid for it.
Of course, there’s risk in the stock market too. If the company falters you can lose money. Even, in theory, your entire investment.
Investing in stocks doesn’t have to be hard. But there are a few important questions you should tackle before you commit your hard-earned savings:
Question to ask before you start buying stocks
What kind of investor are you?
Should you own individual stocks or mutual funds?
What kind of stock market account should you open?
How to grow your stock portfolio
What kind of investor are you?
The appeal of the stock market isn’t hard to fathom. According to research from Vanguard, the stock market has returned around 10% a year, on average, going all the way back to the 1920s.
That means, if you’re patient, owning stocks is one of the surest ways to build wealth — and even become a millionaire. Start saving $500 a month in your 20s and, if all goes well, that 10% annual return could turn into a million dollars in around 30 years.
The problem is that that 10% represents a long term average — think over a period of 30 years or more. In any given year the stock market may be up or down as much as 40% from the previous one. If you need your money at the wrong time or if one of the stock market’s periodic bear markets spooks you, you could end up losing, not compounding, your savings.
That means you need to think carefully about what your goals are — and what kind of temperament you have — before you start investing in stocks.
Are you a long- or short-term investor?
The first question you need to settle is: What are you saving and investing for? Perhaps the most common goal for stock market investors is a comfortable retirement years in the future. It’s the reason millions of Americans save in their 401(k)s and IRAs. If that is your aim — and if you are still in your 20s or 30s — you can be reasonably confident you have enough time to ride out any bear market you encounter.
If, on the other hand, you are saving for a shorter term goal like the downpayment on a house, you may need to take a more careful approach, such as owning some bonds to protect your savings against a catastrophic loss.
How to invest in the stocks if you need the money soon
Of course, not everyone has the luxury of waiting decades for their investments to mature. If you need — or even worry that you may need — to tap your stock market investments in the next few years, experts typically recommend investing in bonds and cash (such as money market funds or CDs) alongside stocks.
While bonds’ investment returns typically don’t match stocks’ in the long run, devoting even a relatively small share of your portfolio to bonds can make it significantly less volatile. That can help you avoid the risk of having to sell when stock prices are down.
How Bonds Smooth Stock Market Returns
How three different stock and bond mixes have fared historically
Average annual return
Worst year
100% stocks
10.3%
-43.1%
70% stocks / 30% bonds
9.4%
-30.7%
50% stocks / 50% bonds
8.7%
-22.5%
Figures are from 1926 to 2020. Source: Vanguard
One more thing to remember: Even if you think you won’t need the money, you might get caught off guard. That’s because the stock market and the U.S. economy tend to move in tandem. You are most likely to lose your job during a recession — when a bear market is also most likely to happen. To protect against this double whammy, many experts recommend keeping as much as six months of living expenses in cash before investing in the stock market at all.
Are you a risk taker?
There’s an old investing saying that Wall Street has only two emotions: greed and fear. That’s because even if in theory you can ride out the market’s ups and downs, in the heat of the moment, it’s pretty tough.
That means in addition to your time frame, you’ll want to adjust your stock market investing strategy to what financial advisors call your “risk appetite.”
Stock Market Ups and Downs
The best and worst stock market returns over four different time frames
Best on record
Worst on record
1 year
53%
-37%
5 years
29%
-12%
10 years
18%
-4%
20 years
13%
0.50%
Average annualized rolling returns, 1872 to 2018. Note: Measure of a Plan’s figures do not precisely match Vanguard’s because they are based on different market indexes. Source: Measure of a Plan
Yes, I’m a risk taker
If you consider yourself a risk taker, you may want to still do a gut-check by studying the above table and asking yourself, “Am I ready to lose close to 40% of my life savings in a year, or even in a few weeks?” (In March 2020, the stock market dropped about 13% in a single day.)
If you are confident you can weather that downturn, it may make sense to invest 80%, 90% or even 100% of your long-term savings in stocks.
Some other things to consider:
Be aware of your age. Losing half your life savings can be a lot easier to stomach if you are in your 20s and you have only a few thousand dollars at stake and plenty of time to make up any shortfalls, than when you are in your 50s or 60s and investing a lifetime of savings.
