Investing in Stock Market For Beginners┃A Complete Guide
The key to making money in stocks is not to get scared out of them. — Peter Lynch
Investing in the stock market has made people fortunes and some lost fortunes.
But before investing in the stock market, you have to know what stock is and why it matters.
Most people think that the stock market is like a gambling casino. Although, in the short term. Yeah, it is a kind of gambling.
But in the long term, if you know what you are investing in, Then it isn’t gambling because you are not just blindly investing in the stock market.
Instead, you calculate your risk in the investment and read about the company behind that stock so you can make wise investment decisions.
In the short run, a market is a voting machine. But in the long run, it is a weighing machine. — Ben Graham
Some people use the Stock market for gambling, in which most people lose money. But it also can be used for making wise investment decisions to create wealth in the long term.
Why should you start investing in the stock market?
The reason people have to start investing in the stock market is historically for a hundred or more years. Stock market returns had outperformed any bond or any other alternative asset returns.
Sometimes the stock market may not have a good year. But in ten or more years, stock market returns always outperform other alternative asset returns.
The stock market provides the highest returns, and that’s the single most crucial reason you have to start investing in the stock market.
What is a stock?
It is a financial asset that represents fractional ownership in a corporation. If a company-issued 100,000 shares and you buy 1000 shares. Then you have 1% percent ownership of that corporation.
Why do companies issue stock?
The reason companies issue stock is because they want to raise a large amount of funding, which they couldn’t get from a private investor.
Companies have to issue stock to the public, so they obtain the funds from a private investor, and companies dont have to return that money to the shareholder who sells the stock. There are many buyers and sellers in the stock market. So if one investor wants to sell a stock, other people may want to buy it.
What is a market cap?
Market capitalization is the market value of the public company’s outstanding shares.
Stock price multiplied by the number of outstanding shares and you will get the market cap of that company.
- Large-cap ( 10 billion or more )
- Midcap ( 2 to 10 billion
- Small-cap ( 300 million to 2 billion)
These categories of large, mid, and small market capitalization are for the US stock market. Every stock market in a country has different requirements for what is considered a large-cap, medium, and small-cap.
So if you invest in foreign stock markets, then make sure to identify what is generally considered a large-cap, mid, and small-cap on that market.
Most people who invest in penny stocks usually invest in small market cap companies because they have more potential to grow.
Although, small market cap companies can grow exponentially. Most of them fail, so it’s high risk and high reward investment.
An investor who is just starting to invest in the stock market should not invest in small-cap companies because they don’t have the experience and skills to identify a winner in thousands of small-cap companies.
When you get more experienced with investing in the stock market and are willing to take higher risks for big rewards, Then you can consider buying a small-cap stock.
But if you are a first-time investor in the stock market. Then you shouldn’t start investing in small-cap companies.
Mid-caps are desirable for many investors because they are stable. But at the same time, they still have more room to grow.
Most investors who want to take risks but not too much usually invest in mid-cap companies because they are stable companies and still have the potential to grow.
An investor who is just starting and is willing to take some risk can invest in mid-cap companies because they are not small companies. But at the same time, they are not too big companies that dont have growth potential.
Mid-cap companies are great for investors who want some growth but at the same time want to invest in well-developed companies.
Large caps are for those investors who want to invest in companies that have already grown to their maximum level. Why do people want to invest in companies that don’t have room for growth?
Most people invest in those stable large-cap companies because they provide a dividend to shareholders. The dividend income is a sum of money paid annually or quarterly by companies to their shareholders out of their profit.
Investors who don’t want to invest in risky stocks and want passive income usually invest in large-cap companies because they provide dividends.
Large-cap companies pay dividends because they have a lot of cash. But they don’t have room to grow, so they start paying out dividends to their shareholders.
Preferred stock VS Common stock
Preferred stockholders have a fixed dividends income, and companies must pay dividends to preferred shareholders, While companies can choose not to pay dividends to common stockholders. But preferred stock doesn’t have voting rights while the common stock has.
In the event of bankruptcy, preferred stock has a higher claim on the company’s assets than common stockholders but less than bondholders.
It makes preferred stock desirable because it has characteristics of bonds and stock that appeal to some investors.
The downside of preferred stock is that it appreciates less than common stock. Preferred stock doesn’t have voting rights and gets a fixed dividend.
Common stockholders have voting rights. So they can take part in companies’ decisions, and Common stock prices give more capital appreciation than preferred stocks. Both have their pros and cons.
Do you want a preferred stock that pays dividends with no voting right and limited price appreciation or do you want a common stock with voting right and give you capital gains? You have to know what type of stocks are suited for your investment strategy.
You have to know what type of stocks you want in your portfolio by knowing how much risk tolerance you have.
Common stock is risky and rewarding, whereas preferred stock has less risk with less reward. Throughout this article, we will learn about common stocks because 90 percent of the stock issued in the stock market is common shares.
