Q: I have always been curious about investing in the stock market but don’t know how to get started. I have built some amount of savings through the years and I plan to invest some of it in stocks. What should I do? – Jer Brinas, by email
Investing in the stock market is one of the best ways to make your money work hard for you. Stock prices tend to appreciate over time with returns historically better than bonds or property.
While there is no doubt that buying stocks can help you build long-term wealth, the same can also wipe out all your savings if you don’t handle it properly.
Here are the five basic things you need to know to get started in investing in the stock market:
1. Know how much you are willing to risk
When you invest in stocks, there is always the risk that you are going to lose. You need to decide how much money you need to invest as a starter based on the amount of risks that you are willing to take.
For example, if you are willing to lose Php20,000 at a maximum loss of 20 percent of your investment costs, you can start with a budget of Php100,000 to buy stocks.
If you are investing in the stock market for the first time, you can start small while you are building your confidence. You can allocate maybe only 10 percent of your total savings to stock investments. As you become more confident in investing, you can increase your allocation slowly up to as much as 50 percent.
2. Know how the stock market works
Everyone knows that stocks go up and down every day in the market, but in order to take advantage of the daily fluctuations, you need to understand the story behind it.
What is causing the stock to go up? Why is the market selling the stock today? What is the probability that the stock will continue to fall? At what price should you start buying?
When you try to dig up stories about a particular stock, you need to know the terminologies used in the market. For example, the price-to-earnings (P/E) ratio of a company is computed by dividing the current share price of the stock with the earnings per share or EPS. EPS, on the other hand, is derived by dividing the net income with the outstanding number of shares of the stock.
3. Know how to screen and select stocks to buy
Understanding the dynamics of how the fundamentals of a company affect the share price helps in selecting the right stock. In this case, when the income of a company increases, its EPS also increases. Higher EPS lowers the P/E ratio of a stock, which promises higher share price appreciation in the future, making it a good investment.
There are other metrics that you can possibly use when selecting stocks but you can only know this if you invest your time to study. Try to buy some investment books to read or attend seminars while you are doing your research.
It may take some time before you can master the essentials, but the more you learn, the more confident you become in selecting the right stocks to invest. If you know how investing works, you should be able to manage your risks better, too.
4. Know how to build your investment portfolio to lower your risk
As you buy more stocks, you need to manage your risks by building your investment portfolio properly. You can allocate a portion of your capital to certain stocks according to your risk exposure.
For example, you can allocate 50 percent of your stocks to blue chip stocks, which are part of the PSE Index such as Meralco, SM Prime Holdings or Ayala Land. These stocks are relatively more stable than the non-PSE index because of their market capitalization size and earnings track record.
On the other hand, you can allocate a portion of the remaining balance of your portfolio maybe to preferred stocks that givearound seven percent annual dividends to you. You can also allocate a budget to invest in special situation stocks that are riskier but potentially more aggressive in returns.
Depending on how risk aggressive or averse you are, you can design your portfolio exactly the way you want it to fit your risk profile.
5. Know how to sell stock to take profits and control risks
What is the use of picking good stocks if you are not able to benefit fully from them? When you plan to invest in stocks, make sure that you also set your minimum target returns. In the same way, you also set your maximum target loss in case your stock price falls.
Setting parameters in your investment helps you become more objective in your decision-making. Trading in the stock market can give you an emotional rollercoaster and, often, you can get carried away by your emotions.
Sometimes you fall in love with the stock that you want to hold it forever even at the risk of losing the opportunity to take huge profits. Or sometimes you may believe so much in a stock that you hesitate to cut your loss, hoping it will turn around despite the strong downtrend.
Henry Ong, RFP, is president of Business Sense Financial Advisors. Email Henry for business advice email@example.com or follow him on Twitter @henryong888