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Whether you are looking to learn how to invest in stocks or perhaps you have the stock market fever and looking to discover how to invest money in this bull market. But before you do, you should review these seven steps below before throwing your money into the wind.
1. Understand the Difference Between Stocks & Bonds
It is imperative you know the roles of equities (stocks) and debt instruments (bonds) as they vastly play key roles in portfolios for a variety of reasons. This isn't to alarm you but to educate you to ensure that as you are investing your money, you have the basic foundation to apply your due diligence.
When you are purchasing a new car, you conduct research on it. You are checking the vehicle history ensuring it has a clean title, no major damage such as a bent frame, how many owners the automobile has, etc. This type of due diligence must be applied to your portfolio as well.
Stocks are sold giving investors a piece of "ownership" into the company. This means you are a stockholder and stand to profit from the good decision making ability of its management. The opposite is true when poor decisions are made and the company starts to lose money. It is the supply and demand of the market that determines what your stock is valued at, more or less (in terms of common stock).
Bonds are considered debt because a company will sell these instruments to either pay off higher interest loans they may owe, or perhaps looking to purchase new equipment. It can be a variety of reasons on why the company is looking to issue bonds.
Think of this process as you getting a loan from a bank. In this case, you are the banker and the company is the one applying for a loan. Should you decide to loan your money to the company, they will in return pay interest payments known as coupons. The payments can sometimes be monthly, quarterly, semiannually, or annually.
Without getting into many details and at a deeper level of understanding, this is the basic difference between stocks and bonds.
2. Investing in Stocks comes with Risk
Back in 2001 when I purchased my first share of stock, I knew nothing about risk. All I knew was that stocks go up which means I was going to be rich! Fast forward a few years and the stock was relatively flat.
When investing in stocks (this is the usual method people invest without a broker), you must understand that the risk of losing your investment is possible. Don't believe me, ask the stock holders of Enron, WorldCom, Lehman Brothers, Countrywide, and may more. Companies such as these can fail for a variety of reasons and if there are any resources remaining, these are usually sold off to pay off debts, bondholders, etc.
Stocks also come with a variety of risks such as political, currency, inflation, global, etc. Any number of factors can come into play affecting the equity price.
3. Have a Large Sum to Invest
It is so easy to be enticed by financial firms offering low priced trades such as $9 or $7 per trade. I am not referring to IRAs, etc but rather individual trading. What firms do not disclose is while purchasing a stock or trade may cost you $7, $9, or whatever the charge, they also charge you a fee to sell. This means, the expense of owning a stock is now doubled, at least.
Therefore, ensure you have a substantial number of shares you can afford which will lower the cost per share. For example, if you purchase ABC stock for $100/share (1 share), then your stock must move up 14% before you even make a profit, or $14. Now consider the taxes on anything after $14 in this situation.
Let's compare that to XYZ stock selling at $10/share. It moves up $1.40 to $11.40 but you bought 10 shares. The total amount is exactly the same but the cost per share is substantially different thereby allowing you to owe more shares for your money.
Cost per share:
$100 x 1 share + $7 purchase commission + $7 selling commission / 1 share = $114.00/share
$10 x 10 shares + $7 purchase commission + $7 selling commission / 1 share = $11.40/share
However, with that stated, ensure you are buying quality stocks but I need to mention that while you are saving to invest, you'll need a short-term account or an escrow to invest. I personally use USAA as they offer a FREE checking account that saves you money such as making non-USAA ATM withdrawals from other banks, USAA will refund any bank's charge.
4. Pay Off Credit Cards Before Investing
Many of my colleagues do not like me writing this but I have to stand with many personal money coaches on the reasoning that it makes ABSOLUTELY no sense to invest in a stock earning between 1-8% when on the other end of the spectrum, you are paying out of pocket, a debt with 12-19% interest.
Put these two instruments on a teeter-totter and which side wins?