Type of risk in the stock market
Every investment people make comes with a risk, whether on a stock market or other markets. You have to know what type of risk you are taking by investing in the stock market.
Some of the risks you will face when investing in the stock market are.
- Interest rate risk: when interest rates go up, stocks go down because investors are selling stock to invest in bonds that provide better returns than before. If you are investing for the long term (5 to more years), then if you invest in a good quality business. The interest rate won’t affect your investment in the long run. But it is still a risk that may make your stock go down in the short term.
- Market risk: when the overall market is going down. Then your stock will also go down. If the businesses you invest in are in good condition. But their stock price has gone down because of the overall market. Then it might be a good opportunity for you to buy the stock at a bargain price and increase your capital returns.
- Liquidity risk: liquidity means how quickly you can convert your asset into cash. The more liquid asset is, the more quickly you can convert that asset into cash.
When you invest in small-cap companies with a low trading volume. Sometimes, it gets hard for investors to sell their small-cap stocks because there are not enough buyers and market makers. But liquidity risk rarely occurs in today’s market, where you can quickly convert your stock into cash. But still, you should be aware of liquidity risk.
- Political risk: it is a risk that stock would suffer because of political instability and unrest in a country’s politics. When a country has political unrest, Its economy will suffer, Which also drives its stock prices down. You have to analyze if the political unrest is long term or the short term and whether their economy may recover in the long run. The political danger that continues, in the long run, can affect your stock portfolio negatively.
- Volatility risk: When the price of a stock goes up and down more than a market, it is called high volatility risk. Volatility can measure by the metric called beta. S&P 500 or other market indexes have a beta of 1.
If a stock has a beta of more than 1, it is considered riskier. But If beta is less than 1, it is considered less risky. But usually, volatility is not a good measure that tells the whole story about whether a stock is risky or not. The beta will consider the share a high risk because it is more volatile than a market. But some stocks with more volatility are likely to provide higher returns. But still, It is a risk you should be aware of when investing in the stock market.
- Inflation risk: most investors invest in the stock market to get returns higher than inflation. So they can increase their purchasing power. But some years stock market doesn’t perform well, and inflation may be higher than the returns you got. Inflation risk is one of the crucial risks that investors should know about because if you understand the risk, you are better able to increase the return.
- Foreign exchange risk: when you invest in the stock market outside your home country, you have to convert your home currency into that country’s currency. So you can invest in their stock market. But investing in international stock has a foreign exchange risk.
For example, if you invest in Thailand. you will first exchange your currency for the Thai baht. let's say the exchange rate is one US dollar for 34.31 Thai Baht and you want to invest 100 dollars so you can convert those dollars into Thai baht which means you will have 3,431 Thai baht.
Assuming you don't earn any return on the investment and the Thai baht amount is the same. So When the US dollar appreciates relative to the Thai baht, Now You would need more Thai baht to get the same amount of dollars that you had before. Keep foreign exchange risk in mind whenever you invest in any international stock market.
Determine your investing approach
Some people are interested in actively picking stocks by themselves. But some people dont want to actively do stock picking because people have other things to do.
Every person has a different investing approach; some people who are not much into stock-picking will usually invest in index funds, ETFs, and mutual funds.
A professional fund manager picks the stock for them. So people who don’t have an interest in the stock market will not have to spend so much time reading about the company and doing valuation. Instead, they can focus on what they like to do and also build wealth in the stock market.
But some people are passionate about stock investing and want to pick companies by themselves.
These people also tend to take more risk than someone who invests in the index or mutual funds because funds invest your money into hundreds of companies, which reduces your risk.
Some people who want to take a high risk also get great rewards or losses by investing in individual stocks. But keep in mind to get great returns, you have to read everything about the company you want to invest in. so you can make better investment decisions about the company.
Picking an individual stock is not easy. But if you are passionate about it and do your homework on the company, you will likely increase your returns in the long term.
But first, you have to know what type of investing approach you want to take to build wealth in the long term.
Determine how much income you will invest in the stock market
You have to decide how much money you will set aside for investing in the stock market. Start with investing 10% of your income and then gradually increasing the percentage.
Focus on investing for the long-term
Short-term trading won’t build you wealth in the long term. If you want to be rich, you have to think long-term about your investment in the stock market.
Most people fail in the stock market because they don’t have patience. They get impatient and start trading stocks daily, which in the long term makes them poorer.
You have to focus on investing in the stock market for the long term because that’s the only way most investors can get rich.
Although, these are not the only thing to know when investing in the stock market. But these are some of the crucial things to keep in mind when investing in the stock market.
You have to learn every day in your life about investing in the stock market as you go through your journey to becoming a great investor.
“Spend each day trying to be a little wiser than you were when you woke up.” — Charlie Munger
Originally published at https://vocal.media.