If you are investing as a hobby, to learn how to research stocks and have fun, and only a small fraction of your life savings are at stake, you can probably safely take on more risk. Some investors set aside around 5% of their portfolios as “play money” to invest more aggressively than their life savings.
No, I am not a risk taker
If you don’t consider yourself a risk taker, it may make sense to buy some bonds, or bond mutual funds at the same time you buy stocks. Not only are bonds less volatile, but bond prices tend to rise when the stock market falls, as both professional and individual investors rush to move money into safe assets.
Some other things to consider:
It’s better to err on the side of caution. While owning more bonds may shave a few points off your long-term investment returns, if you panic and sell when the market is down 30% or 40%, there is a good chance you will lock in those losses, leaving you much worse off.
The best way to deal with the stock market’s ups and downs is to just ignore them. While it can be fun to check the progress of your investments daily, most financial advisors recommend logging in just once a quarter or even less. On average, bear markets last about 10 months, according to Hartford Funds. You should be able to rest assured that by the time you need the money, prices will be back up.
Are you a hands-on or hands-off investor?
Investors come to the stock market with all different levels of sophistication and interest. Some of us are eager to pour over financial documents looking for the next Apple or Amazon, while others…would rather get a root canal.
The good news is, you don’t need to love charts and numbers to be a great stock market investor. Many experts argue hands-off investors are actually the best, since they tend to favor the buy-and-hold approach that works the best in the long run.
Yes, I’m a hands-off investor
If the stock market isn’t your passion, don’t worry. You’re like most of us. Your aim as an investor should be to reap the market’s long-term average returns of 10% a year. You need to make a few smart decisions at the outset, but otherwise all this approach takes is patience.
Your main goal as an investor should be to buy a broad basket of stocks, so you don’t risk too much on any one company, and to keep your costs as low as possible, since investment fees eat into your returns. You will probably want to invest in mutual funds or ETFs, which allow you to own hundreds of stocks at a minimal cost. You can do this either on your own, through an online brokerage or mutual fund company, or with help from a financial advisor or robo-advisor.
No, I am a hands-on investor
If you have the time and inclination, building a stock market portfolio based on your own convictions can be fun and rewarding. Just don’t expect to get rich overnight — or even any faster than set-it-and-forget-it investors. Years of academic research shows even most professional investors tend to underperform the market as a whole in the long run.
The good news is it’s cheaper and easier than ever to trade individual stocks commission-free at online brokerages like Robinhood or Schwab. Experts typically recommend owning at least a dozen different individual stocks to get the full benefits of diversification.
One trick of the trade: It’s not unusual to find your best investing ideas clustered in one segment of the economy like tech or consumer products. If so, round out your portfolio with a mix of individual stocks and mutual funds or ETFs that target other areas of the market.
Should you own individual stocks or mutual funds?
Once you have figured out your goals, you are ready to decide what kind of vehicle you should use to own stocks. You may have assumed you would buy stocks directly. But most individual investors — including millions of 401(k) investors — usually buy large baskets of stocks known as a mutual fund. While mutual funds (and their cousins ETFs) may mean paying extra fees, they can save you a lot of time and hassle. Here is what you need to know about each of the major stock market vehicles.
Mutual funds
Easy option for beginners
Great way to own hundreds of stocks
Buy and sell once a day
Costs vary
If you want to buy an entire portfolio of stocks — or even one that includes other assets like bonds and commodities — in one fell swoop, a mutual fund is the way to go.
These vehicles, which have been around since the 1920s, own dozens or even thousands of stocks and are overseen by a professional fund manager. For sale through brokerage accounts, in 401(k)s or directly from large fund companies, they allow you to buy or sell once a day, guaranteeing you that day’s market closing price.
Index funds: While mutual funds follow many different investment strategies, a great place to start is an index fund. Index funds own all (or most) of the stocks in the market and aim to match the stock market’s overall returns, while keeping fees as low as possible. Despite aiming for only “average” performance, studies show high fees associated with funds that try to beat the market mean index funds typically perform better.
Mutual fund fees: In general, look for a mutual fund with a strong long-term track record (at least five years) and an “expense ratio,” a measurement of investment fees below 0.5% ($50 for every $10,000 invested.) Many index funds from well-known providers like Vanguard, Fidelity or Schwab charge annual fees of less than 0.1%.
