How Do I Know What Stocks To Buy?
Investing is essential for building wealth but the shouting people on the New York Stock Exchange floor is off-putting to say the least. Thankfully, you don’t need to become the next Wolf of Wall Street to invest in stocks, but you will need to do some research. Let’s break down how to invest in stocks so you can confidently choose how you want to build your nest egg.
This article provides information for current and potential investors. The Money Manual does not offer financial advisory services, nor does it advise investors to buy or sell particular stocks or securities.
Table Of Contents
How Do I Know What Stocks To Invest In?
The stocks you choose to invest in will depend on several factors including your own personal financial situation. Before you dive into researching and buying stocks, you’ve got some homework to complete.
1. Figure Out Your Investment Style
Your investment style is dependent on how much you want to be involved in your investments. Do you want to be the one picking each investment? Do you also want to manage these over the years? If this is you, then you’ll want to dive into the research full force so you can make educated decisions about the companies you choose to buy stocks with. You will also want to review online brokers who provide accounts where you can pick and choose your stocks.
If managing your own stocks and investments sounds like your nightmare, don’t worry, you’ve still got options for investing in stocks. You’ll want to review robo-advisors or brokerage firms that will do most of the investment management for you at a low cost.
Whether you’re the uber involved investor who loves number crunching or the more passive investor who is happy to hand off that responsibility, you’ll need to understand the basics of how investing in stocks can impact your wealth and that is where your risk-tolerance comes in.
2. Identify Your Risk Tolerance
Anytime you invest, you’re taking a risk. That’s because you are putting some of your money into the stock market which moves up and down over time. That movement is called volatility and how much of that you want to weather is your level of risk tolerance.
Your risk tolerance depends on your own comfort but will also take into consideration the following factors:
- Your age
- Your time in the market
- Your expected retirement date
In general, the younger you are the more time you have before you would need to withdraw from your investment accounts. This means you also have more time to recover from any market volatility and you can handle a more aggressive investing mix. As you age, your investment choices will likely mature and transition to a moderate portfolio with a bit less risk. Finally, as you close in on retirement, your investments might adjust again to be more conservative (risk-averse).
At this point, you might be wondering what makes your investments more or less risky? The answer is stocks. We will dive into the details of stocks versus funds below, but what you should know now is that individual stocks are one of the higher risk investments. Generally, the more individual stocks you’re invested in the higher your risk level of your portfolio.
3. Open An Investment Account
Now it is time for you to open an account. No need to panic, you don’t need to know exactly what stocks to buy now. A common misconception is that your investment account is your investment, but that’s not quite how it works. For example, your 401(k) is not your investment, it is simply a type of account that holds your investments, like a nest. Your actual investments are the eggs in that nest – things like stocks, mutual funds, index funds, ETFs, bonds etc.
The type of account you open depends on the two factors we discussed above, your investment style and your risk tolerance.
If you’re a hands-on type of investor and want to choose your own stocks (this means you can handle a higher level of risk) then a brokerage account is a great place to start. There are a number of online brokerage accounts to choose from and you’ll want to take your time to review the costs associated with each one.
If you were the more hands-off kind of investor who would like to invest in stocks but not run the show, then you will want to look into opening a robo-advisor account. Robo-advisors will have you answer some important questions in the onboarding process that relate to your risk tolerance and current financial position. Then they will automatically provide you with investment choices that fit those needs.
4. Set Up A Budget For Stocks To Buy Now And In the Following Months
Once you have opened your investment account, you’ll need to figure out much you can afford to invest each month. This isn’t a number we can give you as there are many factors that go into it, including your available income. However, there are a few general rules to keep in mind when looking for stocks to buy now.
If you’re investing only in individual stocks, you typically want to keep this a small portion of your overall investments. If you’re investing in funds or ETFs, then you might consider expanding your budget.
Some investments, like mutual funds, have a minimum to invest (usually around $1,000). The cost of individual stocks varies and depends on the share prices at the time.
You don’t ever want to have all of your eggs in one basket, so it’s a good idea to continue contributing to your other retirement accounts like a 401(k) or IRA in addition to your new investment accounts.
If you have not opened an IRA or are not contributing to your employer retirement plan, then you should start there. Once you have those working for you, then you can learn how to invest in stocks individually.
Your personal finances should be in order, so if you have $0 in savings then investing in the best stocks of 2021 might not do you much good when you need to buy new tires.
