How to Invest in Stocks

John Mlekoday is a senior investment consultant with the Northwestern Mutual Wealth Management Company.  

When you start investing, stocks play a key role. But first you need to understand what they are and why they are such a big part of how people invest their money. 

Below, we define both stocks and investing for beginners. Then we explore the main benefits of stocks. We also take a look at the risks and walk you through the different options to start investing in stocks. 

What are stocks?

A stock, at its heart, is a financial instrument that conveys partial ownership of a company through the purchase of shares in the company. Stocks can be bought, sold and traded via brokerages. You may also receive company stock from your employer as a part of your compensation package. 

When you buy shares of a company’s stock, you become a partial owner of that company. As a partial owner, or “shareholder,” you get part of the company’s potential success and profits. 

Of course, this isn’t a guarantee, because not all businesses succeed over the long term. That’s what makes stocks a riskier investment compared to other investments.¹ But it’s also true that investing in stocks can be one of the best ways to grow your wealth over time.  

By accepting a certain level of risk, you are opening yourself up to the possibility of a greater amount of reward than you might receive from “safer” investments. For this reason, stocks play an important role as a growth driver in a well-diversified investment portfolio. 

What is investing? 

When we say the word “investing,” we’re typically talking about evaluating and purchasing assets—like stocks. The goal is to make a profit over a certain period of time. 

Buying and selling a handful of stocks is considered investing, but this approach can be a risky way to invest. To help balance risk and reward, many investors prefer a diversified portfolio that includes stocks, bonds and other assets that all work together to grow wealth over time. This also reduces risks associated with investing. 

Reasons to invest in stocks 

People invest in stocks for a number of reasons, but the primary reason is that they want to share in the future value of or profits generated by the companies they invest in. 

Over the long term, investing in the overall stock market has proven to be a very effective means of building wealth and beating inflation. From 1926 through 2023, large cap stocks enjoyed an average annual return of 10.3 percent—speaking to the long-term value of staying invested. 

How to get started investing in stocks 

1. Decide how much you want to invest 

Your first step is to determine how much of your investment portfolio you will allocate to stocks. 

Most portfolios will include a target allocation of a certain amount in stocks and bonds (although other assets may also be considered as part of an overall financial plan).  

Unfortunately, there is no single target allocation that works for every person and in all circumstances. Because everyone’s financial situation is unique, the ideal portfolio allocation for you may be a lot different from someone else’s. It’s typically best to discuss your individual situation with a financial professional. 

To help figure out how much of your portfolio you will dedicate to stocks, think about: 

• Your risk tolerance: This is how much risk and volatility you can handle in your investments. The higher your risk tolerance, the higher the percentage of your portfolio you can likely dedicate to stocks. (Remember that all investments carry some level of risk, including the potential loss of all money invested.) 

• Your investment time horizon: Consider how long you plan to keep your money invested before you need to access it. The longer your investment timeline, the more risk you may be able to take. 

• Your financial goals: Think about your specific goals. The more growth you require to reach your goals, the more you will likely need to dedicate to stocks in order to help reach them. Your Northwestern Mutual financial advisor can help you figure this out. 

2. Open an investment account 

Your next step is to open an account so you can purchase stocks. You can choose from many different types of investment accounts. Which type of account you choose will depend on the specific goal that you are investing for. Here are some common accounts: 

• Employer-sponsored retirement account: If you are employed by a company offering retirement benefits, you may have access to accounts designed to help you save and invest for retirement, such as a 401(k) or 403(b). When you contribute to these accounts, you don’t pay taxes on your contributions until you make a withdrawal during retirement, giving your money more time to compound and grow. Contribution limits for these types of accounts, as of 2024, are $23,000 for those younger than 50 and $30,500 for those 50 and older. But distributions before age 59½ might be subject to a 10 percent early withdrawal penalty. 

• Individual retirement account: An IRA allows you to save for retirement either alongside or instead  of an employer-sponsored retirement account. These tax-deferred accounts enjoy many of the same tax attributes as 401(k)s but have much lower contribution limits—$7,000 a year if you’re younger than 50 and $8,000 a year if you’re 50 or older.  

• Roth retirement account: Roth 401(k)s and Roth IRAs allow you to invest after-tax money now in exchange for tax-free withdrawals during retirement.² These options can be especially powerful for younger investors, who are typically earlier in their careers and therefore in lower tax brackets. 

• Brokerage account: A brokerage account allows you to purchase different investment assets, including stocks. There are several types of brokerage accounts, each with different tax treatment. A standard brokerage account is taxable. But a retirement or education savings account (IRA, Roth IRA or 529 plan) is tax-deferred. A brokerage account may be a good way to invest in stocks for people who prefer a “pay as you go” fee structure. 

• College savings account: If you are specifically investing for education-related expenses for your child, then a college savings account like a 529 plan may be the best way to go. Like retirement accounts, these enjoy certain tax advantages as long as you use the money for qualified educational costs.  

• Custodial account: A custodial account is a specific type of investment account that you can open for a minor in order to put money away for their future. It transfers to them once they turn 18 or 21, depending on the state. Like brokerage accounts, custodial accounts are taxable accounts. 

3. Choosing investments 

Armed with your target allocation and the proper investment account, you can now construct your stock portfolio by selecting investments. Typically, you buy individual stocks, one or more funds or a mixture of individual stocks and funds. And there are many funds that include stocks mixed with other assets. A financial advisor can help you build a portfolio and may even help manage your investments on an ongoing basis. 