Exchange-traded funds (ETFs)
Trade whenever you want
Requires some attention
Usually inexpensive
For most mutual fund investors, the ability to buy and sell a basket of stock once a day is plenty. But many professional investors want the convenience of being able to buy and sell dozens of stocks with a single trade, and the ability to do so all day long.
Enter exchange traded funds, mutual funds that trade throughout the day on the market like an individual stock. Most ETFs — especially those from major providers like Vanguard, iShares and State Street — are index funds, meaning they aim to replicate the returns of the market as a whole, or particular segment such as energy, technology or even marijuana stocks.
ETF Fees: Investors love ETFs because they have low annual fees. In general, you should look for funds with an expense ratio below 0.3% ($30 per $10,000 invested.) It should be noted however that ETFs are not necessarily any cheaper than traditional mutual funds that follow similar investment strategies.
Where to buy ETFs: It’s worth noting that because ETFs trade on the stock market like an individual stock, you cannot buy them directly from fund companies or, typically, in a 401(k). Instead you trade them in a brokerage account. Still, many financial advisors and robo-advisors will help you buy ETFs if you are not comfortable on your own.
Individual stocks
Control over your portfolio
Requires attention and skill
Buying individual stocks lets you invest directly in companies you love — and perhaps believe will see their values rise much faster than the overall market. Of course, you have to be willing to do the work of researching companies — and willing to stare down the long odds, since even the most professional investors who aim to pick winning stocks underperform the market as a whole.
Additional risks of individual stocks: Owning individual stocks also comes with extra risk. Data from fund researcher Morningstar shows nearly 40% of individual stocks have endured at least one three-month period with a price decline of 50% or more, compared to just 2% of mutual funds. Experts typically recommend owning at least 20 stocks in different industries to build a diversified portfolio of individual stocks.
Paper trading: Want to own individual stocks but nervous about getting started? Try starting out with a practice account, or what is called “paper trading.” TD Ameritrade, for instance, has a platform called think-or-swim where new traders can get familiar with how the process works, without putting any actual money on the line.
What kind of stock market account should you open?
In the old days, you could get your hands on a physical stock certificate once you bought a stock and keep it in your bank vault. But in the digital age, you open an account with a financial services company, either online or in person.
Unless you’re investing for something particular — like retirement in which you might invest in an individual retirement account (IRA) or education in which you would invest in a 529 Plan — your investment account will be called a brokerage account. These are offered by most of the major financial companies you’ve likely heard of, like Fidelity and Charles Schwab.
Information to gather before opening an account
To open an account, you’ll need basic information like your Social Security number and date of birth, but you will also likely be asked about employment. If you’re not a U.S. citizen, you’ll likely need to share details from a passport and residency visa. In most states, you’ll need to be 18 years old, but many brokerages allow adults to open custodial accounts for children.
How to open a retirement savings account
For millions of Americans the simplest route to investing in the stock market is through a workplace retirement plan like a 401(k) or 403(b). If you work for a large employer you may even be automatically enrolled. Most 401(k)s offer investors a roster of mutual funds to choose from, including a default investment option that is usually a broad-based mix of stocks and bonds.
Retirement plan contributions and matching: When employers automatically enroll workers in a retirement plan, they typically set your contribution rate (the amount of money deducted from your paycheck) at 3%. The employer may also offer a matching contribution, contributing its own money to encourage savings. Financial advisors almost always recommend contributing at least enough money to get the full employer match, since this represents free money.
401(k)s and taxes: One of the benefits of a 401(k) or similar plan is that you contribute pre-tax dollars. You do eventually pay taxes — at income tax rates on your withdrawals in retirement. But the accounts allow you to avoid taxes on capital gains and dividends.
How to open a retirement account on your own
If your employer doesn’t offer a retirement plan, you can open an individual retirement account (IRA) through a brokerage like Charles Schwab or Fidelity. Traditional IRAs allow you to grow your retirement investments on a tax-deferred basis, like 401(k)s. Roth IRAs, meanwhile, allow you to contribute after-tax dollars, so your withdrawals are tax-free.
How to open an online brokerage account
Outside of a retirement account, most investors own individual stocks, ETFs and mutual funds through what is known as an online or “discount” brokerage account.
