If you feel like it’s the best time to start investing but you don’t know how or where to start, read forward so you can start on the right foot, and be prepared for success in the market. Once you read this, you’ll be well-informed on what to do before you invest in a stock.
Investing in stocks is a very big deal. Investing-apps and its easy accessibility have made it seem as if it’s not something to be taken seriously and something you can make a quick buck with.
While making a quick buck with investing apps is possible, it’s not ideal.
Investing is a very pivotal and important step to take in your life. If you take this step without knowing what you’re getting into, you’ll end up like the majority of speculators who end in tears and lose their money. In order to take the first step into investing, you must know what to do before you invest in a stock.
Without any research, you’ll start out as the majority of the younger generations: a Robinhood account, and some random stock that you think is cool.
FYI, that’s not actually investing. There are several steps to take before you start investing and once you start, you need to know what you’ll be investing in, how much, and what investing actually is. All this, so that you don’t confuse investing with speculation.
Keep in mind that when I talk about investing in this article, it can be either investing through a Roth IRA or in a taxable investing account. More than likely though, you don’t want to be trading in your Roth IRA, it’s a long-term account and should be used only for long-term investments, but if you really want to use your Roth IRA to trade, do as you wish. I just know I wouldn’t do it.
Step 1: Know what Investing actually is
People often confuse investing with what some, like Warren Buffet or his mentor Benjamin Graham, call speculation. These terms are so often used interchangeably (especially by traders) that people have forgotten the differences of what investing and speculation actually are.
Let me explain it in the words of Benjamin Graham himself. “An investment operation is one which upon thorough [fundamental] analysis, promises safety of principal and an adequate return. Operations not meeting this requirement are speculative.”
What does this mean? Very simple, investments are operations that are performed after thorough and fundamental analysis has been conducted. This means that the investor knows (in the case of a single company/stock) what all the operations of that company are. They know the intrinsic value of the company, not the price it has on its stock.
This means that despite the price being at a certain level, the investor is aware of the value of the company by examining what its profits, management, labor, and other parts of the company look like. Also, if you’re a consumer of the company’s products, you have a bit of an edge there. More than likely, you won’t be buying a stock or examine all of its intricacies if you don’t like its products.
In essence, once you examine all of these complexities of the company, you are aware of its real intrinsic value. Now you are aware of whether the company is overpriced or under-priced on the stock market because you can compare it to its intrinsic value.
Upon this analysis, you make the decision to buy the stock if it’s under-priced, knowing that your principal investment is safe. Even if the company’s price goes down on the stock market, you remain unworried because you are educated on its intrinsic value and you are in it for the long-run.
Speculation is any other operation that does not follow these guidelines. Trading is not investing, by the definition of the most successful investor in the world, Warren Buffet. Trading is speculation based on technical analysis.
Speculation is how you make quick profits in the market by looking at price movements on a graph. As a trader, you should always be ready to lose the money you’re using to trade. Even if you believe that your technical analysis is absolutely right, trade with money that you are willing to lose. If you make a profit on that, then it’s a win-win scenario because you were using money that you were okay with losing, and you’ve now made a profit with it.
On a note from Benjamin Graham himself, never put more than 10% of your assets (in this case money) into your speculative ‘account’.
I don’t have anything against trading but the lack of education on the technicalities of investment vs speculation is something that needs to be addressed and corrected. Especially now that people continue to use the term “investing” for speculative operations.
Tracking your expenses is one of the first steps to take when building wealth. When you look at the stats of millionaires, something they all have in common is that they track their cash flows. This means the cash coming in and the cash going out. They track how they save, spend, and invest.
It’s worth noting that the majority of Americans don’t do this. If you start tracking your expenses, it will put you ahead of the game when compared to the majority of America.
So why should you track your expenses? When you do this, you begin to pay attention to what your money is actually doing. You begin to make certain discoveries about things that are taking a huge chunk of change and you never even noticed.
Things like food, an unused membership or subscription, daily unnecessary expenditures like Starbucks coffee, and more.
