When it comes to investing in stocks, it’s best not to put all your eggs in one basket.
If you want to become a stock shareholder it’s important to avoid common pitfalls and be smarter with your money.
The recent GameStop surge is an example of the pitfalls new shareholders and investors can make when buying individual stocks, says Edison Byzyka, CFA, and chief investment officer at Credent Wealth, a financial planning firm in Indiana, Michigan, and Texas. “Stories like GameStop make the stock market [seem] very appealing and easy to make money.” But “those [situations] are rarities, and that is not the nature of investing,” says Byzyka.
Rather than purchasing shares of individual publicly traded companies, incorporate diversification strategies such as index investing to reduce risk.
Instead, Byzyka suggests potential shareholders “focus on fundamentals, companies that have a sustainable path to earnings, and follow more of a fundamental approach.” You are much better off playing the long game than “trying to capture an instantaneous sentiment in the market,” says Byzyka.
Here’s more about the role of a shareholder, how to become one, and the safest path to investing.
Shareholder vs. Stakeholder: What’s the Difference?
The Role of the Shareholder
Most people recognize the concept of a shareholder, says Riley Adams, CPA, senior financial analyst for Google, and owner of personal finance blog the Young and the Invested. A shareholder is “someone who owns at least one share of a company and [has] a vested interest in the going concerns and profitability of the company,” says Adams.
A shareholder’s main concern is the price of the stock, and they are not involved in the company’s day-to-day operations, says Ken Innis, chairman of The R.O.W. Group, a financial planning firm in Nashville, Tennessee.
The Role of the Stakeholder
Stakeholders have a vested long-term interest in the company to be considered a stakeholder, says Adams.
Stakeholder roles include:
- Company vendors
- Business partners, suppliers, and vendors
- Regulatory bodies that oversee industry operations
- Residents of the community where a company has facilities
- Consumers that rely on the goods or services the company provides
There can be an overlap between roles, such as when an employee owns company stock.
How to Become a Stakeholder or Shareholder
There are many ways to become a stakeholder in a company. You can apply for job openings or throw in your bid when the company needs suppliers or vendors, says Byzyka.
The path to becoming a shareholder is simpler: Open an investment account and buy shares.
You can hire firms with advisers that build personalized investment strategies tailored to your goals, budget, and appetite for risk. But these days, many Americans are self-managing using online investment platforms such as Fidelity or Vanguard.
If your job offers a 401(K), you already have an investment account in your name. If you don’t yet have an account, the first step is selecting an online brokerage or investment adviser, such as a tax-advantaged Roth IRA. Transfer money into this account, then buy shares in a company.
The Virtues of a Diverse Portfolio
To get the best results, you’ll need to make investing a consistent habit and hedge your bets through smart investment strategies, such as diversification and index investing.
Diversification, or maintaining a diverse portfolio, refers to spreading your money across investment classes to reduce risk.
- Owning stock in domestic and international companies, since one country may thrive while another experiences economic setbacks.
- Keeping money in stocks, bonds, CD’s, or money market accounts, so a stock market correction doesn’t wipe out your entire portfolio.
- Investing in different market sectors, such as healthcare, energy, consumer staples, or technology, to be protected from individual sector variability.
Personally, “I’m super boring, and I stay in index funds,” adds Adams. “By having exposure to a broad swath of companies, you’re not exposed to any one company’s failures or success,” Adams explains. This is why many experts recommend diversification.
Index Fund Investing
A common diversification strategy, the index fund, attempts to replicate the performance of an index, such as the S&P 500, by buying shares of companies in that index. In contrast, mutual funds are actively managed by investment managers who make high-level decisions about what to buy and sell, which comes with higher fees. Index investing, or owning index funds, not only ensures diversification but offers financial benefits.
According to the Journal of Accountancy, index funds are smart investment choices because:
- Actively managed funds (like mutual funds) come with steep fees that reflect the manager’s time.
- Passively managed funds (like index funds) don’t require significant hands-on time, so their fees are lower.
- Investment managers generally don’t beat the market with enough margin to make those higher mutual fund fees worth it to investors.
- It’s difficult and riskier to pick winners than it is to bet on well-performing stocks, such as those in an index.
- Index investors tend to win out since they pay less in fees over time while spreading their investments across a subset of well-performing stocks.
Diversified approaches, such as index investing, are less risky than buying single stocks. Over the long term, they tend to reward investors handsomely. “Even the best investors can’t outperform the margin most times,” says Adams.