For those who have never invested in the stock market, exchange-traded funds (ETFs) are a great starting place. ETFs generally track the performance of specific indexes or industries. So if I buy a share of an Samp;P 500 ETF, I will be buying a tiny piece of all 500 companies that are included in the Samp;P 500 index.
This approach helps by giving you lots of exposure to the 500 largest US-based companies, as well as the diversification necessary to avoid being wiped out by a crash in any single stock or industry. Three popular ETFs that offer broad exposure and have low fees are SPDR Samp;P 500 (NYSEMKT: SPY) , Vanguard Samp;P 500 ETF (NYSEMKT: VOO) , and iShares Core Samp;P 500 (NYSEMKT: IVV) .
If I were just beginning to invest today and had a lump sum of cash to invest, I would open a Roth IRA and put 80% of that cash into ETFs, keeping the other 20% for later (more on that below). This isnt by any means the only way to go; its just what I would do.
Buying your first stock
Im going to make the assumption that you not only have a lump sum to invest, but will be able to put away a little money every month -- thats what happens when you spend less than you earn!
The process of buying your first stock can be daunting. We have a whole page devoted to it. There are literally millions of ways you can go about choosing your first stock to buy. Generally, however, I would suggest using these four criteria as basic guidelines.
1. Pick a company you know. Its OK to invest in brands everyone knows, like Coca-Cola (NYSE: KO) or Apple (NASDAQ: AAPL) . Be sure you could explain to even a kindergartener how the company makes money. That familiarity is important.
2. Check for sustainable competitive advantages. Does your company offer something no one else can? Will that something be around for the foreseeable future? If so, your company has a sustainable competitive advantage. This can take the form of a popular brand, like Cokes; a quality service or product, like Googles (NASDAQ: GOOG) (NASDAQ: GOOGL) search engine and other offerings; or superior price and convenience, like Amazon.coms (NASDAQ: AMZN) competitive prices and fast shipping.
3. Are long-term trends in the companys favor? No one can predict the future, but we can usually see where things are headed in general. When the digital camera came along, it became pretty clear that Kodaks days were numbered. With the advent of the e-book, the same has been true of booksellers. Be sure you can see your company continuing to succeed as technology advances and tastes change.
4. Investigate management. Here at the Fool, were big fans of founder-led companies. But you dont necessarily need to find a founder-led company to pick a good stock. Do some research on your companys CEO and search for interviews he or she has conducted. How long have they been with the company? What kind of track record do they have?
If I were to start investing today, I would probably invest about 80% of my monthly leftover cash in individual stocks. Then again, Im not sure I would have been totally comfortable investing that much in individual equities as a beginner. You might want to start with a smaller allocation -- perhaps just 20% or 30% -- until youre ready to work your way up to 80%. The rest you can either keep in cash or invest in ETFs like those mentioned above.
For now, keep cash on hand
When it comes time to decide where to invest money, keeping cash on hand is usually not a popular choice. Over time, cash thats not invested will lose its value due to inflation -- and no one wants that! And theres lots of research out there that says you should invest all you have, as soon as you have it. Historically, over long enough periods, the market has always gone up, so its not smart to try to time the market.
That being said, I personally think todays market is quite expensive. Id still be investing about 80% of my cash in it (for the reasons mentioned in the paragraph above), but I think theres some value in holding on to some cash right now.
A little over a year ago, our brightest Fool, Morgan Housel, wrote about what he plans to do when the market crashes. In essence, he knows that there will be crashes in the future, and when they come, he wants cash on hand to take advantage of them, buying up quality stocks at low prices.
That doesnt mean he tries time the market; hes still investing the whole time. But he is setting aside cash -- likely more than usual right now -- to take advantages of crashes when they come.