If you are a retiree who did a good job planning for retirement, chances are you’re sitting on a large nest egg and wondering how to make your money last while providing a regular source of income. You may also be thinking of splurging a bit on that luxury car you always wanted or investing in a third holiday home that a friend suggested. Notwithstanding, investing and trading in stocks is a prudent way to manage your retirement savings. However, most retirees, even seasoned business operators and talented professionals, sometimes find it hard to take care of their finances and trade stocks independently.
Retirees mostly rely on financial advisors, who charge their clients a hefty fee for their services even when those advisors might be incompetent at picking the right stock or fund for their clients. Although we believe that most retirees should consult an experienced financial advisor to plan their investments, we also think that retired folks should try to manage their assets actively. It is your hard-earned money, after all. So, if you feel ready to take the plunge and start trading for the first time, here are a few general steps you can follow to start your stock trading journey.
Step #1: Learn all you can about the stock market.
Yes, that’s correct. Start reading. If you are a complete newbie, you must start by getting acquainted with terms like stock index, ETFs, mutual funds, quarterly earnings, EPS, price chart, and everything else. You’ll find many free resources on the Internet to help you understand the terms commonly used in stock trading and finance. For example, free investment dictionaries like Investopedia.com are a reliable source to learn about standard investing terms. Once you have your basics down, you can proceed to the next step.
Step #2: Open a brokerage account.
Although most retirees will already have an account with a stock broker like Fidelity or Charles Schwab, if you don’t, then it’s time to register for one. Once your brokerage account is all set up, get acquainted with the trading platform. Know where you have to click or swipe to buy or sell a stock, where you need to click to see your holdings and open positions, and how you can add and withdraw money from your account. Understanding your broker’s fee structure is also vital before you start trading. That way, you won’t be hit by unpleasant surprises when you want to cash out. If the platform has the option to open a demo account, you should start there to get some practice before risking your real money. After exploring the platform, you can fund your account with real money using a credit card or bank transfer and make your first trade. But, what should you trade?
Step #3: Choose the right type of asset to trade.
If you have done the first step well, you will already know what an individual stock is and what ETFs and REITs are. For the uninitiated, buying a stock is basically purchasing a part of the ownership in a company. This means that your profits or losses are directly tied to that company’s performance and growth, which can be both good and bad, depending on whether or not you chose a good company to invest in. This makes stocks a bit risky, especially for new traders. Before you start actively trading stocks, we suggest you first try your hands at ETFs. Why ETFs? Because they are a type of pooled investment (think mutual funds) that track an index made up of many different stocks. This makes ETFs less volatile than individual stocks.
Some examples of ETFs you can consider for your first trade are Vanguard Total Bond Market ETF (BND), a bond ETF, and SPDR S&P 500 ETF Trust (SPY), which tracks the S&P 500. You can also look at sector-specific ETFs if you are bullish on a particular sector (i.e., you expect it to go up). For example, the iShares Semiconductor ETF (SOXX) invests in the 30 largest US-listed semiconductor companies, and the Vanguard Real Estate ETF (VNQ) provides you exposure to U.S. equity REITs. At this point, you may be asking yourself what REITs are.
REIT stands for Real Estate Investment Trust. These companies own shares in income-producing real estate and distribute that income among their investors. If you did your research, you’re probably aware that companies share their profits with shareholders by giving them dividends, which is the portion of a company’s earnings that it decides to return to investors. Similar to dividend-paying companies, there are companies set up as trusts whose primary business involves investing in real estate and associated securities. These companies, called REITs, generally pay 90% of their taxable income to shareholders as dividends. Though these dividends are taxable at the hands of investors, if planned in a tax-efficient manner, they can be a source of regular and reliable cash flow.
Now that we have understood the different securities you can trade, the next obvious question is, how to decide when to buy and sell? That’s where steps four and five come in.
Step #4: Learn fundamental analysis.
If you don’t have a background in accounting or finance, you may be frightened by the term fundamental analysis, but it’s nothing to worry about. At its core, fundamental analysis is all about knowing how good of an investment a company is on a standalone basis or when compared to its peers or other investment options. There’s no need for an accounting degree to figure it out; basic math skills will suffice.
To perform fundamental analysis, you start by reading the financial statements of a company whose stock you want to trade. There are three primary financial statements that you must begin with:
- The income statement
- The balance sheet
- The statement of cash flows.
Don’t worry if, at first, you can’t understand what all those numbers mean. Start by going through the income statement. This will tell you most of what you need to know. It will inform you about the company’s gross margins, operating margins, and net margins. If you have run a business before, you already know what those margins mean. Even if you haven’t, you can quickly learn about them.
