Young investors are piling into stocks. Yet before you follow their lead, there are several things you should do first.
Otherwise, you could get burned.
“Sometimes the shiny object or the stock that is being flashed around the screen or talked about on Twitter gets the most attention,” said Amy Richardson, a certified financial planner with Schwab Intelligent Portfolios Premium.
“You need to think about, is that the right investment for you?” she added. “It is always about being informed and making sure that you do your research so that you feel comfortable with the investment.”
For instance, traders who bought GameStop during the Reddit-fueled buying spree could have lost a lot of money, depending on when they bought and sold. The video game retailer started the year at under $20 a share and on Jan. 28 hit a high of $483. It briefly fell below $50 at one point in February and is now hovering around $150 per share.
“Do I think it’s dangerous to invest based on what they read on social media?,” said Winnie Sun, co-founder and managing director of Irvine, California-based Sun Group Wealth Partner. “It can be, but doesn’t necessarily have to be a bad thing.”
Here’s what you should consider before you start investing.
Ensure your financial house is in order
Make sure you are on the right path towards financial wellness prior to buying any assets. That means knowing your short-and long-term goals, having a healthy emergency fund (experts generally suggest at least three to six months of expenses) and contributing to a retirement account.
If you have a 401(k), contribute at least enough to get the employer’s match, Richardson advised.
“Those contributions add up over time and that power of compounding and the tax deferral can be really, really powerful,” she said.
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For those who don’t have a 401(k), whether it isn’t offered through an employer or if they aren’t in the workforce yet, Richardson thinks a Roth individual retirement account is a good way to get started. Since Roth IRAs have income limits, you may not be able to invest in one later in your career. Contributions are made after tax, so you won’t be taxed when you withdraw funds in retirement.
If you have debt, hold off on investing, Sun suggests. That means debt of any kind, whether it is a large amount of student loans or credit cards.
Choose investments wisely
To start investing, make a wish list and note why you want certain names. Do the research behind the stock and the industry you are interested in, said Sun, a member of the CNBC Financial Advisor Council. Then, learn about mutual funds and exchange-traded funds.
A mutual fund is a pool of money in which investors buy shares. The money is invested in assets such as stocks and bonds. An exchange-traded fund, also a pool of investor money, generally follows an index, like the Dow Jones Industrial Average or Nasdaq 100.
“In this day and age, stocks are the celebrities of the day and mutual funds and ETFs are seen as boring,” Sun said. “I like the idea of having a balance of both.”
She suggests picking maybe two stocks from a list of six, for example, and then for the others try to find a fund in the same industry or one that holds that particular stock.
Also consider your risk tolerance, which means how comfortable you are when the market goes down.
“That should guide you how much you invest into stocks, and how much you want to keep in a more conservative investment, like a bond fund,” Richardson noted.
To get the most out of your investments, think long-term.
“Getting in and out of stocks has proven time over time to not produce good long-term returns,” Richardson said. “It is all about staying in the market.”
Serious money vs. play money
That said, if you are drawn into the excitement of trading individual stocks, understand the risks you are undertaking and make sure you are using what Sun likes to call “play money.”
Your serious money has a name attached to it, such as retirement savings, a new car or college. With play money, you’ll have to be OK with losing it completely.
“If we teach young people the difference between the two, then we can let them take some risks, but still encourage them to do some serious long-term planning,” Sun said.
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Disclosure: NBCUniversal and Comcast Ventures are investors in Acorns.