The number-one thing to know about the stock market? It’s unpredictable.
Think of it like a wild bull — and I don’t mean “wildly successful bull market” where everyone is always making money.
I mean, literally a wild bull: a large, powerful entity that has zero interest in your personal concerns, feelings, happiness, or well-being.
That doesn’t mean a bull is necessarily out to get you. But it would suggest that failing to respect it (or flagrantly disregarding its ability to hurt you) because you have no clue what you’re doing around a one-ton animal with a mind of its own, you’re gonna get bucked.
The stock market can do the same thing to you if you fail take some time to understand and respect how it works, or if you disregard the risks you run when you dabble with it.
Fail to do so, and things will end up much the same as that bull. Because the truth is, the market can definitely buck you.
Let’s look at how you can avoid that, and instead, leverage the stock market to your advantage.
The Stock Market Basics You Need to Know (So You Don’t Get Bucked)
A good place to start with the stock market is in acknowledging how, in many ways, it’s unpredictable.
Understand that no one knows what the markets will do tomorrow. We can get a general sense of market trends (like the fact that markets generally go up over time), but:
- There’s no guarantee the stock market will continue to act as it always has, and
- No one knows precisely when we’ll see a change in trend.
Lots of people like to predict that they know when the next market crash is coming. Or they like to guess at what hot stock will blow up next. But that’s the thing: all those people are simply predicting or guessing.
They’re not knowing.
And therefore it’s completely unreasonable for you to act as if they did know, and start fiddling with your investments based off someone else’s predictions.
When you do that, you’re engaging in market timing — and that is one of the surest, fastest ways to get bucked.
Here are some other stock market basics you should know and understand before you throw your hard-earned money into a single investment.
1. Invest for the Long-Term
If you’re in your 20s, 30s, or 40s, you have a huge investment advantage: time. No, not market timing — but time in the market.
Again, we can get a sense for some market trends and one of the most important is the fact that markets tend to rise over time. “Over time” in this case can mean over 10-year periods or multiple decades… or 20, even 30 years.
If you can simply give your money enough time in the market, you don’t need to worry so much about what the market does day-to-day.
A good strategy to use is dollar cost averaging. Here’s an example of how that works:
- You choose a specific amount to contribute to your investments.
- You choose a specific time period you’ll make the contribution.
- You keep making that set contribution at its periodic interval for the next 10, 20, or 30 (or more!) years.
Personally, I use dollar cost averaging to fund my brokerage account. I have a set amount of money that I contribute to that investment account every month on the 20th.
And I mean every month. It doesn’t matter what the market is doing on June 20th or December 20th; my contribution is automated and it’s going into that brokerage account.
This works for me because I’m investing for the long-term and I know my money is going into the account to stay there for at least 15 years — and much likely longer.
Over that 15 or 20 year time period, the day to day movements of the market will be but tiny blips on the radar.
The fact that I’ve automated the contribution as part of my overall investment strategy and plan means it’s one less thing for me to worry about, forget, or feel tempted to mess with along the way.
2. Diversify Your Investments (and Where You Invest)
The second on this list of stock market basics: diversify. You need to diversify your investment portfolio and the types of accounts those portfolios live in.
When you invest, you can put cash into a number of different asset classes, like:
- Equities (or stocks)
- Fixed income, or debt (i.e., bonds)
- Real estate (whether that’s a physical property you own or something like a REIT)
- Commodities (like gold, natural resources, and other valuable physical things)
Investing in a single (or even just a handful) of asset classes is risky. If you poured all your cash into equities, for example, then your entire potential for wealth is tied to the performance of stocks.
It’s the “don’t put all your eggs in one basket” advice, applied to finance. Diversification allows you to spread out your cash into different asset classes that behave differently from one another.
If one drops, all is not lost because your wealth wasn’t 100% in that asset class.
That’s part of what makes an asset class different from other assets: securities in a single class tend to behave similarly. Securities in other asset classes tend to behave in other ways.
The simplest example is the fact that while stocks are volatile, bonds are less so — which is exactly why you’d include bonds in your portfolio (even though they return less than stocks).
They help provide stability to your portfolio as a whole… and prevent your investments from crashing through the floor when stocks wobble around or experience a dip in value.
Again, that’s a simple example. But investing gets a lot more complicated than that.
There are various types of “equities” that you could invest in, like growth versus value stocks. Large cap versus small cap. Global versus domestic.
The list goes on — so if you’re serious and want to set up an advanced investment strategy, make sure you understand those complexities and are capable of formulating the right asset mix to properly diversify your portfolios.
And by the way: on top of all this, you also need to diversify where you invest. Dumping all your money into a 401(k) and calling it a day is not a smart strategy. You can get more details on why — and what to do instead — in this article I wrote for Kiplinger.
3. Feeling Emotional? Take a Step Back
The biggest reason average investors under-perform the market? Because they get emotional.
