Equity Investment: 5 Rules To Follow

Equity investing might sound like a complex strategy for Wall Street brokers or experienced financial pros, but it’s actually one of the easiest and most common ways to put your money to work.

Thanks to the rise of no-fee brokerages and partial-share investing, just about anyone can make an equity investment on just about any budget. It’s a great way to grow your money over time, diversify your holdings and own your own piece of your favorite companies.

What Is Equity Investment?

Equity investment is the purchase of a security that represents partial ownership of a company.

Corporations issue shares — which equity investors buy and sell on the stock market — to raise capital to fund their businesses. When you buy a share, you help the company fund corporate operations like expanding its facilities, hiring employees, investing in technology, settling debts and launching new products.

In exchange, the company gives its shareholders — equity investors who purchased its stock — partial ownership of the company. Equity investors who buy common stock typically get voting rights for corporate actions like mergers and acquisitions, dividend payouts and the selection of members of the board of directors.

How Does an Equity Investment Make Money?

Most equity investors aren’t interested in voting on corporate business. They buy shares because they believe the company will succeed, grow and add value. If that happens, the stock price will rise and the equity investor can earn a profit by selling shares previously purchased at a lower price.

What Is an Example of an Equity Investment?

If you’ve ever bought a share of Amazon, Coca-Cola or any other company on the stock market, you’ve made an equity investment.

It’s possible to invest in private companies, but that’s harder, riskier and more expensive. Publicly traded companies sell their shares on the stock market to any and all buyers. If you buy one — or even part of one — you’re an equity investor.

Is It Good to Invest in Equity Funds?

ETFs and mutual funds that contain equity shares — as opposed to non-equity securities like bonds — offer investors an easy way to spread their money around to many equities at the same time. Most experts caution against picking individual stocks, which makes equity funds a great way to diversity your portfolio — more on that shortly.

Is Equity a Safe Investment?

There is no such thing as a safe investment. Although some equity investments are a whole lot safer than others, all investments come with risk and there is no such thing as a guaranteed return. But by adhering to the following five rules, you can mitigate that risk.

The 5 Rules of Equity Investing

Only qualified financial professionals can give investment advice, but most industry experts agree on a few general guidelines for people who are considering investing in the stock market.

1. Create a Plan and Stick to It

Before putting money into play, learn as much as possible about the many different stock investing strategies.

• Warren Buffett, perhaps the most successful investor in history, is a value investor. He looks for stocks that he believes are “on sale” — trading for less than they’re worth on the stock market.

• Growth investors look for companies they believe are poised for massive gains. For example, some investors who bought Amazon or Netflix at less than $1 in the early 2000s made millions with relatively modest investments.

• Dividend investors buy into companies that use their profits to make periodic payments to their shareholders. Many seniors buy dividend stocks as a source of income in retirement.

2. Rely on Your Own Research, Not Tips — and Never Fall For FOMO

You should always be open to input and alternative points of view, but never base your decisions on tips about the next hot stock from the person next to you at the salon or the Little League game. From friends and family to online influencers, there’s no shortage of amateurs who overestimate their own equity investing abilities.

If you get a stock tip that interests you, conduct your own research and determine if it’s an equity investment that fits into your strategy.

You’ll also likely be tempted by stocks that seem to be making everybody rich but you. GameStop, for example, soared in value during its now legendary Reddit-based short squeeze, peaking near $87 a share on Jan. 27, 2021. But the stock was artificially inflated, and by Feb. 4, GameStop crashed back down to less than $14.

Nothing attracts a crowd like a crowd, and many newbies who invested based on fear of missing out bought GameStop stock when it was high and sold when it was low, which is the polar opposite of successful equity investing.

3. Diversify, Diversify, Diversify

The old adage of not putting all your eggs in the same basket might as well have been written for equity investors. One of the most important rules, especially for beginners, is to spread your money around to protect yourself in case one of your picks doesn’t pan out.

Don’t put all your money into one stock or even one sector, like tech or energy. Instead, you should balance your portfolio with a blend of different stocks from different segments of the economy.

The cheapest, easiest and fastest way to achieve broad diversity is to buy exchange-traded funds. ETFs are like mutual funds, but they trade in shares on the open market just like individual stocks, and since they aren’t actively managed, they’re typically much cheaper.

4. Pursue Long-Term Wealth Instead of Short-Term Gains

When you start your equity investing journey, you’ll likely be tempted to swing for the fences and get rich quickly — but just like with baseball, home run hitters strike out a lot.

Virtually all credible experts advise stock investors — novices, in particular — to invest for the long-term, pursuing steady, achievable gains over time.

Avoid trying to “time the market” by buying or selling stocks based on what you think they might do in the future. Instead, buy and hold shares of companies that you believe will grow and prosper over time.

One common strategy for long-term investing is dollar-cost averaging, in which you invest a set amount of money on a set schedule to smooth out natural price fluctuations. If, for example, you contributed $50 to an ETF every other Tuesday, you would buy more of it when it’s cheaper and less of it when it’s expensive, which is the desired outcome of equity investing.

5. Stay Engaged

Don’t set and forget your equity investing portfolio. Always continue learning, researching and growing as an investor and keep an eye on your stocks, making adjustments when necessary. That could mean rebalancing your holdings or swapping out your current ETF for a similar one with a lower fee.

Modern Equity Investors Don’t Have to Pay to Play — Get Started Now

The stock market is the greatest wealth-generating machine in history, and you can get in on the action as an equity investor even if you don’t have a lot of money or any experience. The fees and commissions associated with stock investing used to be cost-prohibitive, but today, you can start with nothing more than the money you plan to invest.

Open an account with a no-fee, no-minimum brokerage that allows partial-share investing, which lets you invest whatever money you have, even if it’s not enough for a full share. Stick with “blue chip” stocks, which are the major, brand-name companies that tend to be more stable and less volatile than smaller businesses that are still finding their footing.

Just one share of an ETF that tracks the S&P 500 includes the 500 biggest companies in America — and you’ll own a sliver of every single one.

This article originally appeared on GOBankingRates.com: Equity Investment: 5 Rules To Follow