How To Invest In Stocks For Beginners

When most individuals consider investing in the stock market, they often think about finding the next big thing, like the next Amazon. 

However, that's not the only approach to making money in stocks, and in reality, it's a strategy that often leads to losses. 

Many people lose money in the stock market because they are looking for the next hot stock without a solid long-term plan. 

They're constantly seeking quick profits, which is why the majority end up losing money. 

Despite the historical upward trajectory of the stock market over the past century, including periods of crashes and recessions, people still tend to focus on chasing trends and the next hot meme stocks rather than making genuine investments. 

Let's break this down into three main areas: 

1. first, we'll discuss what you can invest in the stock market, such as stocks, index funds, mutual funds, and ETFs. 
2. Then, we'll delve into the distinction between investing in stocks that generate cash flow versus those that don't. 
3. Finally, we'll explore different stock market investment strategies, whether passive or active.

Individual Stocks

Let's delve into the differences between stocks, ETFs, mutual funds, and index funds. 

When you invest in a single company like Amazon, you're essentially putting all your eggs in one basket and taking on a lot of risk. 

This is what most people think investing is. 

Trying to find the next big stock may seem enticing, but for the vast majority of investors (around 90 to 95%), it's not the best strategy. 

You know why? 

Because investing in individual companies requires keeping tabs on the company, and keeping up with things like: 

• its earnings calls, 
• how the financials are doing, 
• its innovation efforts, 
• the competitive advantages or the moat (which is how easy is it for competitors to come in to compete with this company)
• and the overall market dynamics. 

If you're not interested in or not willing to or just don't have the time to do this kind of research, investing in individual stocks may not be suitable for you. 

Because when the stock of a company you've invested in starts to decline, and you don’t understand what’s going on, it's easy to panic and sell, or conversely, to get caught up in the hype when the stock price rises, so you just buy because you keep hearing people say the stock is going up. 

This is where understanding your willingness to do the necessary research and take on the associated risks becomes crucial. 

While investing in individual stocks offers significant potential rewards, like if Amazon takes over the world, and you own some Amazon stock, then you will be making big bucks. 

But if Amazon were to go bankrupt for some reason, then your money also will go to zero and that is a really hard pill to swallow for most people especially when things are going down, but it's very easy to understand when things are going up.

Index Funds

Then the alternative is instead of investing in individual companies, you can consider investing in funds. 

There are three main types: 

• index funds, 
• ETFs, 
• and mutual funds. 

Index funds are passively managed, meaning they track a specific group of stocks typically managed by a computer. 

This automated approach keeps fees lower compared to funds managed by humans. 

For instance, there are index funds that mirror the performance of the S&P 500, consisting of the 500 largest companies in the stock market. 

If a company struggles and drops out of this list, the computer can kick it out of the list and replace it with a new company automatically. 

So this is one type of Index fund that offers exposure to the S&P 500, there are others that focus on various sectors like: 

• technology, 
• healthcare, 
• or specific indices like the Dow Jones or NASDAQ. 

Another thing about index funds is their restriction on how often it can be traded. 

So if you want to go and buy an Amazon stock, you can buy it right away, but with an index fund, it only trades once a day. 

So they have lower volatility as people can’t keep on buying and selling them, which makes sense given they are a long-term investment. 

The last thing is that index funds often have minimum investment requirements, ranging from $500 to $5,000, to own an index fund.

Mutual Funds

A mutual fund operates similarly to an index fund, but with one key difference: 

mutual funds are usually actively managed by a human money manager instead of being passively managed by a computer. 

While this may sound promising, in reality, the higher fees associated with mutual funds often don't justify the returns. 

Studies, like the one conducted by Moody's, have shown that about 75% of the time, these highly-paid money managers fail to outperform the market over the last decade. 

This means that just buying a low-cost fund could have yielded better returns after accounting for fees. 

Due to these higher fees, mutual funds may be less attractive to investors, at least for me. 

And like index funds, mutual funds typically trade once a day and also usually have minimum investment requirements.

Exchange-Traded Funds (ETFs)

Then there are ETFs, which can be seen as a blend of index funds, mutual funds, and individual stocks. 

Because ETFs offer the flexibility of being either passively or actively managed, depending on the specific ETF. 

