You are eager to invest in stocks, but because of the lack of education and experience you do not know where to start? For this, I wrote a guide so that any novice investor will learn how to invest in stocks. This article will serve as a starting point for more detailed articles on investing in stocks for beginners.
Basic ways to invest in stocks
There are 4 basic ways you can invest in stocks:
- Brokerage account – a taxable cash or margin account opened with a brokerage company. A broker is an intermediary between you and the financial markets, taking commissions for maintaining an account and executing your brokerage orders to buy or sell assets;
- Individual Retirement Account (IRA) – a cash account opened by an investor and managed by him independently. It has many tax benefits under certain conditions. It opens in almost any financial company: in a bank, brokerage company or mutual fund;
- Direct Stock Purchase Plan (DSPP) – the company offers investors to buy its shares directly, bypassing the broker and the stock exchange. Thus, investors save on transaction costs and prices, which are often lower than the market prices;
- Dividend Reinvestment Plan (DRIP) – the company offers investors to automatically reinvest all cash dividends into shares. In most cases, investors buy shares at a price below the market price with eventually no brokerage and stock exchange fees.
Basic assets for investment
As a rule, there are 8 types of basic assets in which investors invest. These assets can be invested directly or indirectly, through trusts, mutual, index and hedge funds:
- Common stocks – have the right to vote at the shareholders’ meeting. Dividends may be paid on common stocks. In case of bankruptcy of the enterprise, they are the last in the queue to receive the liquidation value;
- Preferred stocks – do not have the right to vote, but have the right to higher dividends, regardless of the company’s profits. In the event of a loss, dividends are not paid. In the case of liquidation of the company, they have the right to receive part of the assets before they are divided between the owners of common stocks. Can be converted into common stocks under certain conditions;
- Bonds – the issuer of a bond is obliged to pay fixed interest payments to the holder of the bond. In addition, at the maturity of the bond – is obliged to return the entire amount of the principal debt. Bonds are considered safer than stocks, because enterprises first pay interest and only then distribute the remaining profits among the shareholders. In case of non-payment of interest, the bankruptcy procedure of the company begins, in which bondholders are the first in line to receive liquidation assets;
- Mutual funds – regulated collective investment structures that use only certain long-term strategies. Investment portfolios are formed as pools consisting of funds from a large number of small investors. Managed by professional managers who receive salary and remuneration for earned income;
- Hedge funds – less regulated and riskier funds. However, potentially more profitable. These structures use a variety of strategies that are prohibited for mutual funds. For example, short-term speculation, short selling of stocks, trading in derivatives, etc.
- Index funds – types of mutual funds that form portfolios identical to market indices. They are distinguished by profitability at the level of stock indices, low costs for investors and an understandable strategy;
- Real Estate Investment Trusts (REIT) – specialize in investments in various projects and real estate. It is not necessary to invest in real estate directly, it can be done through such funds. One of the advantages is the high liquidity of the fund, in contrast to real estate. Fund shares can be immediately sold on the stock exchange, and real estate may have to be sold for months or years;
- Money market instruments – a market of currencies and highly liquid cash equivalents. Typically, these are various types of short-term debt with a maturity of up to 1 year.
Basic documents for stock research
Before investing in stocks, it is vital to conduct a thorough research. Otherwise, it threatens the loss of capital. There are 5 documents that contain all the necessary information for stock research. These documents are freely available and investors can easily obtain them:
- Form 10-K – is a type of annual financial statements that meets the stringent requirements of the US Securities and Exchange Commission. All public companies whose shares are traded on the US stock market are required to submit 10-K forms to the commission at the end of each fiscal year. Forms are available to everyone in the SEC EDGAR database. In fact, it is the most important document for investors;
- Form 10-Q – is a type of quarterly financial reporting that meets the stringent requirements of the US Securities and Exchange Commission. They are sent to the commission at the end of each quarter of the fiscal year;
- Annual report – as a rule, published in the form of a beautifully designed document for investors, according to GAAP or IFRS standards. Almost 10-K, but may also contain letters of top managers to shareholders. Management often describes its business vision, reports successes and failures, sets development goals for the next years, etc.
- Proxy statement – contains the final decisions of the shareholders’ meeting. At such meetings, shareholders appoint or dismiss members of the board of directors, set salaries to top managers, determine the development strategy of an enterprise, etc.
- Key ratio summary – many corporations publish a summary of the last 5 or 10 years, consisting of various key operating and financial indicators. Using this summary, you can quickly determine how profitable and efficient a company is.
Basic statements for stock research
Before investing money, buying shares of any corporation, carefully read the following 3 financial statements:
- Income statement – shows the size and structure of the accounting income or loss for a certain period. The structure consists of sales, gross, operating and net profit, interest payments, tax deductions, etc.
- Balance sheet – shows current and long-term assets and liabilities, including the structure of stockholders’ equity. The statement is not drawn up for the period, but at a certain point in time, being a “photographic snapshot” of the assets, liabilities and stockholders’ equity of the company;
- Cash flow statement – accounting income is not equivalent to real money earned or lost by a company. The statement shows the actual cash flow, namely, how much money has arrived or is lost from operating activities, from reinvestment in yourself, from taking and paying off debts, from paying dividends, from investments in production, etc.
All 3 statements are interconnected, displaying a complete picture of the financial condition of the company. It is impossible to study one statement of the report, ignoring others. Such mistakes will be expensive, especially if you invest in stocks that are a more risky instrument than bonds.