When you start investing, you know the least about investing that you will ever know.
This can lead to poor initial results, and ultimately ‘quitting’ investing without ever benefitting from the prosperity creating effects of compound interest.
If you are starting from scratch, it pays to begin your investment journey with the knowledge necessary to succeed.
This article is your guide on how to invest well, from the start.
Investing can seem extremely complicated.
There is a staggering amount of industry-specific knowledge in investing. Case-in-point: here are 101 financial ratios and metrics that are important to investing.
Fortunately, you don’t need to know all 101 to do well in the stock market.
In fact, how to do well as an investor can be boiled down into the following sentence:
Invest in great businesses with strong competitive advantages and shareholder friendly managements trading at fair or better prices.
Buying high quality businesses has historically been a winning strategy, but please do not just take my word for it…
Claims without facts are just baseless opinions.
The bolded statement above covers all there is to know about successful dividend growth investing. Admittedly, it is missing some detail.
The rest of this article discusses in detail how to build a dividend growth portfolio, starting with $5,000 or less.
Choosing the Right Stock Broker and Funding Your Account
The way that we purchase stocks has changed dramatically over the decades.
It used to be very expensive to purchase stocks – a ‘broker’ was an individual, not an online platform. Buying stocks involved calling your stock broker and seeing if he knew anyone who was selling your desired security.
Today, there are a plethora of online stock brokers with low fees and easy-to-use trading platforms.
The purpose of this section is not to recommend a specific stock broker for Sure Dividend readers. Rather, certain positive characteristics will be identified to help you on your search for the right broker.
The biggest factor is fees. Investing fees can be a serious detriment to overall investor returns.
As a self-directed investor, the largest fees you will incur are when you trade. Most brokers charge a flat per-trade commission which can be as low as $1 (though often much higher).
When you start investing and your portfolio is small, these fees can really eat into returns. This is one reason to support long-term investing – long holding periods means less trading, which reduces fees.
Some investors will also elect to trade on margin as a way to increase returns (with a proportionate increase in risk). This means that an investor will borrow money from their stock broker to purchase more stocks, using existing investments as a collateral.
Different brokers will charge different interest rates on borrowed margin. The lowest I have seen is 2% for an entry-level portfolio. Typically, the interest rate will decrease as portfolio size increases.
For large portfolios that trade on margin, margin interest rates will be a larger factor than commission fees when determining which broker to use. This is because margin is calculated as a percentage of portfolio size, while trading commissions are a flat fee and generally do not change based on trade size.
A further consideration is a broker’s built-in research capabilities. For investors that are new to the markets, some brokers will have dedicated in-house stock screeners and investment seminars that will help flatten the learning curve as you build your dividend growth portfolio.
All of these factors should come into play when deciding which stock broker to use.
Once you have selected a stock broker, you must then ‘fund’ your account. If you do not fund it, there will be no money available to buy stocks.
There are many different mechanisms through which you can fund your investment account. Some brokers will accept checks delivered via mail. Others accept payments via a bill payment from your financial institutions. Arrangements can often be made to have money automatically withdrawn from your checkings account on a periodic basis (which is ideal for the systematic investor).
Instructions for funding your first investment account will be available on your broker’s website.
Should You Build Your Portfolio With Stocks or ETFs?
In the past, the only way to gain exposure to the financial markets was by investing in individual securities. Investors would buy stakes in companies like Wal Mart (WMT), Exxon Mobil (XOM), or Johnson & Johnson (JNJ) directly.
That changed with the introduction of the mutual fund and later the exchange-traded fund (ETF). These offerings are financial products where retail investors like you and I purchase units of a fund and our money is professionally managed by an expert investment manager.
While we oppose mutual funds because of their high fees, ETFs are a low-cost way for investors to gain diversification and access to the financial markets.
ETFs are traded through the same mechanism as shares on the stock exchange (which is not the case with mutual funds). You can purchase ETFs in your brokerage account and hold them for as long (or as short) as you like, just as with stocks.
There is much back-and-forth in the investing industry about what is better: ETFs or individual stocks.
The truth is that both options have pros and cons. I personally prefer to invest in individual stocks – systematically.
The 8 Rules of Dividend Investing systematically identify and rank high-quality dividend growth stocks using metrics that have historically either improved returns or reduced risk.
I say this so that you can understand my bias from the beginning. With that said, I will now present the pros and cons of ETFs versus individual stocks summarized from the article mentioned below.
Pro: Investing in dividend ETFs provides wide diversification.
This is helpful for investors with small portfolios as they can get the necessary diversification from owning multiple stocks without wasting money on many brokerage commission fees.
Evidence shows that most of the benefit of a diversified portfolio comes from owning ~20 stocks (more on that later). ETFs often hold hundreds of positions, so they might be overdoing it a bit.
With that being said, though, when diversification is needed, it is often really, really needed. ETFs are a simple way for investors to gain diversified market exposure.
Pro: Investing in dividend ETFs has a low time commitment.
Once purchased, investors can ‘sit and forget’ about their ETF. No additional research is required since the fund is being managed by talented a team of investment professionals.
This low time commitment is beneficial for two sorts of people: those who do not find stock market research interesting and those who are already too busy with other activities.
Pro: Dividend ETFs almost always have lower expense ratios than their mutual fund counterparts.
There are several dividend ETFs that have annual expense ratios below 0.1%. Most dividend mutual funds would have a fee of 1% or more (which amounts of $1,000 of annual fees on a $100,000 portfolio).
Related: 7 Tips to Grow Your Wealth Like the Best Dividend Investors (hint: one is to minimize fees)
Con: Dividend ETFs are always more expensive than owning individual stocks.
After the initial purchase is made, individual stocks will always have an expense ratio of 0.00%. There is no cost to hold a stock, regardless of the holding period.
You may be thinking – but what about brokerage commissions?