First-Time Stock Market Investors’ 5-Step Model

The suggestions and illustrations in this blog are not intended as financial advice. They are my personal opinions.

Making your first investment in the stock market can be a daunting experience. Many people own stocks through mutual funds in their 401k or 403b accounts maintained by their employers. I noticed there is often a disconnect between these accounts and how investment accounts in individual names are handled.

Here is a five-step model to get started with stock market investing. I used these five steps to respond to requests for assistance from two friends. I believe the model – with my explanations and commentary – could be helpful to many others.

Step 1 – Determine your total funds available to be invested.

Step 2 – Subtract your rainy-day funds.

Your rainy-day funds should represent the amount of cash you feel you would need in case of an emergency or unanticipated halt or loss of your cash flow. Pre-COVID, this might have represented about six months of your spending. Post-COVID, many people increased this to up to three years of spending. This amount provides security for you. This is a personal decision and depends, in part, on your circumstances, spending patterns and other cash flow obligations.

Whatever amount you decide on, you would unlikely need to access your entire rainy-day fund all at once. For example, if you select a three-year spending amount, you would not need that entire amount at the beginning of that three-year period. It is more likely that you would access the sum monthly, quarterly or semi-annually. I suggest providing for six months of cash availability at the beginning of every semi-annual period. For example, if you select a rainy-day fund with three years of cash, I suggest keeping the cash for the first six months in an insured interest paying money market account or checking account. The balance of the funds could be invested in a series of insured interest paying accounts that come due every six months thereafter. As each account matures, the funds could either be used for your expenses for the next six months, or reinvested in an account that will mature six months after the longest maturing account in your string of accounts. Note: This is called a laddered portfolio, and the purpose is to maximize your interest income while maintaining the safety and availability of the principal.

Step 3 – This new value – total funds minus the rainy-day fund – is the amount you have to invest.

Step 4 – Determine if investing in the stock market is appropriate for you.

I do not recommend investing any funds in the stock market that you might need in the next seven years. Stock market investing is a long-term endeavor. I define long-term by a minimum of seven years. This is my opinion, and you can select any period you want, but do not lose sight that you need a period long enough to recover from any temporary downturns in the stock market.

If there is a possibility of needing access to a proportion of your funds within the next seven years, hold those back and invest only the balance. It doesn’t need to be an all-or-nothing situation.

Erring with too much caution will not subject your funds to risk of loss. You might lose some opportunities but will not lose what you have. Note that occasionally doing nothing can be harmful, but that has to do with inattention to, or not understanding the proclivities of, the investment markets. If you are not fully sure, do not do it!

Any funds not invested in the stock market could be invested similarly to the rainy-day funds, but perhaps with longer time horizons.

Step 5 – Select your Investments

If you believe you will not need to access your funds within the next seven years, then you are a candidate to invest in the stock market, and that is what I will discuss now.

The “stock market” is comprised of tens of thousands of stocks with dozens of attributes. It is virtually impossible to thoroughly analyze individual stocks as you cannot access all the relevant data. For that reason, I suggest you consider mutual funds made up of United States-based companies with large market values or capitalizations.

A type of investment that has become very popular is a mutual fund that duplicates the S&P 500 index. You can invest in the same way you would purchase shares in any mutual fund or by buying shares of stock (as you would purchase shares in any publicly held company) in such a fund. The latter is called an Exchange Traded Fund (ETF).

Note that any investment in the stock market is subject to many risks, and the values could decline as well as increase. You should understand the primary risks before you make any investment.

Do not construe these suggestions or illustrations as recommendations. Rather, you should consider what I suggest: understand how you could make or lose money on a particular investment, the dividend policies, and how they integrate with your entire investment portfolio, your investment purposes and goals, and your risk tolerance.

Keep in mind that investing is a long-term endeavor to secure your financial security. Investing to make a killing, get rich quickly, or take advantage of current trends or hot stocks is not a safe way to invest. While you would hope to gain immensely, there is a comparable possibility that you would lose with the investment.

Use this as a guide to get started, and good luck with your investing.

Please remember that the suggestions and illustrations in this blog are not intended as financial advice. They are my personal opinions.