From an outsider's perspective, the stock market can seem like a daunting place. Given the wide array of investment options and the complex rules and regulations surrounding modern investing, many individuals feel that investing is simply too overwhelming. This couldn't be further from the truth.
In fact, newly minted investors can use a few basic strategies to create an investing strategy built to outlast the test of time. Exploring and analyzing some of the more fundamental stock trading strategies will help ensure that you have the information you need to begin investing on your own terms.
The specific stock market strategy you use will be informed by your particular investing goals and the timeframe in which you are looking to invest. Individuals who are using their investments to prepare for a pending retirement will need to choose far less risky investing strategies than younger adults who have years of employment ahead of them.
Investing in Individual Retirement Accounts
For those individuals who are using investing as a means to build a retirement "nest egg," an individual retirement account, or IRA, can be highly effective and relatively easy to manage. IRAs are what are known as tax-advantaged accounts. This means that individuals choosing to invest in an IRA will be able to benefit from one of two unique tax formats.
For traditional IRAs, individuals do not have to pay tax on the funds they place into the retirement account. This means that an IRA account owner can deposit up to $6,000 a year and deduct this amount from their yearly earnings before tax is assessed. With a Roth IRA, individuals do pay tax on the funds they deposit at the time they enter the account, but they are not required to pay any tax on the funds once they are withdrawn.
With either form of IRA, individuals can choose the particular combination of stocks and other investment vehicles that are included in their account. Contributions up to the mandated limits can be made on an annual basis, and withdrawals from the account can begin when the account holder reaches the age of 59 1/2.
How to Obtain an IRA
Many brokerage services and retail banks offer IRA services to individuals. It is quite common for these account providers to present a series of investment options classified by their risk type and ranging from "very low risk" to "high risk." Your particular risk level will likely be informed by your own goals.
For example, if you are nearing retirement age and are seeking to create a stable retirement foundation, a low-risk IRA will likely be your preferred choice. However, if you are years away from retirement and have the time and tolerance for significant gains and losses alike, a higher-risk portfolio may be the right choice. In either scenario, you will have the ability to consistently monitor your account's performance and adjust your holdings as needed.
Although it is possible to withdraw funds from an IRA before the mandated age requirement, these early withdrawals will be accompanied by a stiff penalty, typically a percentage of the amount withdrawn. In addition, a portion of the money you withdrew may then be subjected to taxation.
Exploring Mutual Funds
Mutual funds are yet another popular investing tool and strategy that many casual investors use to grow their wealth with relatively manageable risk levels. By definition, a mutual fund is a collection of money deposited by a variety of investors that is then used to invest in a carefully selected grouping of stocks, bonds and other viable assets. The fund is overseen and actively managed by the designated fund manager.
The manager typically has extensive experience in market investing and leverages his or her talents and abilities to attract new investors. In exchange for their services, the fund manager is typically paid a percentage of the overall value of the fund they are managing. Because of this, the fund manager is incentivized to deliver the best possible results for their clients.
There are two basic types of mutual funds in existence today: open-end and closed-end mutual funds. The differences between these two fund types are quite significant.
Open-End vs. Closed-End Mutual Funds
When an individual chooses to invest in a mutual fund, they buy shares of the fund just as if they were purchasing shares of a company on the stock market. Depending upon the type of fund they are investing in, however, these shares may be quite different.
Open-end mutual funds have no restrictions on the number of shares that can be issued to investors. Because of this, these funds are not available on the actual market, even though the fund itself is composed of assets that do trade in the marketplace.
Generally speaking, the manager of an open-end fund will allow new and current investors to continue to purchase shares of the fund up until a point when they deem that the fund has become too large to manage with the same degree of precision. At this point, the fund itself may become closed to new investors. In order to purchase shares of an open-end fund, investors will typically have to communicate directly with the fund itself since these shares are not publicly traded.
Market Forces and Closed-End Funds
Unlike an open-end fund, a closed-end fund has a limited number of shares that are available for purchase. Shares of a closed-end fund are sold on the stock market, meaning that the price of these shares is directly influenced by a myriad of factors influencing all stocks.
A closed-end fund is created and organized as a company in its own right. As demand increases for shares in a closed-end fund, the price of these shares will increase. With that in mind, potential investors seeking to choose a specific closed-end fund for their own money will likely consider the experience of the managerial team, the likelihood that demand for shares in the fund will increase and the performance of the assets within the fund itself.
Mutual Funds vs. Exchange-Traded Funds
Investors who choose to deposit their funds in mutual funds commonly look to exchange-traded funds as well. The reason for this lies in the array of similarities between these two fund types. Although both mutual funds and exchange-traded funds – commonly referred to as ETFs – feature a diverse selection of stocks trading in the marketplace, there are some distinct differences between these two formats.
For starters, the shares of an exchange-traded fund are priced differently than those of a mutual fund. ETF shares are priced and traded no differently than other stocks being sold on the stock market, meaning the value can fluctuate at a moment's notice. This differs from a closed-end mutual fund due to the fact that the price of the mutual fund's share is reset at the close of each trading day. Although investors can sit on a mutual fund share during the trading day without monitoring its performance, this is not the case with an ETF.
ETFs are also commonly considered to be a more tax efficient investing option given the fact that buying and selling shares of the ETF can be accomplished without ever having to take money out of the marketplace, which would be required with an open-ended funded. A tax obligation could be created each time shares of an open-ended fund are redeemed, which makes for a significantly larger administrative headache compared to an ETF.
Income Investing vs. Value Investing
Among the wide variety of investment strategies that work, income investing – or investments in stocks that typically pay regular returns, such as mutual funds and ETFs – is commonly considered to be the optimal balance of risk and return.
For those who are seeking potentially larger returns and are also willing to wait a significant amount of time before reaping profit from their investments, a value investing strategy may be preferred. Value investing is typically defined as the buying of shares which, compared to the predicted price of the share over time, is highly undervalued. This methodology could be applied to established companies which, for whatever reason, have fallen on hard times, or newly minted companies which have yet to catch the eye of the general investment public.
In either scenario, this particular form of investing is commonly considered to be more tailored to individuals who are willing to wait an extended period – possibly months or years – without any form of payoff. With that in mind, value investing may not be the ideal choice for soon-to-be retirees seeking to build and sustain wealth. However, adults who have the capacity to invest funds allow them to grow indefinitely may find that this particular methodology yields the best results over time.
Leveraging Risk in Small Cap Investing
Investors who have a hearty appetite for risk and are willing to chase large gains may find that small-cap investing matches their expectations. Broadly defined, small-cap investing involves purchasing shares of companies which currently have a market capitalization somewhere in the range of $300 million to $2 billion.
These companies are often considered less popular for mainstream investors compared to large-cap stocks such as Apple, Google, etc. Their appeal, however, lies in the fact that they are prone to increased volatility and significant price action. If, for example, a small-cap stock catches the attention of the general public for any number of positive reasons, it is entirely possible for the stock to experience tremendous gains.
Moving Forward With Your Investments
Again, the point must be made that these stocks do carry their own fair share of risk. Investors who are choosing to pursue small-cap companies should already have some basic knowledge of the marketplace and are willing to engage more actively with the stock than they would with something like a mutual fund or IRA.
With any investment, investors should be fully prepared for any gains or losses that occur. Risk is an undeniable and unavoidable facet of the marketplace. Newly established investors may benefit from consulting experienced professionals in order to determine the best use of their current budget as it relates to their own investing goals. Many online brokerages offer additional assistance for those who are seeking out stock strategies for beginners or investment strategies that work for all budgets.