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How to start investing in the stock market
Starting out as a first-time investor can be daunting. Read on to find out what you need to know to get started.
Savings rates have been very low for a long time — at or below the approximately 2.24% inflation rate from 1984 to 2020. This means that cash sitting in a bank account is hardly making anything at all, at best. And, at worst, it’s losing money in terms of purchasing power.
Instead, if you’re willing to take some risk and put your money to work, you could consider investing. When you invest, your money is at risk — prices rise and fall, and there is always the chance of getting back less than you put in. However, you could also reap inflation-beating financial rewards.
3 things to consider before investing
Before you start investing, spend some time figuring out:
1. What is your goal?
Because of the risks involved — and the potential for loss if you are forced to sell your investments early in order to access cash — it is important to have a plan rather than simply throwing an arbitrary amount into the stock market because you happen to be able to afford it today.
Think about what you will use the investment money for. Will you rely on it for retirement? To buy a house? Or is it for something less consequential, such as a vacation, general savings or even “fun money?”
2. What is your time frame?
Investments regularly rise and fall, and the choices for what to invest in as well as what to expect to happen after you buy are largely dependent on how much time you expect to keep your money invested.
- Long term: Investors with long-term or retirement goals often keep their money in the market for decades and reinvest their dividends in order to maximize the compounding of their returns. Even if markets crash, they have faith that prices will rebound before they reach their goal.
- Medium term: Investors who are approaching their goal or who are trading a broad market trend may be investing for several years. They generally ignore small corrections but may be following a risk management strategy like a hard stop-loss or trailing stop-loss to protect their portfolio during bigger corrections or bear markets.
- Short term: Investors or traders who put their money to work for temporary opportunities or seasonal trends often develop plans for when to buy and sell, or they follow technical chart signals.
If you think about your goal and your time frame, you might realize you don’t need to take much risk and can reach your target in time with less risky assets such as government or investment-grade corporate bonds. If you are going to need significantly more money in less time, you may face having to take more risk to get it.
3. How much risk can you take?
There are 2 types of risk: activity risk and investor risk.
There are 5 main asset classes, and each carries its own typical level of risk. In order from least to most risky, it generally goes: cash, government bonds, corporate bonds, rental real estate and stocks.
Risk typically means unpredictability of returns. With cash, you know how much you have, you know how much interest you’ll get, and you know you won’t lose any of your capital based on government insurance. What you don’t know is a) how high inflation will be and b) how likely your bank is to go under — although the latter has historically been a rare thing.
On the other hand, with stocks, you have much less of an idea about how much the price will fluctuate or how the dividend payout will change. This is why they are seen as the riskiest mainstream asset.
If you can’t afford to lose much money in a given year, you should put more of your money into government bonds and investment-grade corporate bonds — in other words, bonds from very stable companies.
If you could afford to lose more — say, 15% to 30% of your portfolio — in a bad year, and you would feel comfortable with that level of risk, then you could allocate more money to stocks.
Similar to the difference between a child driving a car and an adult driving a car, there is also risk in the person investing. A new stock investor is taking more risk than an experienced stock investor. You can reduce this risk by learning about and trying different investment strategies with a small portfolio, then expanding as you gain understanding and expertise in a particular asset type or strategy.
Your investment account options
There are several investment account types within which to start investing in stocks or any other regulated type of investment.
- Employer-sponsored retirement plans: These must be set up by an employer and offered to employees. While asset selection is commonly limited within these plans, a big advantage is the potential for your employer to match the amount of money you contribute to the account.
- Registered Retirement Savings Plan (RRSP): RRSPs offer the benefit of tax-free contributions and growth – you only have to pay tax when you withdraw funds. These types of accounts are meant for long-term investment, because you’re heavily taxed on pre-retirement withdrawals. Depending on the company offering the RRSP, you may be able to invest in select investment portfolios managed by a professional advisor, select investment portfolios managed according to computerized rules, select mutual funds or individual stocks, ETFs, options and more of your choosing.
- Tax-Free Savings Account (TFSA): While RRSPs let you make tax-free contributions, TFSAs let you make tax-free withdrawals. This means you can’t deduct TFSA deposits from your income tax. TFSAs can be used for any type of savings, whether long-term or short-term. Like RRSPs, you can have your investments professionally managed, self-managed or selected and maintained by a robo-advisor. Investments include mutual funds, individual stocks, ETFs, options and more.
- Taxable investment account: Invest using a normal investment account without any contribution or withdrawal limitations, though capital gains will be taxed.
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Other investment options
- Residential property: A home is a common investment, as value tends to increase over time.
- Life insurance: Some types of life insurance — like whole life, variable life or universal life — have a cash value component that produces a guaranteed and/or variable return.
- Exotic assets: These could include wine, art, cars or anything that could increase in value over time.
- Peer-to-peer lending: These are websites that allow you to loan money to individuals or businesses for a set rate of interest. It’s possible to earn more on these loans than you would make in cash, but some people are wary of this relatively new financial product.
- Cryptocurrency: Another new and exotic asset is cryptocurrency, with Bitcoin being the most well-known. Be careful when investing in crypto: It is an exceedingly volatile asset, it trades all hours of the day — even when you’re sleeping — and it can be more cumbersome to set up and fund an account.
Taxes on investments
When you invest outside of certain tax-advantaged retirement accounts, you will owe taxes on the money you make. Qualified dividends and long-term capital gains (investments held a year or longer) are part of your taxable income – but only on 50% of what you make. So, if you realized a capital gain of $10,000, you’d only have to add $5,000 of this amount to your taxable income.
Should you invest?
If you have money that you can afford to put at risk and want to try to make it work harder than it would in a savings account or Guaranteed Investment Certificate (GIC), and you are prepared to ride the ups and downs of the market, you might be ready to invest. Make sure to think about what you need the money for, when you’ll need it and how much risk you are prepared to take, then try to diversify your holdings accordingly.
The keys to getting started with investing center on having a plan and understanding the assets you’re investing in. If you can handle the volatility of investing and minimize the risks, there exists an opportunity to grow your money. Evaluate your options, learn what fits you best and compare the products and services that will help you achieve your goals, starting with online trading platforms.