Investing may sound daunting. But 24% of beginner investors find it easy to invest on their own and know how to become an investor. Which means it is also possible for you to become one. You do not know yet how? This article will tell you precisely in only 10 easy-to-follow steps! Following these steps brings you further than most beginner investors will ever get.
1. Make an investment plan
The first step is to make an investment plan. It helps you to sit down and think of what you want to achieve with investing. Buying an asset, like a stock, is not a lottery ticket where you hope for a good outcome. You, as an investor, can nudge the odds in your favor. And it starts with planning. The investment plan is a guide for your investment decisions.
A good start is answering the following questions to create your plan:
What is your current financial situation?
What is your financial goal?
What is the risk you are willing to take with your investments?
What is your time horizon for your goal?
First, assess your current situation. Find out for yourself how much debt you have. Are you able to pay off more than the monthly interest? Maybe you have savings or an inheritance. Everyone’s situation is different, so make a balance of your assets and debt. Making up a balance of your situation is also a good exercise to understand the basic financials of companies.
You also have to answer for yourself the amount of money you are willing to invest. This can be an initial investment capital followed by monthly addition coming from salary. The monthly addition is not necessary. Decide what you can afford to use for investing.
Second, define your financial goal. A goal can be lots of things: a vacation home; your children’s college tuition; a nest egg for retirement or a passive income. These are just a couple of examples. The goal is up to you. Express the goal in money, i.e. I want to retire at 65 with $1.5 million in financial assets.
It is allowed to have multiple goals that will benefit you or your family. But be careful with chasing multiple goals at once. Some goals require different investment approaches and you, the investor, may make the wrong long-term decision.
The third is how much risk are you willing to take to achieve your financial goal. As you come closer to your goal of retirement, you would like to minimize your risk even further. The last thing you want is to see the nest egg being reduced in a market crash, while you retire next year. But when you still have 30 years before retirement, then more risk is accepted to grow wealthier. The investments have more time to make up for lost ground.
Last is the time horizon. Define properly when you want to achieve your goal. State a realistic time horizon. It is unrealistic to start the first year investing with $10.000 and expect to be a millionaire within two years. People who claim it’s a possibility, are lucky gamblers on the stock market. Which obviously has nothing to do with investing.
2. Pay off your debt
Investing works best when you have no financial worries. Without it, you make rational decisions. A stable income and zero debt obligations reduce these worries significantly.
Identify all your debts, such as student loans and credit cards. Are you able to pay off the monthly interest and a portion of the principal? Your debt only reduces with paying off the principal.
It is in general wise to start paying off debt with the highest interest first. Or talk to a financial advisor to find out what the best step forward is in your situation. After you paid off all the debt, you can finally start saving up for investment capital.
3. Decide the asset class
Most people think about the stock market when they talk about investing with friends, colleagues, and family. But stocks are only one of the many asset classes in the realm of investing. Bonds, real estate, and commodities are examples of other asset classes.
How do you decide the right asset class for you? Look at the goals and the risk in your investment plan. Match the goal and risk to the right class as not every class is as effective for every goal:
Real Estate: it is an ideal way to generate an income stream by renting out the property. Real estate has gone up for decades with temporary dips. Properties are considered illiquid, which may be not ideal for you. Other risks are finding the right location, the state of the building, and tenants. In addition, you have to maintain the property, which reduces the profit.
Bonds: you get an interest payment from the issuer on a regular interval. Bonds generate a stable income and are less risky than the stock market. Inflation and the issuer bring risk to bonds. Governments are unlikely to go bankrupt and payment of interest is almost guaranteed. Corporate bonds, on the other hand, can have a higher interest because they are less likely to be able to pay off the bond. The liquidity of bonds is higher than the real estate market.
Commodities: gold, silver, agricultural products, and oil are included in this asset class. Gold is well-known as a hedge against inflation. Some investors include gold in their portfolio for this sole reason. But the downside is that gold only goes up and down in value because of price speculation. Gold does not create value like real estate or stocks do. That is why many growth or value investors do not invest in commodities for the long term.
