How to pick stocks: when to invest, what to invest in, and how

Investing is daunting but it’s useful (and still very possible) even if you have only a few dollars to invest.

Derek Silva

By

Derek Silva

Derek Silva

Personal Finance Expert

Derek is a personal finance editor at Policygenius in New York City, and an expert in taxes. He has been writing about estate planning, investing, and other personal finance topics since 2017. He especially loves using data to tell a story. His work has been covered by Yahoo Finance, MSN, Business Insider, and CNBC.

Updated June 17, 2021|15 min read

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If you haven’t invested much or at all, getting started is daunting. And with thousands of companies listed on U.S. stock exchanges alone, how do you know which stocks to pick? Luckily, there are some simple guidelines that can help you get started. You also don’t need a lot of money. In fact, it can be beneficial to begin investing as soon as you can, even if you only start with a few dollars. For example, you should start saving and investing for retirement now because retirement is expensive and it’ll be very difficult to build enough savings unless you start investing as early as possible.

For new investors, there are companies and apps, called robo-advisors, that will simplify the process for you and make the learning curve much less steep. Choosing and managing investments yourself may be easier than you think, though. The DIY approach also could help you save money.

"You should do your research and make sure investing in that company aligns with your overall financial picture and risk tolerance," said Patrick Hanzel, certified financial planner and advanced planning specialist at Policygenius. "We recommend consulting with a financial advisor to help you pick which options might be right for you."

Key Takeaways

  • Investing isn't a way to get rich quick but it can help you build significant wealth over the long-term

  • You can start investing for as little as $1

  • ETFs and passively managed mutual funds generally have low management fees, saving you money and boosting your earnings over your lifetime

  • Human financial advisors and robo-advisors can make investing much easier, but managing your own investments is easier than ever

Understand why you want to invest

Before you spend any money, think about why you’re investing. Your financial priorities will ultimately determine how you invest, if investing is even the right decision for you. Saving for a retirement that’s decades away will look very different than saving for the down payment on a house or day trading to try and build a major source of income in the present.

One reason not to invest yet

Investing can be risky and it’s probably best for you to have some liquid savings before you start putting money into the stock market.

If you struggle to build savings or don’t have enough to cover your daily expenses, start by getting a high-yield savings account. Don’t settle for a savings account with an interest rate of  0.05% or less, because you’re missing out on free money. Also think of your savings in terms of an emergency fund. An emergency fund is money that you can fall back on when something unexpected happens. This could be buying a new tire for your car, calling a plumber when your toilet breaks, or paying a medical bill when your child gets sick. Without some easily accessible money that you can use to cover unexpected costs, you may need to go into debt just to pay your bills. And while investing can help you build wealth, some investments may be difficult to sell off if you need the money, and their values can change quickly and often.

How much can you afford to invest?

If you have enough savings to cover your day-to-day expenses plus at least a small emergency fund, then you can probably invest as much of your remaining savings or income as long as you feel comfortable putting your money into the stock market. Start small if that’s what makes you most comfortable. There are services and funds that allow you to start with only $1. If you can afford more, some funds require minimum investments of $3,000 or more.

2 main types of investments

There are two main ways to invest in stocks: trading individual stocks and investing in a fund that contains many stocks. "All investments come with some risk," Hanzel said. "Investing in companies with strong financials may come with less risk than others, but past performance is never a certain indicator of future results."

Buying stocks from an individual company involves researching the company’s financials, looking at things like their profit and loss statements, to determine whether or not it’s a company that fits your investing strategies and goals. We’ll discuss this process more later, but it can take a lot of work and involve a lot of risk.

Investing through funds, like mutual funds or exchange-traded funds (ETFs), is a better option for the average investor. A fund contains shares (or fractions of shares) in dozens or hundreds of companies. Buying shares of a fund can quickly diversify your investments, potentially minimizing your risk if one company or sector of the economy doesn’t perform well. ETFs in particular usually have low minimum costs — as low as $1 — and many brokerages now allow you to buy and sell ETF shares without paying broker fees.

Understanding mutual funds and ETFs

A mutual fund or ETF works as a bundle of many individual stocks. A fund could invest in dozens or even hundreds of stocks and when you invest in the fund, you’re partially investing in all of the stocks it contains. Funds offer the advantage of quickly diversifying your portfolio.

Diversifying is important because investing in multiple companies can protect your money in the event that a single stock or sector of the economy performs poorly. "Always make sure to be properly diversified across many companies/funds and industry sectors so you aren't putting all your eggs in one basket," Hanzel said.

What are mutual funds?

Mutual funds are a classic type of investment fund that have been around for years, but they usually require a minimum investment of $3,000 or more, which makes them inaccessible for many people.

A mutual fund is usually actively managed, meaning there is an actual person (or group of people) choosing the stocks that they think will do best. In order to pay those people, actively managed mutual funds have relatively high expense ratios. An expense ratio is a percentage of your investment that you pay in order to cover management of that fund. Active funds can have a fee of 1% or more, so 1% or more of the money you invest goes to the fund managers and not into your actual investment.