5. Select Your Stocks After Doing Your Company Research
The best stocks to buy depend on you knowing the company you’re going to invest in. When researching a company you will want to review the following:
- Revenue trends and price history
- Profit margins and dividends
- Debt-to-equity ratio
- Competitive advantage
Once you analyze a company you can use this data and decide if you think your investment has the potential for returns over time. No matter which stock you buy, you should be thinking long term. Short term stock investments have a higher chance of losing money due to the volatility of the market. It’s about time in the market, not timing the market.
Remember how we said not to keep all your eggs in one basket? It’s a cliche, but one that is essential to understand. When investing you want to diversify your portfolio. This helps minimize your risk by offering a variety of investments. So when you’re looking for stocks to buy now, you shouldn’t drop every penny into one company. Even if you think Starbucks has potential to grow and earn you returns, there is never a guarantee and if you choose wrong you can lose your money fast.
Bottom line: Select your stocks only after company research (check out the section below for more on the factors to consider). Individual stocks should not take up your entire portfolio, nor should you only invest with one company as that puts you at a higher risk. Lastly, there is never a guarantee when it comes to the market and short term stock investments tend to be the most risky since you’re not allowing time in the market.
6. Don’t Drop the Ball, You Need To Manage Your Picks
No matter which investment path you take, you will want to manage your portfolio. If you go with the more passive approach and a robo-advisor you’ll certainly have a bit less work to do than the hands on investor who chose a brokerage and decided to pick their own stocks. Still, you need to be aware of your growing wealth so utilize a tracking app like Personal Capital or your investment account app itself.
Keep an eye on your investments, but don’t make rash decisions. The market will move and your investments will drop at some point. That doesn’t mean you should sell. You’re playing the long game, and in general this means you have patience and give your investments time to grow.
Let’s Do A Review: What Are Stocks And How Do They Work
Individual stocks are a common investment choice, but they aren’t your only option. You can actually buy multiple stocks all bundled up into sweet packages and those are called mutual funds, index funds, and ETFs. Let’s look at what separates these investment types below.
A stock is a small sliver of ownership in a company. When you buy stocks you’re hoping to earn a return on your investment. The return depends on many factors, including the assets and profits of the company whose stock you purchased. Stocks are also called “shares” and those who own shares are called shareholders.
Some stocks will pay dividends. Typically these are distributed to shareholders (that’s you if you own the stock) on a quarterly or annual basis. Dividends can often be reinvested right away buying you more shares. While dividends are an income source, they should never be your only plan for retirement income or building long term wealth.
A mutual fund is most often a collection of stocks, but they can also contain stocks and other securities like bonds.
Mutual funds can be actively or passively managed and this should be something you pay attention to. An actively managed mutual fund has an individual or qualified team of managers who make investment decisions. This means your investments will be changing and managers will be trying to outperform the market. These tend to cost you more money for three reasons:
- Every time a investment is bought or sold you pay the taxes and fees
- The managers themselves will often charge a fee
- Outperforming the market is not probable with studies finding that 95% of professionals can’t do it
Passively managed mutual funds (which can be an Index Fund) tend to be a better choice in order to avoid these excess charges. Basically, hiring a professional to constantly be buying and selling and monitoring your stocks in a mutual fund may sound like a good idea, but for most people it will cost them.
Index funds are structured similarly to mutual funds in that they are a basket that holds stocks. The difference is that an index fund tracks a particular market index such as the S&P 500 or Dow Jones Industrial Average. This means that you’re investing passively for the long term and your strategy is to gain the returns the market index over time. For example, the S&P 500 Index (the top 500 companies in the S&P) provides a historical annualized return of around 10%.
ETFs or Exchange Traded Funds are a common investment option. These investments provide exposure to a wide range of the market and they can be filled with stocks and securities.
The major difference between an ETF and the other funds is that they can be traded like you would trade stocks throughout the day. This makes them a common intermediate choice for the investor who wants to branch out from Index Funds or passive mutual funds. That said, you do not necessarily need to do the trading yourself as many online brokers and robo-advisors have ways you can set them up to track an index or operate another investment strategy- making them a passive investment option with low fees.
Please Note: There are the occasional actively managed ETFs offered by investment firms, but these are rare. If you choose an actively managed ETF the same downsides for the actively managed mutual funds above would apply.
What Are The Best Stocks for Beginners?
If you’re totally new to investing then it’s best practice to avoid buying individual stocks right away. Start simple and open an IRA or similar investment account. You’ll then want to choose an investment that is a bit easier to manage such as an Index Fund or ETF (passively managed investments are key!). Because these investments act as a basket for multiple stocks and securities, they come with much less risk and can still build your wealth in the long term.
