This is for those who have never invested or had much investing success before. This is from my experience, backed by the numbers.
Disclaimer: I'm not a financial advisor. This is just my experience from investing in both ways that work and ways that don't.
Why should you invest?
Because investing modest amounts now and regularly over time can give you financial freedom to live your life how you want. A dollar invested now can lead to 10x, 20x, or 30x the amount in the future. I made a compound interest calculator that you can use to play around with to see how much money you can make with investing. The Compound Interest Calculator Spreadsheet is below for download.
Just as a quick example to show you the power of compound interest, if you invested $10,000 right now at an average return of 10% per year, in 30 years that would be worth $174,494!
But wait, what if you don't have any money to invest right now. Let's say you have $0 savings to invest, but you decide you are going to set aside $500 per month for the rest of your life and invest it at that 10% interest rate. In 30 years you would have $1.13 million!
What if you're 20 years old and started investing $500 per month at 10%? How much would you have when you're 65? $5.24 million, that's how much.
If you're still not convinced investing is a good idea, stop reading now and see a doctor. If you do want to invest, great. The returns you calculate with the Compound Interest Calculator Spreadsheet are real and guaranteed at the given numbers you put in. The one big question is, how do you maximize your annual return (interest rate) and maintain an average of 10% per year?
How do I maximize my annual return?
When I started investing in stocks I was lost. If you Google "what stocks should I buy" you're not going to be successful. Most inexperienced investors lose or at least don't make money - including myself in the beginning. Don't make those mistakes.
There is a near limitless supply of opinions, metrics, investing philosophies, and numbers to looks at. You don't need to know all of that. I'm assuming you don't want investing to consume all of your time. I went through a few websites that claimed to be experts in recommending stocks. I'll spare you the details, but they had me buying steel manufacturing companies, Brazilian gold mining companies, and stodgy old utilities, finance companies, and auto makers. The results sucked.
I'll save you lots of time. Get your recommendations from The Motley Fool. They're strategy is to buy and hold great companies for a minimum of 3-5 years. They do all the hard work researching companies and making recommendations. They send out a new recommendation every month and let you know what companies they've already recommended are a great value now. They are no BS, and have real money behind a lot of their recommendations. Having access to their site as a member also gives you great resources to do some of your own reading.
I'd highly recommend getting the service called Stock Advisor at the bare minimum. It's $199 per year but usually discounted to $99. This is an absolute must. If you don't know what companies to buy, those millions of dollars we talked about earlier are never going to happen. If you are feeling like you want more, their Rule Breakers service is fantastic too and is only $199 per year. They will try to sell you their more premium services for $1,500, but you don't need those. I have some of them and their great, but Stock Advisor offers plenty of value for you to be successful.
What actually is buying stocks?
I won't go into detail here, but basically when you buy a stock you are buying "shares" which are small ownership stakes in a company. When you've purchased shares, you are now a part owner of that company - called a shareholder. The company then uses your money to help grow it's operations and provide more products and services to customers. If the company successfully grows and becomes more valuable, your shares grow in value too.
Some people who are uneducated about the stock market think that making money in the market is somehow bad or unethical. That's not true. By buying a stock your are investing in a company and betting on (and assisting with) its future success - its ability to create and provide products and services that people want, need, and willing to pay for.
How do I actually buy stocks?
You buy stocks through an online brokerage. I recommend E*Trade. Gone are the days of calling up a stock broker and telling him what you want to buy. Get an E*Trade account, set it up to link with your bank account so you can move funds into it, and you're pretty much ready to buy stocks.
When you go to buy a stock, it might seem complicated but it's not too bad. First locate the stock by it's unique set of letters, or "ticker". To buy stock, under "Action" select "Buy". Enter the quantity of shares you want to purchase. The total amount you pay is the share price multiplied by the number of shares. For "Price type" use either "Market" or "Limit". Market orders execute immediately when you hit "Place Order" at whatever the price currently is. This is simple and easy. Then leave the "Duration" set for "Good for day".
I tend to use limits, where you set a price that you want to pay for the stock, and the order executes when the price drops below your limit price. The advantage of limits is that you are guaranteed to pay the limit price (or sometimes even below) you set. The disadvantage is if the stock keeps going up, your order will never actually go through. In the example above if you wanted the order to have a good chance of going through, you would set the limit price to maybe $64.85. Or if you wanted to just let it sit for a few days or weeks so it would buy the stock if the price dropped, you could set the limit price to say $58.00. Keep in mind though, if you have an open limit order, the total value of that order will be counted as "reserved for open orders" which can prevent you from buying another stock if the cash balance in your account isn't high enough.
That brings up another point.
When do I buy?
When should you buy stocks? What is a good price? I won't get into this since The Motley Fool has many articles on this, but the short answer is... now. The psychology of investing goes deep. In short, the more emotional you get and the more you look at your portfolio, the more likely you are to do something stupid and end up losing money.
The best strategy is to come up with a plan in advance and stick to it, such as buying $500 of great companies on the 15th of every month for the next 30 years, no matter what the prices are. Sometimes you will pay more, sometimes you will pay less. This is called dollar-cost-averaging, and it's simple and it works out well in the long run. Do not try to time the market. You will lose. There are thousands of intelligent investors with way more resources than you that also lose when they try to time the market.
Trading stocks vs. investing
You should be an investor, not a trader. Trading is a full time job. Trading involves making lots of trades on a daily or weekly basis. This is not the path to wealth. This is how you lose money. The short term stock prices are not based on anything other than fear, greed, and news headlines. Emotions generally make trading a losing battle, not to mention time invested and higher taxes on any gains you might get.
Investors buy great companies and hold them for many years. The long term stock price is much more predictable and is based on the company's earnings (profit). When you hold a stock for more than a year, you end up paying the long term capital gains tax rate rather than the short term one. The short term rate is much higher. Investing is not a get rich quick scheme. It's get rich slow.