You're at a party with a bunch of people you don't know, but you manage to strike up a conversation with someone who told you he or she made a fortune trading stocks. This person tells you all about a hot new Internet stock that's sure to take your fortune to another level. You're hanging on this person's every word and can't wait to get home and put a big chunk of your meager life savings in this next big thing, because you want a fortune of your own and you want it now.
For better or worse, you can do just that. You can hear a tip on some hot stock, go home, and open up an online brokerage account, and with a few clicks of the mouse you're easily able to invest your hard-earned savings in a company you probably had never heard about until today. In fact, the only research you might be doing on investing is clicking on some Internet articles to figure out just how to buy a stock.
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Well, you've come to the right place. I'll not only explain to you the process of buying a stock for the first time, but I'll take it a step further and give you some tips to make sure your first stock purchase isn't also your last. All you have to do is follow these five easy steps.
Step 1: Answer this critical question firstBefore even opening and funding a brokerage account, any prospective investor must first answer one critical question: Can you afford to be an investor right now? To answer that question, you need to consider the following three questions:
- Have you paid off all credit card balances? If not, then pay your credit cards off before investing.
- Do you have an emergency fund with three to six months of basic living expenses? If not, then invest in your financial security first by building up an emergency fund.
- Do you have a little extra cash left over each month that you won't need for the next three to five years? If not, look for ways to cut unnecessary expenses out of your budget so you have room to invest.
By laying a strong financial foundation, a beginning investor will have the confidence necessary when times get tough. And I'll warn you now that tough times will happen at some point.
Step 2: Open and fund a brokerage accountIf your financial house is in order, the next step is to find an online broker that's suitable for your needs. Not sure which broker to use? We have a handy comparison guide here. One key thing to remember when opening your account is to fund it using only money you don't need for the next three to five years, since the stock market can be quite rocky over the short term. Over the longer term, though, it tends to march higher as the economy and businesses grow.
Step 3: Look at businesses, not ticker symbolsWhile your new friend at that party told a compelling story about a hot new Internet stock that's poised for greatness, it's best to avoid stock tips. Instead, your mission, should you choose to accept it, is to find a great businessthat's selling for a fair price, as opposed to buying a hot stock.
It's vitally important to remember that a stock represents a direct investment in a business and should be treated that way. Further, to have the greatest chance at success in investing, one should seek out top-notch businesses, which are those that tend to have a sustainable competitive advantage, a strong balance sheet, and great leadership. These businesses are harder to find, but the long-term rewards are well worth it. If you need some help finding great businesses, we've got you covered.
Step 4: Now it's just point and clickWith your financial house in order and using money you don't need for the next few years, you're finally ready to buy a great business that you can confidently hold for the next several years. Now all you need to do is hop on your broker's website to enter your order.
Most brokers will have step-by-step instructions on how to buy or sell a stock using their website, so be sure to check that out. However, as a general rule of thumb, you'll open up the order page, search for the ticker symbol, and enter the details of your trade. Among the decisions you need to make is how many shares to buy and whether to enter a market or a limit order. My advice is to always enter a limit order, which can be entered around the current stock price, or lower. Taking this step will ensure that the market won't take advantage of you and force you to pay a higher price for the stock than necessary.
Step 5: Check in, but not too oftenOnce your order goes through, you'll be the proud part-owner of a very small piece of a great business that should reward you through the years. That said, most beginning investors will have the urge to check in on that stock every few seconds or so to see how they're doing. They might even get disappointed as it goes down a few pennies, and depression could set in after it's down a buck or two. That why it's best to keep a long-term mindset, remembering that this is money you don't need for several years, which is why it's best not to check in on your stocks all that often.
Instead of checking the stock price, it's better to check in on the business. Read its quarterly and annual reports, and check out its latest investor presentations to make sure the business is still heading in the right direction. As long as the business is doing well, the stock price should follow, as long as the initial purchase price wasn't too rich, although even rich stock valuations can be outgrown by great businesses.
TakeawayBuying a stock for the first time is almost too easy. What's tricky is learning how to invest correctly, which is where these five easy steps come into play. Follow them closely, and you'll be on your way to a becoming a successful investor.
The article How to Buy a Stock for the First Time originally appeared on Fool.com.
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