Online Investing | What You Should Know to Invest Money Online

Overview: Online Investing | What You Should Know to Effectively Invest Money Online

Online investing is a relatively new way for people to make their money work for them. The practice began in the late 1990s, with brokers acting as online investors of their clients’ funds. In the intervening 20 years, individual investors have also adopted the practice of investing money online.

And although online investing is more commonplace today than it has been in recent years, it can still be a confusing and risky endeavor if you’re not properly prepared.

With that in mind, we’ve prepared a sort of “Online Investing for Dummies” guide. This is not a comprehensive list of all the things you’ll need to know in order to be a successful online investor, but it can act as a valuable resource in guiding you through the initial steps of investing money online.

First, however, let’s go over a little history.

Online Investing: A History

Before the Internet was as common a utility as gas and electricity, would-be investors had only one way of accessing the market: by calling their broker on the telephone.

Even if a savvy individual studied the market and spotted a trend before anybody else had the opportunity to do so, that person would be barred from acting on the research unless he/she had the proper licensure to execute trades.

In many ways, this was a form of protection for individual investors.

Prior to the advent of the Internet, it was a lot more difficult to research and understand the complexities of the market, and going through a broker helped investors avoid making rash or unwise decisions without at least having to get a second opinion before executing the trade.

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In 1985, Trade*Plus rolled out the option for brokers to begin trading through the Internet. At that time, online investing had not reached its saturation point, mainly because the Internet had not become as massively popular and widely used as it is today.

In 1991, one of Trade*Plus’s founders created a subsidiary company whose sole purpose was to allow individual traders access to the market via the Internet: E*TRADE. Of course, E*TRADE as it existed in 1991 was nothing like the E*TRADE you know now since individuals weren’t yet allowed to execute trades on their own. However, that all changed a few years later.

In 1994, K. Aufhauser & Company offered its customers the option to invest money online via its WealthWEB system. Online investors could now participate directly in the market or trade with other individuals investing online, thereby circumventing the traditional system. Trades made by online investors were still sent to a broker or compliance officer for review – a practice that continues today.

As online investing grew in popularity, companies began to offer a greater degree of detail to their customers. Whereas in the early days of investing online, online investors were expected to perform their due diligence on their own, today’s companies provide news releases, real-time quotes, and analyst reports. This level of additional detail allows online investors to be sure they have the most complete information available when they choose to invest money online.

How to Invest Money Online

Now that we have a clearer picture of how online investing started and the ways in which it has evolved, you’re probably wondering, “How do I become an online investor?” There are quite a few services available for those interested in online investing, but, in the interest of time, we’ll only cover what is probably the most common name in online investing: E*TRADE.

As one of the earliest adopters of the online investing business model, E*TRADE is probably the company most online investors investigate first and with good reason: it is consistently rated as one of the best resources for individuals to invest money online. Its adoption of the mobile app allows online investors to make trades wherever they are, affording them unfettered access to the market.

As with most companies, E*TRADE charges a fee for trades; some reviews have indicated that this fee is too high. However, if you’re just learning how to invest money online, E*TRADE makes the process easy to understand. Of course, we recommend you research the available options before opening an account and commencing online investing.

Although it can be tempting to jump right in and start making trades, you don’t want to risk your money to make trades that have dubious value just for the sake of making them. With that in mind, once you’ve selected a service for investing online, the next thing you’ll want to do is research. When performing research, there are typically two types of analyses you can use to guide your online investing: fundamental analysis and technical analysis.

Fundamental Analysis

When investing online, the goal of a fundamental analysis is to determine the value of a company’s shares based solely on the information provided by the company. This involves reviewing the company’s balance sheet, cash flow statement, and income statement to determine the “intrinsic value” of the company’s shares.

From there, the course of action is relatively simple: if the market price for shares of that company is below the intrinsic value, investing online in that company is a smart bet, as the price of the shares will eventually rise to meet the level of intrinsic value. If the market price for the shares is above its intrinsic value, it would be wise to avoid becoming an online investor in that particular company as it’s likely that the price of the shares will eventually fall.

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Technical Analysis

The goal of a technical analysis in online investing is slightly different from that of a fundamental analysis. While a fundamental analysis attempts to determine the value of a company’s shares by reviewing the company’s financial information, a technical analysis uses market data (such as past prices and volume) for a particular share to try and predict future trends.

This method of analysis requires more detailed research and a bit of a “leap of faith” on the part of the online investor since historical data of trends is not necessarily an indicator of future performance.

However, when done correctly, both methods of analysis can give you valuable insight into the stock you’re researching, which will help when deciding whether or not to invest online in a particular company.

What to Watch for When Investing Online

Although it is now easier than ever to become an online investor, that doesn’t necessarily mean you should jump in and invest online right away without keeping a few key points in mind.

Here are a few potential pitfalls of online investing that you should know before you decide to invest money online.

Time in vs. Timing

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The old adage in online investing is to “buy low, sell high.” After all, that’s how you make a profit when you invest money online, and it’s just a matter of timing, right? According to Investopedia, that’s one of the most common (and dangerous) attitudes that causes online investors to lose a lot of money.