When you track your cashflows, you are ensuring that your expenditures and your income are both in line with your budget so you can maximize your savings and minimize unnecessary expenditures. Doing this will allow you to have more cash available for you to use in the following steps and then for investing or trading.
Step 3: Build an Emergency Fund
Emergency funds go a long way, they will keep you out of major financial trouble that you may never expect.
If an emergency arises, you don’t want to have to dig into your investment account to cover the emergency. What if your investment account is currently at a loss? By withdrawing your funds from the account you establish that loss instead of sticking with it until it picks back up.
Dave Ramsey, American radio show host, author, and businessman, recommends people to do the following: Start out with $1,000 in an emergency account. This will serve as a safety net in the case that things go downhill in the short term.
This advice is amazing because $1,000 can really get you out of so much trouble. In fact, according to an article published by CNBC, 61% of Americans would not be able to cover a $1,000 emergency with their own savings. Meaning that a $1,000 emergency would put more than half of the U.S. population in debt.
If you were to follow this in the order of Dave’s baby steps, once you have $1,000, you would pay off all your debt. Then, once it’s paid off, come back to the emergency fund and fill it up with 3 to 6 months worth of expenses.
What I did was simply to get started on my emergency fund, went past $1,000, and all the way to a full 3 to 6 months’ worth of expenses. But what Dave Ramsey recommends definitely works as well.
The simplified way to conclude mine and Dave’s way is as follows:
My way: Build the emergency fund all the way to 3 to 6 months’ worth of expenses from the start, and then move on to debt-payment, don’t separate the fund into 2 separate steps that go around the debt-payment
Dave’s way: Build a $1,000 fund move to paying off debt, and then come back to your emergency fund to complete it to a total of 3 to 6 months’ worth of expenses.
Both of these ways work just fine, the basic difference is that Dave’s way is more of a psychological method that allows you to see progress sooner so that you can start to build a mental ‘snowball’ and continue moving with your steps.
But also, I should add that not everyone can reach 3 to 6 months’ worth of expenses very quickly, and paying off debt ASAP is definitely a priority. So for those people who would take exponentially longer to save 3 to 6 months’ worth of expenses, definitely go with Dave’s way.
You’ll see progress sooner, you’ll also be out of debt sooner.
Step 4: Make a Debt-Payment Plan and Act On It
Whether you want to move on to this step after saving $1,000 for an emergency fund, or whether you do it when you fully fund 3 to 6 months’ worth of expenses, it is crucial to have a plan of action on paying off your debt and being entirely debt-free as soon as possible.
Avalanche Method: this is the method that saves you the most money and seems to make more sense from a mathematical standpoint. This method works by paying off your biggest debt with the biggest interest rates first and then moving down the line, paying off the next biggest debt up until you finish paying off all your debt. Doing this method saves you the most money because you are able to pay off the debt that is costing you the most first. Now, big debt doesn’t have enough time to accumulate interest because it’s being taken care of first. The downside with this method is that seeing progress takes longer because you’re taking care of your biggest debt first. I would say that this method is preferable for strong-minded people. People who don’t have to see immediate progress in order for them to continue with a goal. However, for the majority of people, I would recommend the following…
Snowball Method: this method is brought to you by, you guessed it, Dave Ramsey. This is basically the opposite of the Avalanche Method. You start off with your smallest and lowest-interest debts first, and you move on to the next smallest, up until you’re finished paying off all your debt. This method works for the majority of people because it builds a snowball. Once you see the immediate progress, you have a lot more encouragement to keep going.
Either way works but it’s up to you, one works mathematically to save you more money, the other works psychologically to get your mental snowball moving so that you can pay off all your debt with ease.
As long as you pay off all your debt and you end up debt-free, go with the method works for you.
Step 5: Prioritize Short-Term Saving Goals
Look, investing is a game that you play for the long-run. Trading won’t make you big bucks unless you’re willing to lose big bucks. More than likely, if you’re a beginner, you don’t want to start off trading with large sums of money, you will lose it.
You want to start out with long-term investments, so you need to prioritize your short-term savings goals ahead of that.