At the end of the income statement, you will find the earnings per share number or the EPS. This EPS number tells you the portion of a company’s profit for a period allocated to each share. With this EPS, you can calculate the company’s price-to-earnings ratio or PE ratio, which is simply the company’s current stock price divided by the company’s annual EPS. This PE ratio is widely used in the financial world to compare companies and is one of the favorite ratios of value investors like Warren Buffett.
Over time as you get familiar with financial statements and the commonly used financial terms and ratios, you will be able to read most financial statements easily and make trading decisions for yourself.
Step #5: Get started with technical analysis
Technical analysis is another tool you can use to trade stocks. Unlike fundamental analysis, with technical analysis, you don’t need to go through a company’s financial statements to make trading decisions. Instead, you look for patterns in a stock’s price and volume data to predict how they will change.
Technical analysis is a vast field; to different people, it means different things. For example, some people consider studying a stock’s price action as technical analysis. In contrast, others believe that charting, i.e., making trendlines or marking support and resistance levels on a chart, is technical analysis. Another group primarily uses ‘indicators’ to make buying and selling decisions and considers that approach the real technical analysis. Furthermore, there is the field of quantitative finance, which some believe also comes under technical analysis.
Whatever definition or area of technical analysis you choose, remember that it is just another tool in your arsenal that can help you make better buying and selling decisions while trading stocks.
Tips on what NOT to do when trading stocks for the first time
Until now, we have only discussed what you as a retiree can do to learn how to trade stocks. Now, let’s look at things we suggest you shouldn’t do or refrain from while trading stocks.
Tip #1: Avoid derivatives (Unless for hedging).
The most successful investor in recent history, Warren Buffett, has famously called derivatives “financial weapons of mass destruction.” We mostly agree with that statement. Therefore, unless you are someone with a financial or maths background, we strongly suggest you avoid trading derivatives.
In recent years, all thanks to the euphoria we saw in early 2021 in AMC Entertainment Holdings Inc and GameStop Corp stocks, derivatives, especially options, have become popular among younger investors. We understand the lure of these investment products. If you are right about the direction of a stock and your timing is also correct, you can make a lot of money by betting on its options. Please remember that the last statement’s operative word is ‘betting.’
Like at the race track, you can get lucky, and the horse or the dog you bet on can be the one to finish first, but the probability of that happening is very low. The likelihood that you can be consistently profitable trading derivatives is even lower. You will probably blow up your account and your retirement savings with it. So, stay away from derivatives at all costs. The only situation in which we can comfortably say that a retiree should be trading derivatives is if you have a background in maths or finance – you understand the product you are trading – and you are using the derivative only for hedging.
Tip #2: Avoid putting all your eggs in one basket.
Our first and foremost advice is never to put all your money in a single stock. It doesn’t matter how sure you are about the stock’s movement. Neither does it matter who gave you the recommendation – an old friend or even an investment newsletter – to invest a large sum of money in a single security. The reason is obvious. No matter how sure you are of a company’s success or a stock’s price going up, there’s always the chance that things will go the other way around.
Tip #3: Don’t forget about taxes.
The third piece of advice always appears best in hindsight: don’t trade stocks in a tax-inefficient manner. Most retirees know the income tax they need to pay at the federal, state, and even city levels, depending upon their income. However, many retirees are unaware of the taxes concerning securities transactions. The tax rate on revenue generated by trading in stocks or other securities differs from the tax rates on ordinary income from business or profession. The applied tax rate depends on the nature of securities you trade and how long you hold them.
Generally, if you are trading stocks or securities for short-term gains, the taxes you pay on your profits will be higher than the taxes on profits from long-term trades or investments. Also, as we mentioned earlier, if you receive dividends from a company, check whether it is a qualified dividend or an unqualified (ordinary) dividend. You can also use tax-efficient accounts to hold less tax-efficient securities.
The bottom line
If you have read thus far, you now know enough to approach stock trading with confidence. Retirees, especially those who have never traded, fear losing their savings if they start trading stocks. However, trading doesn’t necessarily mean rapidly buying and selling stocks and losing all your money in the process. On the contrary, if you approach trading like a mental game such as chess and remain prudent, you can protect your savings and turn them into a consistent source of income during retirement.
Just remember, you need to start by learning about the financial market and then trying to find an approach, fundamental, technical, or both, that can give you an edge over the competition. Once you have done that, avoid landmines like derivatives that can take away all your money in a single trade, and never put all your money in one stock. Keep these tips in mind, and you’ll be well on your way to becoming a successful stock trader in retirement.