They make emotional, irrational decisions with their money, their finances, and their portfolios. There are countless ways your emotions can screw up your potential to build wealth, but most people’s reactions come down to one of two things:
Fear or greed.
Or both, but it’s mostly fear that drives us to act. Humans are hardwired to fear and avoid losses even more than we feel motivation to receive a gain.
That’s why when the market experiences a dip or correction, most people aren’t excited about it — but logically, long-term investors should be downright joyous!
Why? Because a dip in the market essentially equates to a sale on stocks. When stock prices dip lower, it provides you with an opportunity to get more equities for a lower price.
Of course, most of us — even people who are investing money they won’t touch for 30 years — don’t think this way.
Instead, we hear the doom-and-gloom of the financial news; we feel certain the entire stock market is on the verge of collapse and we’ll soon be sitting in a cardboard box on the side of the road unless we act right now to sell out and save ourselves.
In the face of potential loss, we can’t even see the fact that the red that shows up in your portfolio when markets go down is just that: potential. It’s an unrealized loss as long as you hang on to those positions.
The minute you can’t stand to stay in your seat any longer — the second you decide you need to make a leap and “get out before it’s too late” — you turn an unrealized, potential loss into an actual loss.
(This is part of the value of a financial planner: we serve as the objective, third-party voice of reason when your emotions and your fear are encouraging you to do something you shouldn’t.)
Again, succeeding as a long-term investor comes down to time in the market, not trying to time when to hop in and out of it. Even if you only invested at the very worst times (i.e., right before a crash), but never sold, you’d likely be a millionaire by the time you wanted to retire.
While it’s certainly easier said than done, perhaps the most important of the stock market basics you could know is to avoid making emotional decisions.
Create a rational, solid investment strategy and plan and put it in place before your emotions kick up and sway you to act in a way that’s detrimental to your own financial success.
As I mentioned in the beginning of this post, the stock market — like that wild bull — does not care about your feelings.
So check those emotions as the investing door and bring as much rationality and objectivity to your financial decisions as possible.
4. Know Why You Want to Get into the Stock Market
Before investing in the market, it’s important to set specific goals for your money.
Doing so helps you answer important questions about the right way to invest it, because you’ll need to know:
- What you want to do with the wealth you create
- When you need to use the money
- How much you can risk (both in terms of how much you can tolerate the risk and how much you can literally stand to lose before you fail to reach your goal because you don’t have enough money) in order to earn a reward
If you need the money in 5 years or less, you probably do not want to put that money into the market. Markets are too volatile to safely assume the money you contributed to your investment account will still be there in 5 years or less.
You stand a better chance of earning money — and earning a useful return — if you can leave the money invested for 5 or more years. The longer you leave your money in the market, the less volatility will likely effect it and the more likely you’ll see a sizable return that can help you reach your long-term goal.
5. Create a System to Monitor Your Investments
Contrary to what some believe, successful investing does not mean “set it and forget it.” Yes, you can automate your contributions and keep a steady flow of funds moving into your retirement or brokerage accounts…
…but no, you shouldn’t just entirely ignore your investments after that. That doesn’t mean check your portfolio daily, but periodically take a look at the following aspects:
- Your asset allocation: Is it still balanced appropriately, or because of market movements are you now holding far too much of one asset? You may need to rebalance to keep your portfolio well diversified.
- Your contributions: Did something in your life change that warrants an update to how much you contribute to your investments? Maybe you started earning more, for example (and need to bump up the amount you contribute to keep your savings rate up). Or perhaps you’re getting close to the point where you may want to use the money you invested, and need to start setting up a withdrawal strategy.
- Your goals: Your earnings aren’t the only thing that may change. Your goals or priorities could have shifted, and that can impact how you invest.
Again, you probably don’t need to check your account daily, weekly, or even monthly. Consider checking quarterly, every 6 months, or once a year.
BONUS: Understand What Risk Really Means
You might know that risk and reward are related; the more risk you take, the higher of a reward you could receive.
Could is a key word there. And while most investment advice will only talk about risk tolerance, this misses an even more critical point:
This is the risk you can actually afford to take. It doesn’t matter how much of a risk-seeker you are; if you find yourself in a situation where the downside risk could devastate your ability to be financially successful, it doesn’t matter how you feel about the investment.
It doesn’t matter how comfortable with risk you are, because it’s a moot point. It’s not something you can afford to do if you cannot adequately recover from realizing a loss.
Before investing in the stock market, don’t just consider your risk tolerance. Consider you true capacity to take and actually realize a risk. What would happen in a worse-case scenario?
If it’s not something you can recover from, it’s too risky.
And of course, remember that everything suggested here is to help educate you and is not specific or personalized investment advice. Everyone’s circumstances vary, and your approach to the stock market should be based on your specific situation.
If you would like true investment advice, you can check out BYH’s investment management services — and in the meantime, keep these stock market basics in mind as you continue to learn about investments and how to succeed in the market.