Stocks: allows investors to benefit from the growth and profits of the company. It is a good vehicle for capital growth, an income stream through dividends, or both. Stocks are considered riskier compared to other asset classes because of their volatility. A higher risk can also result in higher returns. Knowing how to research a company as an investment potential may reduce the risk significantly.
Cash & equivalents: includes savings accounts, short-term bonds, and certificates of deposits (CDs). These carry the least risk and are usually only hold for the short term. The capital invested maintains its value or deteriorates less by inflation. It is a temporal solution to use more time for finding a high-yield investment.
There is for every discussed asset class an ETF. ETFs are acquired in the same fashion as stocks. Here we like to focus as beginning investors on stocks. The following steps are for investors with a focus on the stock market.
>> Learn more: how to invest in stocks
4. Find your strategy
A strategy for investing is nothing more than guidelines and strict rules to follow during your years of investing. Rules and guidelines give direction when you feel the urge to act on your emotions. A strategy includes what type of assets you invest in; when to buy and sell and how much you are willing to allocate per asset.
There are plenty of strategies in existence that help you to make the right decisions. The options for retail investors with a long time horizon are limited. The limitation is good since investing should be as simple as possible. Adding unnecessary complexity does not guarantee higher returns.
>> Learn more: 4 investment strategies for retail investors
When you do not have time to find investments and manage them, look into passive investing. Your initial research is selecting the right ETF or mutual fund and putting capital in the fund regularly. The advantage is that you do not have to think about opportunities or timing the market.
Dividend investing is suitable for a steady income stream. Here you are required to do research. The risk is most likely lower when you choose to allocate capital to so-called dividend aristocrats. These are solid businesses with more than 25 years of dividend payout. They survived for a long time. Be careful here, as future survival is not guaranteed.
Growth investing is for growing your wealth. These types of stocks are considered the most risky compared to other stocks. The price of the stocks in this category is often merely based on future expectations. Doing due diligence here is absolutely required.
Value investing is looking out for undervalued companies and holding onto them for years or even decades. Some argue that the risks are lower because the companies are undervalued. But recognizing a truly undervalued company is difficult. You have to do lots of research to understand the business and its finances. The long-term prospects of this strategy are high. The best value investors like Warren Buffet and Peter Lynch applied this strategy.
Whatever strategy you choose, pick one according to your goals. Find great investors with the same or similar strategy and learn from their mistakes or advice.
5. The investor mindset
Besides a solid plan, capital, and a proven strategy, you need the right mentality. Everyone wants to make money overnight. It is not going to happen. You have to learn to invest, just like you went to college to learn a trade. Studying in college took a good few years. Investing is no different in that regard. Have the patience to get acquainted with investing.
Some of the other qualities of outstanding investors are common sense, self-reliance, open-mindedness, tolerance for mental pain, and willingness to do research. You probably already possess some of the qualities. Which is good, the rest you will learn over time by practicing.
6. Get a broker
To make stock purchases, you need a broker. This step may sound as easy. Open an account and start the investment journey. Finding the right broker for your strategy can be quite a time-consuming task.
A broker gets commissions when you open or close positions. Some have more commissions such as maintenance. The commissions you pay eat away a significant portion of your profits over decades. 1% does not sound like a lot, but it is money you can never compound. After 35 years of investing, you will have a lot less than without commissions at all.
Let’s assume you start with $10.000 and an annual return of 8%. The account balance is ~$147.000 after 35 years. It is with a 0% commission. With a 1% yearly maintenance fee, you will only have $104.000 left. Which is a huge reduction compared to 0%. And in both examples, the commissions for opening and closing positions are even excluded.
As you can see, fees have a considerable effect on future profits. So, take the time to understand the costs of several active brokers in your country. Read the reviews of their services and choose the best option.
7. Find your first investment
Now everything is set up, you have a plan and a strategy. You are eager to find an investment and wait for the profits to flow in. But not so fast, finding the right investment takes time.