Because if you need to make a purchase within the next year to 3 years and your money has all gone into investments, you won’t be able to make that purchase, and you won’t know if your investments will be high or low in the coming year or 3 years. You don’t actually know what’s going to happen with your invested money in the short-term, that’s why it’s a long-term thing.
Since it’s a long term thing, you need to prioritize short-term goals so that when the time is here for you to make that purchase, you have the money to do it. Whether it’s an investment in a business, a house, or anything else… you now have the money to make that purchase.
That being said, don’t think that in order to do this, you have to wait 3 years or so before you can start investing, you can begin to invest at the same time as you save for your short term goals. Just make sure that you allocate your money accordingly, and that more money is going into your short-term savings because you have more time to invest, whereas you don’t have that same amount of time to save for short-term goals.
Step 6: Understand the Risk of Investing
Investing is a risky business. Once you track your expenses, have your emergency fund, you’re free of debt (or in the process of paying it off successfully), and you prioritize your savings goals and make allocations with your money to know where each buck goes, you have to understand that when you invest, you take a risk.
There’s no guarantee that your money will back in your hands with growth. This is why you need to know what you’re doing when you invest. More than likely, if you diversify, you won’t be seeing your money go down to 0. But if you do what I’ve seen some people do and put all your money in one investment, you run a very high risk that you need to understand.
The chances that the value of that money goes up is not guaranteed, and you run a risk of losing it.
I’m not telling you this to discourage investing, I love investing and I think it’s a great tool to grow your money passively. But I have seen individuals who put their money in a random stock or some ‘hot stock’ that’s currently all over the news and expect it to go up.
This is not the case, and if you succeed with that method then you’ve only gotten lucky because that is not a common event. One very important rule that I like to point out about investing is this:
If everyone is investing in it, it’s a bad investment. The high demand for the stock will make its price go up, and it will not be from the actual intrinsic value of the company, but rather all the hot news and the constant purchases of that stock. This is not an investment, it is speculation. You are speculating that the price will go up and when you make stock-purchase because it’s “the best new thing” you will more than likely end in tears.
That being said, trading is no different and it is actually more risky than investing. Returns might be higher in the short-term, but you don’t know where it will be going in the long-run.
These are not the only risks of investing, there is a lot more to consider when making an investment. Your best bet might not even be to buy a stock (or group of stocks) directly but instead to invest in a Mutual Fund, ETF, or Index Fund to maximize your profits without needing to take on so much work to minimize risk.
You have several options when it comes to investing, not just buying stocks alone. There are different approaches you can take and different ways of doing things in order to come out profitable in the stock market or bond market or any other investment you choose to make.
This leads me to my next point…
Step 7: Investment Education
When it comes to investing and knowing what you’re doing with your hard-earned money, education is key.
Please don’t go to one of those ads you see online about “want to learn how to start investing? Jimmy turned $1,000 into $10,000 in 7 days using our method, learn today”. This is not education on investing.
The people making those ads are making money from people like you who believe this nonsense. If what Jimmy did is real, then you must consider that the probability of being successful like this is very low.
There are real resources out there that teach you how to invest and how to be profitable with investing, some of these sources are free! On this website, one of my priorities is educating people like you on subjects like these and I’m doing it for free because I simply enjoy doing it.
This website is only one example, there are other sources and even books that can help you with this. One book I absolutely recommend to any beginner is “Back to Basics: Investing” by Eric Tyson, this book is perfect for anyone who is starting out. In fact, I recommend reading this book before even getting into a book like “The Intelligent Investor” by Benjamin Graham, because it gets you started on learning the lingo and the basics of investing.
“The Intelligent Investor” does a great job of educating you on the fundamentals of long-term investing but it doesn’t go very well in-depth about the basics of investing; it sort of just assumes that you already know the basics. This is why I recommend the “Back to Basics: Investing” book by Eric Tyson first.
Even though I don’t have a personal financial adviser, I do recommend getting a professional to help you with your investments or your general finances, while they may cost some money, the ROI of having an adviser can be immensely rewarding.
