10 Things to Know Before You Start Investing

Investing can be a scary proposition, but it can also be rewarding. Long-term investments can help round out your wealth portfolio, hasten your retirement, or let you work less.

Poor investing can have the exact opposite effect. So before you put your first dollar into the stock market, you should know the necessary principles and best practices. Not doing so would be like riding a motorcycle without ever taking a lesson: fun, but potentially disastrous.

10 Key Stock Market Principles and Practices

Begin With the End in Mind

The first thing to do is understand why you want to invest. Is your goal early retirement? Retirement on time with more money? A passive income stream so you can live a more affluent lifestyle? To have fun playing the game of investing?

Your answer will tell you important things about how you should invest. If you want to retire early, you’ll need a more aggressive — and possibly less stable — position than if you’re making it part of a traditionally timed retirement plan. If you’re investing for fun, it’s best to take your stock purchase money out of your entertainment budget instead of your retirement contributions.

Once your answer, take it one step further and attach some numbers. How much do you need to retire? What yield will your investments need to provide for you to reach that amount on schedule? What dividends do you want to realize each year?

These metrics are the critical connective tissue between having a financial goal and setting up a means to attain it through investing.

Pay Off Debt First

With very few exceptions, the money you have available to invest should first go toward paying off debt. Most of the time, the interest charged by even reasonably priced loans is substantially higher than the reliable yield from many investments.

Let’s compare the recent average interest rates for consumer loans and credit cards, assuming a good credit score:

• Secured Credit Card: 16.63%
• Personal Credit Card: 19.3%
• Personal Loan: 14.5%
• Business Credit Card: 16.83

Compare that to the stock market’s average yield, which historically hovers around 10%. If you invest in the stock market instead of paying off a loan, you’ll lose money overall. There are two possible exceptions to this.

First, like student loans, mortgages, and some car loans, very low-interest loans could cost less in interest than the average yield of your investment. If that’s the case, you can consider investing before those loans are paid off.

Second, if your employer offers pretax or fund-matched investment as a benefit, the net yield between tax savings and matching can double or triple the effective gain from that investment.

Stay Away From Day Trading

Day trading became popular in the late 1990s when the first online investment tools went public, allowing people to make trades in real time without a broker’s help. It gets the name from people trading daily (or multiple times per day) as though their investments were a video game instead of a long-term financial stake.

The two types of day traders are amateurs and big fish. The amateurs don’t realize it’s best to tweak your stock portfolio periodically and let the market keep your average yield on point. The big fish are highly experienced experts who understand the market well enough to make informed, real-time purchase decisions.

Unless you’re an expert, it’s best to avoid day-trading.

Cut Costs to Fund Your First Investment

As you get close to your first investment, the question becomes where you’ll get the money for that investment. Do not borrow that money, either from a lender or from your other retirement contributions. Investment yields reliably show good growth over time but can lose money in the short term.

Instead, find a way to cut your costs to fund your investment adventure. Cancel the gym membership you never use, pack your lunch twice a week, or scale back on your cable package. It’s not hard to find $20 here and there until you’ve saved $100 a month for an initial investment stake.

Understand Your Risk Tolerance

Many of your investment decisions will boil down to making a safer investment with a lower likely yield versus investing in something that’s more likely to perform poorly but could make you a lot of money if things go right.

Look back at your goals, metrics, and timelines for what you want to achieve with your investments. How critical are higher but risky yields as opposed to stable but lower appreciation? How much can you afford to lose short term? How long are you willing to lose money on paper waiting for an uptick in value and growth?

If you don’t have these answers locked down, it will be hard for you to make the informed decisions and risk assessments you need to make when investing. It’s not a bad idea to consult with a financial advisor to help you set these in place.

Practice the Half-and-Half Rule

Once you decide to invest, the half-and-half rule can keep increasing your available stake as you gain experience in the market.

Start with your initial stake from savings, as we discussed earlier. Moving forward, cut any extra money you receive in half. One half you can spend however you want. The other half goes into your investment portfolio.

The next time you get a raise, increase your family budget by half your take-home income and invest the rest. The same goes for your tax refund, annual bonus, money from a side hustle, and any dividends from your existing investments.

This is the most painless way to increase your investments over time.

Know Your Fee Structure

If you buy stock, you buy it through a brokerage or marketplace. Each one has different fee structures, which is how they make their money.

Some brokerage firms charge a flat fee every time you make a trade. Others charge a percentage of the value you purchase or of the profits you gain. Still others do a combination of the both.

Unscrupulous companies will present you with a byzantine and confusing set of fees so you’re never quite sure how much they’re going to charge — which means you can’t complain about how much you’re losing.

Whatever the fee structure is for where you trade, you must understand it. Those fees impact the actual cost of each share you buy and investment you make. That cost can turn a good opportunity into a bad one and a risky trade into a sure loser.

Know the math of your trading costs, and let it inform your decisions.

Fill Your Emergency Fund

Some investments are precarious. Others are safer but can still potentially lose money over time. Only savings bonds and similar accounts guarantee a yield, but that yield is often lower than inflation, so even they lose money from a certain point of view.

The bottom line is you can’t count on your investments, especially in the short term.

It’s a good idea to fill your emergency fund before you go deep into investing. Just paying off your high-interest debt, this move will help keep your finances in good shape if you lose short-term money in your portfolio.

A solid emergency fund also helps you weather periodic dips in the market. If you have no emergency fund, it’s easy to panic during a temporary downturn and sell your stock too early because you’re nervous about your real-time finances. With that emergency fund in place, you can rest easier and make more considered responses to the market.

Know Basic Investing Terms

The world of investing is like any other specialized field. It has its own language. You don’t need to know every word in that lexicon, but you should come in with knowledge of the most basic terms.

Here are some of the most important:

• Ask: The lowest price a seller will accept for an asset.
• Asset Allocation: The ratio of your assets between cash, bonds, and stocks.
• Bid: The highest price a seller will pay for an asset.
• Blue Chip: A company with a solid history of growth, dividends, and low risk.
• Bond: A certificate of a loan you give a business or government. These assets are lower-risk and lower-yield than stocks but higher in both than cash.
• Cash: Liquid money, the lowest-risk but lowest-yield asset you can own.
• Index Fund: A type of mutual fund that ties its yield to a collection of stocks in a certain field, aimed at reducing risk by taking a position in a growing industry.
• Mutual Fund: A pool of money from multiple investors that is invested in dozens or hundreds of stocks.
• Price-to-Earnings Ratio (P/E): The price of a stock divided by its annual earnings. If the P/E is 10 or lower, it’s usually a bad investment.
• Stock: A portion of ownership in a company, which grows or falls with the company’s performance. This is the highest-risk asset, but it carries the highest potential for growth.
• Yield: When a company pays a dividend, the yield is the percentage of the stock price as compared to the dividend paid.

Focus on Net Worth

Always remember the goal of investing is to increase your overall net worth, or the total value of your stocks, bonds, cash reserves, and real property.

It can sometimes be easy to lose sight of this in the face of exciting opportunities, troubling downturns, and the deep complexities of the modern economic landscape. It can be even easier if you get conflicting signals from different sources of information.

Just keep this main rule in mind: If it increases your net worth, it’s working. If it doesn’t, you should consider making a change.

Final Thought: All That Said, You’re Ready

Some people think they shouldn’t enter the stock market until they’re a sophisticated investor and analyst. Nothing could be farther from the truth.

Instead, view the above items as a quick checklist before you make your first investment. Once you’ve wrapped your head around them all, there’s no reason not to take your first affordable position.

Jean McDonald is a financial planner in California who provides hourly advice on retirement and investing strategies.