These accounts, which are designed to be do-it-yourself and easy to use, were pioneered by companies like Schwab and E*Trade in the 1990s. More recently competitors that emphasize zero-commission trades and app-based interfaces like Robinhood and Webull have been gaining fans.
Online brokerage fees: While most online brokerages have followed in the footsteps of Robinhood, which popularized zero-commission trading, don’t fall for the misconception that stock trading at these companies is actually free.Robinhood and other companies earn their revenue in part via a system called “payment for order flow” in which a brokerage firm sends customer orders to high-speed trading firms in return for cash payments. While experts say customers are likely getting a good price for their trade, it’s important to remember that even “free trading” isn’t exactly “free.”
Buying mutual funds in online brokerage accounts: Many online brokerage accounts charge extra fees for buying mutual funds, unless they have a special financial relationship with the fund company. You can avoid these fees by buying exchange-traded funds or by owning an account directly at your favorite mutual fund company.
How to open an account with a robo-advisor
If do-it-yourself doesn’t appeal to you, but you still want an inexpensive, online experience, then you may want to choose a so-called “robo-advisor.” Betterment, Wealthfront and Personal Capital are some of the best known, but there are many others. These accounts, which gained popularity in the wake of the 2007-8 financial crisis, are typically designed for beginners. When you register you are provided with a questionnaire about your goals and willingness to take risks, not unlike the one at the top of this article.
Robo-advisors then use algorithms to design a slate of investments, typically ETFs, tailored to your needs. Some robos also offer access to in-person financial advisors who can answer more complicated investing questions, typically over direct message or telephone.
Robo-advisor fees: The best robo-advisors charge low fees, and are less expensive than hiring a human financial advisor. Betterment, for example, charges a 0.25% annual fee for its digital investing plan and doesn’t require a required minimum investment. Some robos, like SoFi and Personal Capital, include some advice from human advisors as well. And some brokerages, like Vanguard and Charles Schwab offer their own robo-advisors.
How to open an account with a financial advisor
Online brokers are all the rage now, but if you want to visit an in-person brokerage, you still can. You can head to a full-service broker like Merrill Lynch or Morgan Stanley, for example, for individualized investment advice from experts.
If you want old-school human contact that can help with more than just buying and selling securities, consider choosing a financial advisor. Do your research before hiring one, since there are several kinds of advisors — and they won’t all put your best interests first. A financial advisor who adheres to the fiduciary standard is required to put your best interests first, meaning that they can’t sell you a financial product that isn’t the right choice for your portfolio just because they’ll make a commission off of the sale. So before you pick an advisor, be sure to ask that they’re a fiduciary.
Financial advisor fees: But keep in mind, in-person, individualized attention is going to be more expensive than online brokerages and robo-advisors. While the price will vary, the average fee for a traditional advisor is 1% to 2% per year of your assets under management, a fixed fee of between $1,000 and $3,000 for a service such as creating a full financial plan an hourly fee of $100 to $400 per hour, according to financial advice site SmartAsset.
How to buy stock directly from a company
You can still buy stock directly from some well-known companies, like Starbucks and Walmart, through what’s called a direct stock purchase plan. Companies tend to use a third-party institution called a transfer agent — Starbucks and Walmart both use one called Computershare — to facilitate the transaction. You can usually find a link to the third party’s site via the company site of the stock you’re looking to buy. There are sometimes purchase requirements or transfer fees that can add up.
But many companies don’t offer these plans, and it’s now much more common to go through one of the other avenues we’ve highlighted.
How to buy stock from your employer
Some employers offer employee stock purchase plans (ESPP), which allows their employees to buy discounted stock in the company with after-tax payroll deductions or employee stock ownership plans (ESOP), in which the employer offers employees stock in the company without them actually having to purchase shares.
How to grow your portfolio
Diversify
Diversification is key to making sure that your portfolio has an appropriate mix of stocks, bonds and other assets like gold so that when one section of your portfolio tanks, another holds stead during volatility. Within your stock portfolio alone, it’s also important to diversify. Financial advisors recommend including small- and large-cap stocks, domestic and international stocks and those in different sectors. The S&P 500 includes 11 sectors like — technology, real estate and health care — and you want to ensure you’re never invested too heavily in just one.