Investing in individual stocks 

If you are interested in purchasing specific companies’ stocks, you can buy shares of any publicly listed company and hold those shares in your investment account. 

If you decide that you want to build your own portfolio of individual stocks, it’s a good idea to think carefully about diversification. Holding the stocks of too few companies or of companies that all operate in the same industry is risky and can be volatile. 

That’s why most financial professionals recommend building a diversified stock portfolio that spans multiple industries or sectors and includes multiple companies from each sector. But no investment strategy can guarantee a profit or protect against loss. 

Investing in funds 

If you don’t want to pick individual stocks, you might instead choose to invest in funds that hold a variety of stocks (and other assets). Index funds, mutual funds and exchange-traded funds (ETFs) all fall into this investment category. 

When you purchase funds, you’re really purchasing all the different investments that the fund holds. This makes funds an excellent means of instantly diversifying your portfolio, but it comes with a catch—fees. Nearly all funds charge management fees, which makes sense, as the fund is performing a service for you. But it’s worth paying attention to fees as they can eat into your portfolio’s return over time.  

You can get a quick sense of fees by looking at the fund’s expense ratio—a number designed to tell you how expensive a fund is (the lower this number, the better). 

Additionally, most financial advisors recommend holding different types of funds to make sure that you are properly diversified. For example, you might own shares of a large cap fund, a mid-cap fund, a small cap fund and an emerging-markets fund. These would all have specific allocations tied back to your risk tolerance and investment horizon. 

Working with a financial advisor 

A third option is to work with a financial advisor, who will build and manage your portfolio for you. 

Financial advisors should ask deep questions to understand the factors discussed above—your risk tolerance, investment timeline and financial goals. Then they will work with you to design a portfolio that matches those goals. In addition to stocks, it may include other assets, such as bonds, real estate investment trusts, commodities and more. 

Additionally, financial advisors should consider your comprehensive financial plan. This involves the ways that different financial tools—such as life insurance, annuities and estate planning—all work alongside your investment portfolio. 

How do fees work? 

When you invest in stocks, you may have to pay fees. While there are many different types of fees that you should be aware of, the most common include: 

• Transaction fees: These are paid whenever you purchase or sell shares of a stock. You may need to pay transaction fees, whether you purchase stock through a brokerage account, funds or an advisor. 

• Management fees: These are paid either to fund managers or financial advisors. They are meant to cover the costs of administering either a fund or your portfolio. 

• Commissions (sales loads): When working with an investment advisor, you may pay a commission, or sales load, when you buy or sell an investment. 

In general, you want to aim to pay as little in fees as possible. By limiting fees, you keep more of your money invested in the market, where it can be put to work growing and earning you a return. 

How are investments taxed? 

The good news about investments is that you can earn a return on your investment. But when you earn a return, you may owe tax. 

Your return could be in the form of a dividend, which, depending on the type of dividend, is taxed either as a qualified dividend at the same tax rate as capital gains or as part of your ordinary income. 

When you sell stocks, you may also owe tax if you sell the investment for more than you paid for it. You’ll owe tax on your realized capital gain, or profit. If you hold a stock for a year or less, then your gains will be taxed at the short-term capital gains tax rate. (This will be the same tax rate as your ordinary income tax rate.) If you hold stock for more than a year prior to selling it, any gains will be taxed at the long-term capital gains tax rate. The exact tax rate you will pay on your long-term capital gains will depend on your income level and tax-filing status, but it will be lower than your short-term capital gains tax rate. 

If you sell your stock at a loss (for less than what you paid), you realize a short-term or long-term capital loss. Any capital losses are first used to offset capital gains. Then, any remaining capital losses can offset up to $3,000 of your ordinary income annually ($1,500 for married filing separately). You can carry forward excess capital losses to be utilized in future years. Many investors strategically use this to their advantage through a process known as tax-loss harvesting. 

Retirement accounts are subject to their own unique tax structure, described above. 

Building your portfolio 

When building your investment portfolio, it’s important to consider the role that each piece of your portfolio plays. 

Stocks can provide many benefits—helping your money grow and potentially providing income in the form of dividends and capital gains—but they typically cannot perform all roles. That’s why your portfolio should consist of different types of assets. While this includes stocks, it should also include other assets like bonds, commodities, cash, real estate and more, all depending on your unique goals. 

¹Although stocks have historically outperformed bonds, they also have historically been more volatile. Investors should carefully consider their ability to invest during volatile periods in the market. With fixed income securities, such as bonds, interest rates and bond prices tend to move in opposite directions. When interest rates fall, bond prices typically rise; conversely, when interest rates rise, bond prices typically fall. 

²Regular contributions (basis) in a Roth account can be distributed at any time tax- and penalty-free. Distributions of converted amounts or earnings may be subject to ordinary income tax and may be subject to a 10% IRS early withdrawal penalty if taken before age 59½.  

This material does not constitute investment advice and is not intended as an endorsement of any specific investment or security. Returns represent past performance, are not a guarantee of future performance and are not indicative of any specific investment. No investment strategy can guarantee a profit or protect against loss. All investments carry some level of risk including the potential loss of all money invested. This publication is not intended as legal or tax advice. Financial representatives do not render tax advice. Consult with a tax professional for tax advice that is specific to your situation.