As a new investor, your goal should be long term investing so that in the future you don’t need to stress about money. Short term investing — buying and selling individual stocks is sexy — but also risky and as you get started you might want to minimize that.
If you have already established your retirement accounts and regularly fund your investments each month, then you might consider a few stocks to buy now. You’ll need to dive into the company research so you can make an informed decision on which stocks have a potential for return.
How Do I Know What Companies to Invest In?
When you buy stock you’re a partial owner of that company (even if it’s the teensiest bit). You want to take that ownership seriously and invest your money with companies that have potential for returns. This means it is time to study up. Below are 5 key factors you should research before you invest in a company.
Examine Revenue Trends and Price History
Revenue is the amount of money a company made from sales or services. You can find this on the company income statement at the top and it’s often referred to as the ‘top line’.
A company whose revenue trends up over time is a sign of strength, while a company who trends down might be a sinking ship or struggling to sell their services. When you examine the company earnings, you should also review their overall price history of stocks. If this data trends up along with revenue it’s a good sign, but if it trends down you need to dig further.
Assess Company Profit Margins and Dividend Payout
A profit margin (also called a net profit margin) is how much revenue a company takes as profit after all taxes and expenses have been paid. These margins vary by industry so this should always be taken into account when reviewing this number.
A company whose profit margins remain consistent or grows — even in recessions — is a good sign of a company’s strength. If this is paired with a company that pays dividends then it can mean company steadiness.
Compare the Debt to Equity Ratio
The debt-to-equity ratio tells you how much debt (liabilities) a company has compared to their equity (the part you would own as a shareholder). Use the company balance sheet and divide the liability by the shareholder equity to find this ratio.
Keep in mind the company industry can impact what is a ‘good’ debt-to-equity ratio. That said the general rule of thumb is that any company at or over 2.0 is not a good choice and you should walk the other direction. If you have a low risk tolerance, then try to keep the D/E ratio to 0.3 or less.
Find the Company’s Competitive Advantage
The markets are saturated and there is no question there are some big players on the field. Those companies tend to have a leg up compared to their peers and this is called a competitive advantage.
As part of your company research you should always run a comparison of the company and its peers. How do they stand out in their services, products, etc.? While this is completely subjective and we can’t give you numbers, companies who dominate or have hard to replicate products often keep a competitive advantage. This means they will likely maintain their place in the market and your profitability.
Analyze the Company Business Model and Leadership
Lastly, you will want to review the company business model and their leadership. A strategy to build profit combined with an influential leader can spell success for the company. However, if they have recently experienced a major shift or have controversial business relations and practices, this might reflect in the value of their shares.
What Are The Best Stocks In 2021?
Here’s the reality, we can’t tell you what the best stocks for 2021 are because the market is unpredictable and we would never want to push you in the wrong direction. There are some exciting new companies like gene editing technology, but it will be up to you to research each company.
That being said, we can help point you in the right direction. Avoid shiny object syndrome when you are picking stocks in 2021. You’re generally looking for a company that can:
- Withstand some downs and come back strong
- Keep their liabilities low
- Maintain and grow revenue
- Exhibit strong leadership
- Stand out within the industry
These are simply markers that may indicate company stability. The market is still going to be volatile and this means a company’s stocks will go up and down in price. Stock picking will always carry higher risk as an investment strategy, so always approach this conservatively when it comes to your hard earned money.
What Factors To Consider When Buying Stocks For Your Portfolio
- Your Personal Financial Goals – How much can you afford to invest?
- Your Risk Tolerance Level – How much risk are you comfortable with?
- Your Current Portfolio Mix – Do you already have a diversified portfolio and utilize your company retirement accounts?
- Your Portfolio Management Style – Do you have the time and energy needed to pick the best stocks or do you need to have a more passive investment strategy?
- Your Time Horizon – How long before you retire or plan to collect on your investments?
It’s safe to say that for most people, a passive and long term investment strategy is best. However, if you really want to dive into picking stocks and trying to find the best stocks in 2021 then do so with only a portion of your investment budget and the knowledge that you’re kind of playing with fire.
The Key Takeaways For How To Invest In Stocks
We want you to make smart investment decisions and grow your nest egg so you can live comfortably in your golden years. This means you’ve got to approach investing with a strategy that takes into account your risk tolerance and is diversified.
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