There are also passively managed funds, where the stocks chosen mirror some kind of index or automatically update based on certain criteria. For example, an index fund that mirrors the S&P 500 stock index will automatically invest in the companies of the S&P 500. When those companies change, the makeup of your fund will change accordingly. Because the investment managers spend less time researching and picking new stocks, expense ratios can be less than 0.2% for index funds.

What are exchange-traded funds (ETFs)?

ETFs, or exchange-traded funds, are also bundles of stocks, but they are traded on the stock market the same way that individual stocks are. Most ETFs are passively managed and have low expense ratios. ETFs also have low investment minimums. In many cases, you can buy a share of an ETF for just $1 (as long as the share itself only costs $1, or if you can buy a partial share). Ultimately, ETFs are a great option for many investors and they offer a much lower barrier to entry than mutual funds.

For more information, read our full guide to ETFs.

What stocks are in mutual funds and ETFs?

The stocks in a mutual fund or ETF vary greatly, but they usually revolve around a single goal, idea, or industry. For example, a fund that mirrors the entire U.S. stock market will include stocks that represent the entire U.S. market. Some funds may focus on growth stocks (riskier stocks that have a higher chance of growing quickly) or a type of bond.

If you want to support a certain cause, look for a fund that invests based on that cause. It’s possible to buy shares of a fund that only invests in companies supporting environmental sustainability or women’s rights. (Learn more about socially responsible investing.) You could choose to invest in funds that represent emerging economies or just the healthcare industry.

When using funds to save for retirement, consider target-date funds, which automatically adjust their asset allocations over time based on the year you plan to retire and how far away it is. Target-date funds are especially popular in 401(k) plans and traditional IRAs.

Should you invest in individual stocks?

When most people think of buying stocks, this is what they imagine: You choose a company, buy some of its stock, the stock takes off, and you get rich. In reality, very successful companies are not common. Chances are low that you’ll find an unknown company that becomes the next Apple or Google.

Don’t buy stocks with the expectation that a company will take off and you will become a millionaire.

With that being said, there’s nothing wrong with buying the stock of an individual company. If you’re a lifelong buyer of a certain car brand, you might want to buy their stock and hold it in your portfolio. If you want a valuable stock that pays regular dividends, there are multiple international tech companies that could appeal to you. It’s also common for employees to have company stock in their portfolios. Some companies even offer employee stock options as a benefit.

Investing in individual stocks does require some extra attention, though. For example, it may make it harder for you to maintain a diverse portfolio. If you invest thousands in your company and then it struggles, you could lose thousands of your hard-earned dollars.

The 3 ways to start investing

How you start investing depends on what kind of investment you’re making. If you’re saving for retirement through a 401(k), you just need to enroll in your employer’s plan and select your investments. If you want to invest outside of an employer, you have a few options:

  • Financial advisors

  • Robo-advisors and investing apps

  • Do-it-yourself investing

Financial advisors

Financial advisors will choose and manage your funds while also helping with other financial aspects of your life, like creating a trust. Human advisors usually charge a management fee of 2% or more of your assets under management (AUM). AUM is the amount of money that the advisor is managing for you. The management fee is often in addition to the expense ratios of funds and trade commission fees. The high fees mean financial advisors aren’t the best choice for everyone. Most also require a minimum investment. If you don’t have a lot to invest, consider a robo-advisor.

Robo-advisors and apps

Robo-advisors manage your investments for a fee that’s as low as 0.25% of AUM. These services automatically choose investments and manage your portfolio for you. All you need to do in most cases is answer some questions about your goals and how much you have to invest. Robo-advisors and other investing apps are a great option for new investors because they have a low cost and put your investing on autopilot. Robo-advisors probably don’t offer the same amount of investing options that a human advisor would — most robo-advisors invest exclusively through ETFs and sometimes only from a handful of ETFs — but the services from a robo-advisor are enough to help the majority of people to start investing and earn money.

Do-it-yourself investing

Another popular investing option is to do it yourself. Choose a broker, open an account, select your investments, and then manage your portfolio on your own. The major perk of the DIY method is that you save money. Basically the only fees you pay are the expense ratios for funds and any commissions from trades. Many brokers even have commission-free trades of ETFs.

Yes, managing your own investments will require more time and energy than working with an advisor, but there are many resources out there to help you. Brokers typically offer a lot of guides and learning materials. If your broker doesn’t offer educational material, consider another broker. You can also read educational content on the sites of many human and robo-advisors regardless of whether you are their customer. This could give you a great jumping off point for choosing how to invest.

