Investing in the stock market is not a decision to be taken lightly. It’s true that astute investors, fortified with intensive market analysis and other information, have made impressive gains over the years. However, it’s also true that countless investors have lost money, often when they were not financially prepared to absorb the loss.
To help new investors establish realistic expectations, private equity principal Mark Hauser offers seven guidelines that will apply to varied stock market investment scenarios. However, new investors should always seek knowledgeable advice from an investment professional with a proven track record.
How the Stock Market Works
The United States stock market is essentially an electronic marketplace. Investors who want to own a specific stock can purchase one or more shares from an entity that owns the stock. Multiple sellers typically have shares for sale at any given time. In the short term, a stock’s price goes up or down daily based on supply and demand principles.
However, Mark Hauser explains that the market views a company differently in the longer term. The market collectively judges the firm based on its previous business outcomes and growth prospects.
If the business has robust sales and healthy profits, its stock will likely rise accordingly. The converse is also true. A company with declining sales and market share will gradually experience a drop in its stock price as well.
Investors Perform Detailed Market Analysis
Investors analyze multiple factors before developing an expectation of a specific company’s future results. The company’s prior performance, along with industry characteristics and economic variables, all play key roles.
Some market experts say investors look six to nine months ahead. Specifically, investors predict events and market forces that will help to shape the firm’s outcomes and competitive position.
Benefits and Risks of Stock Market Investments
As private equity investor Mark Hauser notes, stock market investments can bring several benefits along with well-known risks. Investors should become cognizant of both potential outcomes before embarking on a stock market investment program.
Stock Market Investment Benefits
Through stock market investments, individual investors can own a slice of many notable companies. If the investor purchases the stock at a reasonable price, and considers it a long-term investment, they have a good chance of earning a favorable return.
Highly astute investors may be able to identify stocks that will perform better than the market average. If so, Mark Hauser says their chances for a good return are even better.
Long-term stock market investments can also have a tax advantage. Even if the stock price rises, the investor won’t be taxed on the gains as long as they continue to hold the stock. However, the investor will owe tax on the money actually received, such as the stock’s dividend distribution.
Stock Sales May Incur Capital Gains Taxes
If an investor profits from selling the stock, they will owe capital gains taxes on that gain. If the entire buy/sell transaction takes place within one year, this is considered a short-term capital gain. The investor is taxed at their regular tax rate.
In contrast, investors who hold the profitable stock for a year or longer will generally pay the lower long-term capital gains rate. Finally, if the investor incurs a loss on the tax sale, it can potentially be a write-off against other gains or tax obligations.
Stock Market Investment Risks
Although the stock market has historically performed very well over time, there is no guarantee that individual stocks will follow suit. Many stocks perform poorly, and some companies end up facing bankruptcy. In this case, the businesses’ stocks are worth literally nothing.
Stock Market Investments: 7 Factors to Consider
As with any business endeavor, performing market research and developing a strategic plan increase the chances of success. Before jumping into the stock market, Mark Hauser says that new investors should develop a well-defined plan that takes multiple factors into account.
1. Build a Solid Financial Foundation
Before investing funds with no guarantee of return, investors should ensure that they are on firm financial footing. First, they should establish a three-to-six-month emergency fund that can provide a cushion for unexpected financial issues.
Examples include a job layoff, unexpected medical expenses, or substantial home or vehicle repair bills. By proactively planning for these incidents, the investor may be able to avoid a panic-driven stock sale that may result in a financial loss.
Eliminating high-interest debt first is also advisable. Examples include credit card debt that carries inflated interest rates and/or a high-interest personal loan. As a guideline, a debt instrument that charges over 6% interest is considered high-interest debt.
For reference, the S&P 500 American stock index has generated a 9.8% rate of return over the last century. Depending on an investor’s goals and risk tolerance, they should eliminate debt that charges interest near or above that rate.
2. Establish Investment Goals and Timelines
Private equity expert Mark Hauser says a “one size fits all” investment strategy does not exist. Each investor has their own investment goals, each of which requires a targeted strategy to achieve that objective.
To illustrate, some investors want to keep their capital intact while drawing income from it. These individuals might choose a conservative investment portfolio containing lower-risk companies or perhaps bonds.
In contrast, other investors (such as young professionals) want to build long-term retirement savings. These individuals may select stocks with chances of higher returns along with higher risks. Because younger investors have plenty of time to recover from a subpar investment, this scenario may be a workable solution.
General Timeframe Guidelines
Investment experts typically recommend that stock market investors commit to at least a three-year timeframe. If the investor’s financial goals rely on short-term income, they might consider a short-term Certificate of Deposit (or CD) or a money market account.
3. Develop a Personal Risk Tolerance
Every investor has their own investment risk tolerance. One individual may thrive on high-risk, high-reward stock investments. This investor’s stock market experience might resemble a thrilling rollercoaster ride.
In contrast, another investor wants to avoid risky investments that can be personally stressful for them. If that’s the case, a portfolio that contains both stocks and bonds might be appropriate, even for longer-term goals.
4. Partner With the Proper Brokerage
Dozens of brokerage companies cater to financial market investors. Each brokerage has its own focus, account types, and fee structures. To illustrate, investors focused on retirement will likely seek a brokerage offering individual retirement accounts (or IRAs). Parents planning for a child’s college education will gravitate to a brokerage with 529 plans.
Certain major brokerages offer their own line of mutual funds without purchase commissions. Investors considering mutual fund purchases might consider working with one of these brokerages.
Regardless of other factors, investors should always determine a brokerage candidate’s specifics before signing on the dotted line. Besides obtaining brokerage fee and account minimum details, the investor should learn about any informational resources the brokerage provides.
5. Utilize Due Diligence and Logic
Equally importantly, the investor is responsible for performing their own due diligence prior to making any investment. With free and paid resources available, investors should choose the mix that best suits their investment goals and budget.
Making investments based on logic is also important. Even if an investor personally endorses (and uses) a specific company’s products or services, they should base their investment decision on sound financial and market data.
6. Avoid Individual Stock Investments
Experienced stock market investors often focus on a specific industry or technology. By narrowing their focus, they develop knowledge (and sources of information) that better equip them to make profitable stock transactions. A brand-new investor is unlikely to possess this knowledge. Therefore, it is unlikely that they can make stock decisions that outperform the market.
Instead, newer investors may want to consider an index fund. These funds, separated into mutual funds or exchange-traded funds (or ETFs), each hold dozens or hundreds of companies’ stocks. Each time an investor purchases an index fund share, they own a slice of every company in that index.
For reference, a widely diversified index fund will include shares of stocks in varied industries. In contrast, a narrowly diversified fund is concentrated in one (or perhaps two) industries. Depending on the investor’s industry knowledge and risk tolerance, either scenario may work for them. Finally, for expense purposes, investors should know that some (but not all) index funds charge annual fees.
7. Prepare for Potential Investment Losses
Although every stock market investor wants to make money, every stock experiences a downturn at some point. New investors should take these stock losses in stride, says Hauser Private Equity’s Mark Hauser. Rather than immediately pulling money out of the market, they should consult with their broker on the best strategy for their needs.
Consider a Virtual Investment “Dry Run”
New stock market investors may consider a risk-free investment option. An online stock market simulator enables investors to analyze the market and make investments without putting their real dollars on the line.
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