The idea behind timing the market is inherently flawed: what one online investor considers a “low” price may not align with what someone else investing online considers to be “low.” Additionally, since you’re reading an online investing for dummies article, you would be wise to assume that your concept of timing the market may not yield the same results as someone who has been investing money online for a long time.

Therefore, it’s best to take a different view of online investing: rather than “timing the market,” you should consider “time in the market.” This is known as passive investing, or a “buy-and-hold” strategy. Essentially, this online investing strategy simply involves buying a set number of shares of a particular company at regular intervals, regardless of what they may be trading for at the moment.

Charles Schwab looked at the historical performance of this strategy beginning in 1926, and, over the course of a 20-year holding period, it never produced a negative result. The returns may not be as high they would be for an online investor who accurately times the market and makes his/her trades accordingly, but Business Insider noted that online investors tend to mistime market rallies more often than not. So, when you invest money online, you shouldn’t be trying to hit a home run on every trade, which leads to the next point below.

The Gambling Mentality/Lack of Diversification

Many online investors fall into this trap when they invest money online for the first time. They want to make a big splash in the market with their trades, but, in doing so, they often overextend themselves and set themselves up for a huge loss.

In some cases, that means putting all their investment capital in one company, hoping for a spike in the stock price. However, if that spike doesn’t come, online investors are left with too many shares of a company that was only potentially poised for one big jump and is now effectively worthless to them.

The gambling mentality also leads to online investors making reckless decisions based on something they saw in the news. For example, if you hear that the new PlayStation is going to come out in October, you may think now would be a good time to invest money online in Sony Entertainment. But what you’re probably missing is that the market has already accounted for the release of the new PlayStation long before it was officially announced and has adjusted the price accordingly.

So, while an online investor might think he/she is being savvy by trading based on this news story, that individual is likely investing online in something that isn’t going to yield a big return (and may even end up in a loss).

Additionally, many online investors tend to put blinders on and focus too much on one particular company without diversifying their investment portfolio. Even if the company is a historically solid bet (like, for example, General Electric), online investing in just one company means that you’re tied to that company for better or worse. Online investors would do well to spread their money around to hedge against unfavorable outcomes with a particular stock.

Buying Bad Stocks

Many online investing companies offer the option to trade what are known as “penny stocks.” That is, stocks whose share price is below $5. And quite a few online investors think that this is a good way to get rich quick – after all, if you buy 5,000 shares at $1 apiece and the price jumps to $2, you’ve just made an easy $5,000, right?

Wrong.

The reason penny stocks are priced so low is because the market has determined that they are highly unlikely to significantly increase in value (or the company offering the shares has no intrinsic value).

If you happen to be a seasoned investor with a successful track record for timing the market in online investing, penny stocks may be worth a second look. However, for a first-time online investor, we strongly recommend you avoid playing the penny stock game.

More often than not, you’ll be emboldened to invest online more than you can realistically afford, and it’s far more likely that you’ll end up losing money than it is that you’ll land on the next big stock. And speaking of investing more than you can afford…

Investing More Than You Can Afford to Lose

Again, this is a common trap that online investors fall into, and it ties into the gambling mentality we mentioned above. Investing online can be a great way to make your money work for you, but you should never think of it as a life preserver for your finances. Too many online investors play hunches and invest more than they can realistically afford, and if the stock doesn’t do what they were expecting, they’re left in worse financial shape than they were before they made the investment.

Before you invest money online, it’s best to sit down and come up with a figure that you can afford to lose if the market were to crash and your shares were devalued to nothing. More importantly, once you start online investing, stick to that number. You can always increase that number based on your investment returns, but a smart online investor has a bottom-line number that he/she is willing to lose and will never go past that.

Online Investing: Is It for You?

The final consideration when determining whether online investing is the right choice for you is to compare what you can do as an online investor and what you can do by working with a broker. If you invest money online on your own and you’re willing to do the research, you’ll have the freedom to act more quickly to identify and capitalize on market trends.

Additionally, online investing without a broker will cut down on broker fees when you decide to execute trades. And because you know your financial situation and goals better than any broker ever could, you won’t have to worry as much about your funds being carelessly managed.

However, there is a reason that brokers far outnumber casual online investors. Brokers are experts in the market: they know what to look for, when to buy, when to sell, and when to hold and let the market play out.

Unless you, as an online investor, have enough time on your hands to perform the necessary fundamental or technical analysis, you may end up buying high and selling low (assuming you don’t adopt a passive investment strategy). Investing money online without a broker may cut out the middleman, but it also removes the safety net and clear-headed advice that brokers can provide.

Ultimately, the choice is yours when deciding whether to become an online investor. And as you’ve seen, knowing how to invest online is important, but not as important as making smart decisions when you invest money online.

When done correctly, online investing can be a great way to diversify your assets and provide you additional future financial security. Also, if you can avoid the common pitfalls when investing online, you’ll find yourself wondering why you ever needed a broker in the first place.

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