This should apply to purchasing mutual funds, opening a brokerage account, or any other investment decisions. One way to help you along your journey is to track your finances. I am continually amazed by the number of clients who state they have a plan to get debt-free, yet, are not tracking their expenses.
I understand that your life is busy, so simplify with it Personal Capital that can compare your month-to-month spending habits and shows where you can cut back or reduce.
5. You Have 3-6 Months of Savings in Your Emergency Fund
We hear this over and over "Save your money" or "You have to get a budget". As redundant as this may sound, there is so much truth in these words. You know you need to but you don't! So ask yourself "Why?".
From an early age, most of us have heard that we need to save but how can we save if we don't have the extra cash to put away? Well consider savings as your spare tire in your car. If you were to take a road trip from Texas to Colorado, you would plot your coordination into a GPS and enjoy a long road trip. However, should your tire hit a deep pot hole and cause your car to receive a flat while stranded out in West Texas, you'll be happy to some degree that you can continue on with your road trip after you change the tire.
Well savings acts in a similar fashion as the spare tire. When you have engine failure or mechanical problems with your automobile, the air conditioning unit fails to turn cool on a hot summer day, your child's bike gets stolen, or perhaps your refrigerator fails, most of us have become accustomed to pulling out our credit cards and swiping our plastic credit. This is what not to do because of something called compound interest. This is your enemy when it comes to credit.
When you have saved smartly, you can avoid what most Americans do (charge their purchase) and you have the ability to pay cash. Yes, it stings, but you avoid receiving those pesky bills the following month not to mention the savings in interest and possible late fees.
Saving money can be a difficult task when most Americans are already currently living paycheck-to-paycheck. But while conditioning your mindset to begin saving slowly, whether $20 a week or $40 a week, you are establishing a positive habit that will allow you to quickly reach your goals. Remember, Rome wasn't built in a day. The point of this is that like the Great Egyptian Pyramids, you have build it slowly brick by brick. Once you become accustom to saving, it is very important to recognize that nobody can touch unless it is a TRUE EMERGENCY so when that flat tire does occur or your AC unit gives out, you'll be thrilled you put away some cash for a rainy day.
6. Determine How Much You Can Afford to Invest
Now that you are debt-free, have your emergency fund saved, and started investing into your retirement, you have determined you would like to invest some extra money. I never recommend more than 2-7% of your take-home income unless you are working with a professional.
The reason for this is that many new investors lose their initial investment due to lack of education in investing and are throwing their hard-earned income into the wind hoping it comes back ten fold. This is where due diligence and homework comes into play. Before investing, I highly recommend you read James B. Cloonan's Investing at Level3.
He is the founder of the American Association of Individual Investors which I have been a member of for over 10 years approximately and this non-profit firm puts the investor, not the financial firms, FIRST! His knowledge and experience since the late 1970's is so vastly well researched that you will learn a lot about investing and what strategy he has stuck with over the last several decades.
7. Find a Quality Low Cost Broker
There are two that I really like because of the low-cost features and the ease of use. While these are both brokers, both have its advantages and disadvantages so I recommend you consult with your financial adviser and planner prior to investing.
The first platform that is known for its simplicity and "near-to-no fees" is Robinhood. Originally it was solely for app based smartphone use, but the website has updated to a more user like platform. I love this resource because it eliminates most fees, if not all. They make their money by drawing interest from your account sitting in escrow until you are ready to use it.
The second platform that I highly recommend for longer term investing that also offers IRAs, etc is Betterment.com. They have Certified Financial Planners on staff ready to answer any questions you may have. Best of all, they provide personalized guidance on just about any financial situations.
They do charge fees but from my experience and solely my opinion, it is very low cost and very competitive to find other firms to beat them.
Another great option is with USAA Brokerage Services' Online Tools. They offer investments from IRAs to Mutual Funds and can quickly get you started. With this link "USAA Brokerage" you can receive 50 Commission-Free Trades for opening a Brokerage Account.