The DIY option: how to trade individual stocks

When you invest in a company’s stock, you can’t get stock directly from the company. You need to go through a brokerage firm, or broker. Brokers are just intermediaries that allow you to buy and sell stocks. Here are some of the biggest investment brokers in the United States:

  • TD Ameritrade

  • Charles Schwab

  • Fidelity

  • E*TRADE

  • Merrill Edge

  • Vanguard

  • Robinhood

How to choose a broker

Brokers all offer many of the same basic services, but they can differ in their cost, services, and the exact types of investments they allow customers to buy. You may also want to consider your experience level. Some brokers offer more educational material or an easier user experience.

When choosing a brokerage, you may want to go in with an idea of how you will invest, so that you can better research their offerings.

Brokerage costs

Each broker has its own investment minimums and fees, so check these before buying anything. Most brokers charge a commission per trade, but commission-free trades are becoming more common. They may waive certain fees if you trade a certain volume of shares, so again it’s good to know what your trading activity might look like.

Brokerage services

Not all brokers offer access to the same variety or type of investments. If you have an idea what you want to invest in, see if a broker will offer access to it. As an example, not all brokers can provide you access to company IPOs. Those that do may have different restrictions on how much you need to spend or how many shares you need to buy in order to receive access to an IPO. And if you’re interested in something specific, like penny stocks, you may need to sign up with a broker specializing in that area.

Certain brokers may also offer more analytical tools to help you research and choose companies to invest in. If you want more personalized financial advice, some brokers offer access to financial advisors. You can also find an advisor to handle all management of your portfolio. Advisory services aren’t available everywhere and they come with different costs based on your situation, so researching prices and services is important. You can also find an advisor outside of a brokerage. For more help, read our guide on how to find a financial advisor.

How to make a stock trade

When looking at how to actually trade a stock, you will generally need to do the hard work of researching companies and buying the stocks on your own. Then there are two common types of trades you can make: market orders and limit orders. With a market order you buy the stock as soon as the market is open, regardless of the stock’s price. It’s common that the price you see at the close of the market will change when markets open, since a variable number of people may be trying to buy the stock. A limit order allows you to buy a stock only when it reaches below a certain price. On the flip side, stock sales work according to similar mechanics, though their names may differ.

Making a career of stock trading

If your goal is to become a day trader who makes a living picking stocks, know that many stock pickers lose money. It’s very risky and comes with a lot of uncertainty. Your earnings will vary from month to month and even day to day. Day trading will require you to thoroughly read the financial statements of thousands of companies to help you choose stocks. You will need to be very in tune with how the market is moving, future trends, and economic policies.

Some training or classes could go a long way. Familiarize yourself with common evaluation metrics, like debt-to-equity ratios, price-to-earnings ratios, and dividend yields. Consider talking with a certified financial advisor, like a CFP, before you make any career moves.

General investing strategies

It’s common to think of investing through short-term or long-term goals. You also need to strike a balance between stocks or high-risk investments, and bonds or other low-risk investments.

Short-term vs. long-term investing

Short-term investments are meant to be bought and sold for quick profits. Depending on your situation and goals, short-term could mean a couple of months or a year. People investing for the short-term may be more willing to buy and sell higher-risk stocks that are perhaps more volatile but present the chance for big gains if timed properly.

However, trying to time the stock market is very difficult and there is absolutely no guarantee of success, so the average person probably wants to buy safer investments that they can buy and hold for the long-term.

Long-term investments are generally those that you plan to hold for at least a year and potentially for the rest of your life. If you’re trying to build retirement savings, you most likely want a long-term buy-and-hold strategy. The formula for long-term investing can be very simple, too: Many investors recommend buying low-cost funds that represent the total stock and bond markets. They suggest holding those investments for years and avoid selling when the stock market isn’t doing well, because holding for the long term makes it more likely that you outlast short-term volatility and see worthwhile long-term gains.

Short-term and long-term investments are taxed differently. Learn more about capital gains taxes on investments.

Balancing stocks and bonds

The two most common types of investments are stocks and bonds. Stocks generally come with higher risk but offer the possibility of higher returns. Bonds don’t usually offer fantastic rates of return, but they can offer steady growth and help you avoid losing significant savings any time the economy takes a hit.

When you’re younger or have a long time horizon (meaning you’re farther from your goal), you may want to invest in riskier or more volatile assets if you can handle that risk. [1] As you get older or closer to your investing goal, you may choose to move your portfolio more into bonds than stocks to better protect all the wealth you’ve built from being lost in a recession or dip in the economy. Everyone has a different risk tolerance (how much price volatility they can withstand) but it’s important to remember that the more stocks you have, the greater the potential for gains. More bonds can help cushion you from price volatility, but you may not gain as much as you need to meet your goals.

Someone who’s young or investing for the long-term may want to put as much as 90% of their investment portfolio in stocks with the remaining 10% in bonds. This asset ratio (sometimes referred to as 90/10) could likely result in higher returns in the long run but the risk of losing money in the short-term could also be higher than for other allocations. [2] If you’re uncomfortable with that much risk or if you’re saving for a goal that isn’t as far away (like if you’re 50 years old and plan to retire at age 62) then you may want to have a more conservative asset allocation, like a 60/40 stock to bond ratio.