Keep in mind that as technology advances, the knowledge on personal finance is becoming very accessible via free online sources so that you don’t need an adviser for every single financial decision you make. Online sources can serve as an adviser, but please be careful and do scrupulous research on your sources if you want to make them a trusted source of information. That goes for websites like mine too.
On the topic of professionals, though, if you choose to invest in a mutual fund, your money will be managed in a pool of investments by a professional money manager, keep in mind that they do charge for their services. More often than not, however, the price to pay is worth it.
Something to Consider
If you don’t currently have a Roth IRA opened or any other type of tax-advantaged account. I highly recommend opening one up and putting your investments into these types of accounts. I recommend doing this before you consider going into investing without tax advantages.
Once you max these out, consider investing outside of a tax advantages account but please make sure to take full advantage of IRAs and other tax-advantaged accounts.
Opening a retirement account and starting as soon as possible will put you so far ahead on your journey.
Now, let’s quickly summarize what we’ve gone over. This is what to do before you invest in a stock or any other security:
- You want to know what you’re actually doing: are you going to invest your money or are you going to be speculating in the market?
- Next, track your expenses and your income it will put you ahead of the game and you will be getting rid of needless expenditures and maybe even motivate yourself on tactics to increase your income.
- After that, start your emergency fund. Whether it’s only $1,000 to start and then you go and pay off your debt, then come back and further fund your emergency fund… or you fully fund your emergency fund with 3 to 6 months’ worth of expenses right from the start. Start that fund.
- Make a debt-payment plan and act on it, do this using either the Avalanche method or the Snowball method. Whatever works better for you, use it. As long as you get rid of your debt, that’s all that matters.
- Next, you want to prioritize short-term savings goals. Make sure that you have the funds necessary to cover short-term goals. Remember, investing is for the long-run so you have time to build it but short-term goals are different
- Next, understand that investing is risky. Your money isn’t guaranteed to go up, and if you don’t know what you’re doing you could lose your money. Especially when you confuse speculation with investing.
- Finally, educate yourself. Find professionals who can help you, or find online sources like this one that can give you advice on subjects like investing. Make sure that no matter what (especially with online sources) you do your due diligent research on whatever your source of information is.
I want to clarify something. These steps don’t happen from one day to the next. They can take several weeks, months, or maybe even years to complete depending on where you currently stand in your financial situation.
I understand that we don’t want to miss on time in the market and more than likely if you’re on this article you’re trying to get started ASAP. So consider the following:
These steps are very important, which is why I wouldn’t want you to walk away from them to simply start investing now. If I were in the position where doing all this would take me several years but I wanted to get started in the market, I would find a way to make quick starts on these steps and have a foundation on each that won’t take me very long to achieve in order for me to start investing.
Let me give you an example, if I had not started any of these steps yet after I figure out what investing really is and track my expenses, I would quickly save up a $1,000 emergency fund in a month (at the longest). Then I’d get started on my debt payment with either the snowball or avalanche method to get the ball rolling. While starting this debt-payment process, I would also allocate a portion of my money toward my short-term goals and educate myself on the risks and intricacies of investing.
Once I have a plan on how my money is being allocated for my emergency fund, debt, short-term goals, and any education, I have a pretty good idea of how much money I have leftover for investing.
If after all this you have very little money left over to invest, start with something as little as $5 or whatever you can afford and make a regular contribution to an investment account where you can purchase fractional shares. Fractional shares basically mean that if I want to buy Tesla stock but only have $5, I can purchase part of the stock at $5. This can be done on accounts like Robinhood, M1Finance, or Acorns.
Any of these methods can be used to start investing, all while also having a plan on how to achieve your 7 steps listed in this article. I would personally recommend opening a Roth IRA account to begin investing for retirement. If you’re looking into trading, you should consider doing this outside of a Roth IRA but remember that short-term capital gains taxes will take a big chunk of your profits.
If you don’t have money to cover your basic necessities then you should probably consider stabilizing yourself before you invest any money in any security, even if it takes a few years. By investing under these circumstances, you are sacrificing your own well-being.
If you’ve made it to the end of this article, feel more than welcomed to leave a comment below! I reply to each of them.
Here’s to future wealth!