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Don’t invest your first $5,000 in these 5 types of stocks
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Investing in the stock market is one of the best ways to build fortune. But figuring out what to invest in when you’re starting out can be overwhelming.
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There are many places that tout “the best stocks to invest in now,” but many are bad or simply high-risk investments for beginners.
We asked a financial advisor about what to avoid when investing your first $5,000. He gave us five types of actions avoid when you start investing.
Rich people know the best financial secrets. Learn how to copy them.
Types of Stocks to Avoid with Your First $5,000
Here’s a closer look at what to stay away from.
1. Stocks with a price/sales ratio above 10 times
When evaluating an investment, it’s a good idea to research whether the company is overvalued or not. A smart way to do this is to check the price-to-sales ratio.
“The price-to-sales (P/S) ratio is a valuation metric that compares a company’s market capitalization to its revenue,” said Ryan Jacobs, financial advisor and founder of Jacobs Investment Management. “An AP/S ratio above 10 indicates that investors are paying a premium for the company’s sales, which may not be justified by its earnings potential. High P/S ratios often reflect overvaluation, making these stocks riskier. For beginners, it is best to avoid these stocks and focus on companies with more reasonable valuations.”
Be aware: 3 types of investments expected to fall in value in the summer of 2024
2. Actions suspected of fraud
Although publicly traded stocks are generally up, some companies get caught up in criminal activity and shares quickly plummet. That’s why investing in stocks is much more than numbers, but investing in a company with transparent finances and reliable management.
“Fraudulent companies manipulate financial statements to deceive investors,” Jacobs said. “These stocks may have promising numbers, but the underlying business may be weak or non-existent. Investing in these companies can lead to significant losses when the fraud is exposed. Beginners should focus on companies with transparent and trustworthy management to avoid the pitfalls of fraud.”
3. Speculative stocks based on future growth
In a world of meme stocks (looking at you, Gamestop) and day trading, you probably shouldn’t bet your first few thousand dollars on speculative investments that pose a high risk. Once the price of some of these stocks rises, they can plummet just as quickly – or more – and take your money with them.
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“Speculative stocks promise high returns based on potential future growth rather than current performance,” Jacobs said. “These actions are often exaggerated and present substantial risks as their success depends on uncertain future events. For new investors, it makes more sense to invest in companies with an established track record and stable profits, reducing the likelihood of significant losses.”
4. The most popular stocks
When stocks start to appear in the financial news, they may already be a little overvalued. When your Uber driver starts giving you hot stock tips, it’s probably not a good idea to go all in on a recently popular stock.
“While popular stocks like big tech stocks may seem like safe bets, they often have inflated prices due to high demand,” Jacobs said. “These stocks can be volatile and may not provide the steady growth a beginning investor needs. Instead of following the trend, beginners should look for stocks that are undervalued or have performed consistently over time.”
5. Value traps
Value investing is the practice of reviewing a company’s financial statements to find stocks that are undervalued on paper, which could lead to outsized growth in the future. But not all value stocks are really that valuable – they can be a trap.
“Value traps are stocks that appear undervalued based on fundamental analysis, but are cheap for a reason,” Jacobs said. “These companies often have underlying problems, such as declining revenue or poor management, that hinder their ability to grow. Investing in value traps can tie up your capital with little or no return. It is crucial to research thoroughly and avoid companies with unresolved fundamental issues.”
How to Invest Your First $5,000
Now that you know which types of stocks to avoid, here are some good ideas on how to invest your first $5,000:
1. Index funds
Instead of focusing on individual stocks and trying to pick a winner, why not buy hundreds of shares in a single investment? That’s where index funds come in.
“Index funds are a perfect starting point for beginning investors,” Jacobs said. “These funds replicate the performance of a specific market index, such as the S&P 500, providing broad exposure and market diversification. Index funds typically charge low fees and offer steady growth over time, making them a reliable option for those new to investing. They reduce the risk of picking individual stocks and help you build a solid foundation for your investment portfolio.”
2. Berkshire Hathaway
Did you know you can invest like Warren Buffett? Buffett’s holding company, Berkshire Hathaway, is a publicly traded company that allows investors to buy shares and reap the rewards of one of the greatest investors of the century.
“Investing in Berkshire Hathaway, Warren Buffett’s conglomerate, is a great way to learn from one of the best investors in history,” said Jacobs. “Berkshire Hathaway has a diverse portfolio of high-quality businesses managed by experienced allocators. For beginners, this stock offers exposure to a variety of sectors and the opportunity to understand solid investing principles. It’s a practical way to benefit from professional management and, at the same time, minimize risks.”
3. High Yield Savings Account
While investing your first $5,000 can be exciting, it’s important to first have an established cash base. If you don’t already have an emergency fund, you might want to avoid the stock market altogether and simply park your first $5,000 in a high-yield savings account.
High-yield savings accounts offer much higher interest rates than a typical savings account, but still come with the same protections and access that a regular bank account offers. High yield accounts currently pay over 4.00%, which is a great guaranteed rate of return. Plus, the funds are FDIC insured up to $250,000, so you don’t have to worry about your money. Overall, parking some money in a high-yield savings account is a great starting point for many investors.
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This article originally appeared on GOBankingRates. with: I’m a Financial Advisor: Don’t Invest Your First $5,000 in These 5 Types of Stocks