However, the main distinction between ETFs and traditional index or mutual funds is that ETFs trade like stocks. 

This means you can buy and sell ETFs throughout the day as many times as you want, similar to individual stocks. 

ETFs typically do not have minimum investment requirements, making them accessible to a wider range of investors. 

So which one should you go for? 

Choosing between individual stocks, ETFs, index funds, or mutual funds depends on your personal financial goals and preferences. 

Personally, I find ETFs to be the most convenient option due to their ease of purchase and sale. 

However, it's important to do your own research and not blindly follow advice from a random guy like me on the internet. 

My preference for ETFs aligns with my goal of generating cash flow from my investments, which involves receiving dividends while waiting for the value of the investment to appreciate. 

And here is where you also need to understand your goals. 

For me, I like cash flow. 

Cash flow is basically when you buy an asset, you would want the value of the asset to go up right? 

But you also want it to pay you while you wait. 

And in the stock market, this payment is called a dividend.

Dividends (Cash Flow)

A dividend is essentially when a company pays its shareholders for owning their stock. 

Not all companies offer dividends, but for those that do, it indicates a few key things. 

Firstly, it suggests that the company is generating healthy profits. 

With these profits, the company can choose to first reinvest in its operations, so things like opening up more stores, investing in research and development to help grow the company. 

The second thing is to save for future needs like if there is ever an emergency, which is basically a rainy day fund. 

Now if they don’t want to reinvest it or save the money, the third thing they can do is to distribute the excess cash to its shareholders. 

If you own shares in a company, you're essentially a part-owner, and dividends are your share of the company's profits. 

This payment can come in the form of a check or a direct deposit into your brokerage account. 

So essentially you get free money for doing nothing except owning the stock. 

However, receiving dividends has its upsides and downsides. 

On one hand, it provides you with a steady income stream without having to sell your shares. 

On the other hand, it usually slows down the growth of the company's stock price since the company is not reinvesting its profits to expand its operations. 

Additionally, receiving dividends also means you'll have to pay taxes on that income, even if you choose to reinvest it all back into the company. 

So if you get paid $500 of dividends and you decide to reinvest it back to the company, you will still get taxed on that $500. 

So here is where you need to decide if you want more cash flow from your stocks or do you want to see more growth? 

If you prefer steady income and are less concerned about rapid stock price growth, dividends can be an attractive option. 

So you might look for more established companies that have a long history of paying dividends. 

However, if you're looking for huge capital appreciation and are willing to forgo the cash flow, you might prioritize growth stocks that reinvest their profits back into the company. 

In my personal investment strategy, I lean towards growth more. 

Partly because I still have a long time before I need to take out my investments, and also I don’t need the immediate cash flow now. 

So about 75% of my investment portfolio, including my stock market investments, consists of assets that prioritize growth. 

While I do have investments that pay me dividends, I lean towards assets that focus on growing their stock price. 

This approach aligns with my long time horizon, but it might change in the future if I want more passive income from dividends without needing to sell the stock.

Passive vs Active Investor

The third aspect to consider is your investing style. 

Are you more of a passive investor or active investor? 

An active investor is someone who directly selects and invests in individual companies, actively monitoring and managing those investments over time. 

On the other hand, a passive investor adopts a more hands-off approach by setting up a system where they might be regularly investing in funds like ETFs, mutual funds, or index funds every week or every month without actively managing or selecting individual stocks. 

You would just be buying more of these funds no matter what’s happening and this approach is consistent, automatic, and requires less ongoing involvement. 

It's important to note that you don't have to choose one over the other. 

For example, I use both strategies. 

While the majority of my investment is in ETFs, I do allocate a small portion of money for choosing individual stocks and keeping up with the companies that I have chosen. 

And everytime my paycheck hits the bank, I automate a part of it to buy the ETFs that I like. 

That’s the passive investment part, and this happens regardless of the market conditions. 

So whether the market’s up, whether the market’s down, whether the market crashes or booms, this strategy doesn’t change. 

Well, maybe I will buy more if the market crashes, but basically finding the right strategy depends on your preferences and level of involvement as an investor.

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Thanks for reading, cheers!

- Ivan