Making money in the stock market may seem easy, but there are just as many stories about failures as there are about overnight success. Most success stories come from a diversified portfolio and many hours of dedicated research since we all know stocks have their ups and downs.
However, if you are determined to invest in an individual stock, ask yourself these five questions before buying.
1. Do You Understand How Stocks and the Stock Market Work?
Before investing in a stock, ask yourself if you understand the basics of owning shares in a company and how these work. By holding a part of a company as a stockholder, you will receive a percentage of the profits according to the proportion you own. Essentially, you are placing money toward owning a part of a company that will give you a return in the future.
Stocks represent the potions of a company, and the units are named shares. However, there are also different stock types. These are some of the most common examples:
- Common Stocks — These stocks represent a corporation’s partial ownership, giving the stockholders the benefit of having a say in corporate policies.
- Preferred Stocks — These stocks are a class higher than common stocks because they offer an exclusive advantage of higher dividends or regular payments to stockholders from the company.
- Big-Cap Stocks — A company with a stock market value of $10 billion or more.
- Blue-Chip Stocks — Blue-chip shares are from established and well-known companies with a huge market cap and excellent; think of companies like Boeing Co, Coca Coale, and IBM.
- Penny Stocks — These stocks have a selling price of below $5 and are from small companies with meager financial value.
All stocks are bought, sold, or exchanged between stockholders through the various stock markets, which must remain fair and transparent. In the U.S., the Securities and Exchange Commission (SEC) regulates the country’s stock markets.
If you want to become an investor in stocks, you trade in individual stocks by buying and selling, building your wealth over time.
2. How Much Money Can You Risk?
All investments carry a risk factor, and stocks are no exception because of price fluctuations caused by complex factors. For newcomers, this price unpredictability can prove terrifying; therefore, before deciding to invest in a stock, determine what you are willing to risk.
Make sure that the money you use to invest in stocks is not needed to meet other financial commitments. Instead, invest your surplus funds to help you generate an income.
How can you work out your investable surplus? Of course, you don’t want to push yourself further into debt if you already owe money, so first, consider where you owe money (mortgage, credit card debt, personal loans, and even other investment commitments. Then, if you determine that you have a surplus to invest in, do a risk tolerance test to find companies worth investing your money in.
Certain companies have a higher investment risk than others due to the specific nature of their industry. Although, that can also make their stocks worth buying. Therefore, before deciding to buy, assess your risk tolerance to prevent disappointment, especially from stocks in unpredictable industries that can even yield unexpected returns—for example, biotechnology stocks, commodities, energy, etc. Also, remember that some industries rely heavily on political or regulatory actions.
3. Why Do You Want to Invest?
Determine your personal financial goals to help you understand why you want to invest in stocks and to help you plan your decisions. For example, individual stocks remain a high-risk investment, so if you prefer a low-risk growth, perhaps you should consider investing in exchange-traded funds (ETFs) instead.
Value investing is one type of participation that can help you increase your wealth over time. It entails buying good stocks from lesser-known companies because of their lower cost.
Your financial goals will help you determine your investment strategy, so plan according to them.
4. Do I Understand the Company You Want to Invest In?
Deep knowledge of the company you are investing in is essential. Understand the company, the risk, and the cost of the investment. In addition, researching before committing can help you check the company’s performance history, potential growth, market cap, and associated fees. Luckily, there are several online resources with all the information you require.
You can check on individual stocks by finding recent earnings call transcripts, which summarize the company’s performance over the past year. You can also read online indicators to reference a stock’s status.
A company’s performance is another vital piece of information that can give you a good idea of its stock’s potential. The information you gather can also help you understand how long you should hold onto a stock. Selling too early might mean you lose on potential future earnings.
5. Does the Stock Match My Asset Mix?
It would help if you also looked at your existing assets to prevent buying too many of the same types of investments. After all, you want a diverse asset portfolio that spreads out the risk in case of underperforming assets or an economic downturn.
Financial advisers recommend an asset mix containing cash, stock market, and fixed-income investments. These need adjusting as your financial goals change.