How to diversify with mutual funds
If you’re going to invest in funds, a certain amount of diversification is already done for you. If you find you’re missing out on certain sectors, you can always round out your holdings by adding a fund that focuses on the area you’re missing. Select Sector SPDR ETFs, index funds for each of the S&P 500’s 11 sectors, can help you easily add sectors like energy through funds.
How to diversity with individual stocks
If you’re investing in individual stocks, experts recommend buying at least 20 to ensure you can actually diversify your holdings. Make sure you diversify between large and small, foreign and domestic companies, as well as growth versus value stocks.
Growth stocks: These stocks tend to look more expensive when compared to their current earnings, but their high potential for strong future results justifies the higher market price. Think of prominent technology companies Facebook and Amazon, which have typically looked very pricey in recent decades, but have grown by leaps and bounds — and rewarded investors handsomely.
Value stocks: Value stocks on the other hand, are seen as currently trading below their true value. Combining the two can help you balance risk and return in your stock portfolio. For any number of reasons — like a broader economic slowdown, or disappointing quarterly results, for instance — a stock may be beaten down at the moment, but as a result it is on sale. Snap up that discount, wait for a rebound, and you should be well-positioned for solid returns going forward.
Be hands off
If you’re a hands-off investor by nature, great. You can sit back and simply ignore the market’s ups and downs. But even if you are planning to pick your own stocks, you should aim to make long-term decisions and stick with them. (When someone asked billionaire investor Warren Buffett what his preferred time horizon was, he famously answered: “forever.”)
Be hands off to avoid trading costs: One big reason even professional investors fail to beat the market: trading costs. Traditionally stock market investors paid brokerage commissions each time they bought or sold a stock. In recent years, most online brokerages have gone commission-free. But this doesn’t mean trading is actually free.
Be hands off to avoid buying and selling at the wrong time: Taking a hands-off approach also helps you avoid making emotional decisions that ultimately mean shooting yourself in the foot. It’s no secret on Wall Street that individual investors tend to throw money at the market when stock prices are high, and fearfully yank it out when they tumble. It’s the opposite of buying low and selling high.Indeed, fund researcher Morningstar recently found investors lowered their potential market returns by 15% by trading in and out of funds at the wrong times. The best ways to combat this: Don’t be too aggressive in your stock bond, and once you’ve made your initial investment, do your best to tune out the market’s ups and downs.
Do your research
Before you invest in a fund or individual stock, do your homework to make sure it fits into your portfolio and maintains diversification.
Research funds: You can check out sites like Morningstar to see details of a fund’s performance, risk and more, along with ratings from Morningstar analysts. Fund companies will also provide information about their funds on their websites, including a description of why certain companies are in the fund and their weightings (here is an example of VanEck’s description of the VanEck Vectors Green Bond ETF).
Research stocks: There is public information you can sift through to get ahead when picking stocks. For example, public companies are required by the Securities and Exchange Commission to publish an annual report called a 10-K with details on a company’s financial performance and bottom line. Companies also have quarterly reports where they discuss financials like revenues and expenses, as well as details relevant to their specific company (Netflix, for example, includes the number of new subscribers per quarter).
Don’t forget about taxes
If you do pick a stock winner, congratulations – but just remember that in taxable accounts, Uncle Sam will want his taste. It’s important to always keep in mind how investing profits are taxed:
Short-term gains are taxed at ordinary income rates, while longer-term holdings fall under the capital gains rates of 0%, 15% or 20%, depending on income level. There are no capital gains taxes for buying and selling within traditional IRAs, although eventual distributions are taxed as regular income. Roth IRA investment gains are entirely tax-free, since the initial contributions were after-tax.
Buying stocks key takeaways
Investing in the stock market is one of the best ways to build your wealth in the long run.
Start by determining if you’re saving goal is far in the future, like a secure retirement, or if you’ll need the money sooner, like for a down payment on a house.
Then decide if you want to own mutual funds, exchange-traded funds (ETFs) or individual stocks.
No matter the investment vehicle you choose, you can you open an account with a financial services company, either online or in person.
Diversification among stocks, bonds and other assets is key to making sure when one section of your portfolio tanks, another holds stead during volatility.
Chris Taylor contributed reporting for this story.
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