Whenever you invest in growth, dividend, or value stocks, you have to find the one that is according to your strategy. Ask yourself how the company is faring compared to the competitors. It happens that a competitor has a better chance of gaining market share or any other metric you are looking at. Stock screeners, such as TIKR or Stock Rover, may help find you great companies.
Have the patience to find the one. It benefits you in the long term. Analyze the company thoroughly, which helps you stay true to your course when the stock or market gets in a downturn. The last thing you want is the emotions taking over and selling the stock at the lowest point.
8. Make your investment
Finally, you found an asset worthy to invest in. Great, now you can buy it through your brokerage account. There are several ways to invest all your capital in the stock. A well-known method is dollar-cost-averaging. This is buying the stock on a regular interval with a portion of the investment capital.
Dividend investors use the dollar-cost-averaging method to put a part of the received dividends in the company to get more and more dividends with future payouts. On the other hand, for value investors, this may be an unsuccessful way. Undervalued companies often stay undervalued for a short period. You likely will miss big opportunities when you want to buy at regular intervals.
Instead, buy the preferred number of stocks at once. Also, do not wait for the price to go down more. You do not know what the market is going to do. The stock you want to buy is already undervalued, so just jump in.
Look at the strategy you follow and decide what method is most effective. The best method came probably already forward when you learned about the chosen strategy.
9.Manage your portfolio
This is the time for holding. During this time, you keep up with financial reports of your investment. Which costs you approximately a couple of hours per quarter per company. Use this time to explore the markets to find new investment opportunities. Maybe you find a better-performing company than you have now in your portfolio.
For retail investors, it is perfectly fine to have a portfolio consisting of 5 to 10 assets. You can keep up with this amount of companies, but not more. And usually, your 15th or 20th investment is not any better than earlier investments. So why do you not put more into investments 1, 2, or 3?
Some would argue that more stocks protect against risk, which is called diversification. Great investors from previous decades argue for the opposite. Understanding the business reduces the risk as opposed to just buying stocks from multiple sectors. When you d not keep up with company reports, you have no idea why performance goes up or down.
10. Sell your investment
You assess your portfolio frequently and there comes a moment when you have to sell an asset. How do you know when the time comes to sell an asset? Ask yourself the following:
Is the company still attractively priced to earnings?
What does the company do to make the earnings increase?
You can conclude 3 things out of the above questions:
The company is doing better than before.
The company is doing worse than before.
The situation is unchanged.
Obviously, sell when the company is doing worse or far overpriced. When the situation is unchanged for a company then you can decide to keep it or sell it. It depends if you have found a better investment already because you can replace this one with the older one.
Sometimes, you will make a loss on an investment. You should sell the asset for two reasons. First, the company is doing worse than you expected, based on public information. Then for a company, it takes time to turn the taken course around.
Second, it is basic math. For a stock price to go down 10 percent, it has to go up 11.1% to get back to the original price. And when a stock price declines 50%, it has to grow 100% to go back. These are serious gains, that do not happen every day.
Bottom line
The 10 steps on how to become an investor show that you have to prepare yourself before investing in an asset. Sit down and create an investment plan. It will guide you through emotional times on the stock market. Paying off debt is another factor to bring stability to your life and investing times.
The following steps are deciding on the asset class you are going to invest in. Most of you will choose stocks and the article also focus on the stock market in the steps thereafter. The strategies proposed are easy to follow. It is proven by great investors in the past that simple strategies work.
You need an investor’s mindset to become successful. It will take practice to get the mindset. Following your plan nudges you in the right direction.
Selecting a broker will be your first profit. Followed by finding an investment and buying the asset. Then you have to manage your portfolio and sell when you see that the company is not working on growing its future earnings.
These 10 steps help you to become a successful investor. Be aware that it takes time to become better. As with everything, it takes time to master a trade. After step 10 you went through one cycle. Repeat steps 7 to 10 every time. Remember, it is fine to have multiple investments in your portfolio.
