The new job is going well; so well that you’ve paid off some loans. You’re living well, and surprisingly there’s a little cash left over after you’ve paid your bills and even put some money aside for your company’s 401K plan. So, what next? You know about the Warren Buffets and Bill Gates of the world, people who had some knowledge, patience, and an uncanny sense of timing and intuition and consequently became incredibly wealthy. You even know some regular folks, like that old couple who live next door to Mom and Dad. The neighbors gossip that they are “comfortable” as a result of savvy stock marketing investing. You hear about the Dow, it’s up, it’s down. And what is the Dow anyhow? You turn on a cable TV channel. Jim Cramer barks advice at you, Suze Orman scolds you like as if you were a naughty little kid. You read conflicting suggestions from so-called “experts” on the Internet, but it’s totally overwhelming and you have no clue how to get started.
The long and short of investing
Saving for retirement is commendable and is an essential component of stock market investing, particularly as you get older. If you are in your twenties, you hope that thirty or forty years into the future, that little retirement nest egg will have grown to provide for your comfortable old age. But for younger people, it is also important to save money for the short term. You may want to buy your first house someday, and having liquid assets (assets that can easily be turned into cash) will make that purchase much more of a reality. It is also essential to have money saved in case of an emergency, health problems, or a job loss. And let’s face it; it’s good to have a little money available for a vacation or some other fun stuff.
Eggs in several baskets
The safest road to successful investing, long or short term, is diversification. When your portfolio, (collection of investments) is diverse you have a variety of investments with minimal redundancy. The recent drop of stock values makes this point clear. People who had all their assets in stocks suffered the most. Those who also owned bonds and other types of investments fared better.
There are many different ways to diversity your investments.
• Invest mainly in stocks but also own some bonds for diversification.
• Choose domestic stocks but also international or global investments.
• Own some large, medium, and small cap (capitalization) investments.
• Diversify with growth stocks and value stocks. Each has its own goals.
• Vary your portfolio with different sectors such as banking or energy stocks.
• Decide on some conservative and also aggressive companies to spread your risk.
Mutual funds are mutual friends for the novice investor.
A collection of stocks, bonds or other investments such as real estate, mutual funds have specific goals for the investor. A mutual fund is like a shopping mall, one roof and lots of different kinds of stores inside. Like the mall, a mutual fund can be a one-stop shop. There are thousands of mutual funds managed by Vanguard, T. Rowe Price, Janus and other companies that you may have heard of. Minimal investment for most mutual funds is $2,500 or $500 if it is for a retirement fund. For example, if you own Fidelity Contrafund whose ticker symbol is FCNTX, you own small pieces of such stocks as Berkshire Hathaway and Google. The advantages of owning mutual funds are that you usually don’t need more than $2500 to get in, you choose a fund that meets your goal such as large-cap growth from domestic stocks and you don’t have to closely monitor the gains and losses of the fund. The mutual fund manager does that for you, in exchange for expenses that you pay by owning the fund.
How do you know if a certain mutual fund is any good?
A company called Morningstar is in the business of rating mutual funds. They have a very systematic way of grading a mutual fund with one to five stars. The mutual fund manager’s competence is one of the factors in the Morningstar rating system. Morningstar ratings are public information that can easily be located on the Internet. The rating on a fund can change over time, much like your school grade point average. A five-star fund this year can become a three-star fund next year. Experts suggest only investing in four-star or five-star mutual funds.
How do you pick the right mutual fund?
Too many eggs. Too many baskets. Your brain feels like a bowl of spaghetti. There are several special categories of mutual funds that are guaranteed to be diversified or designed to your specific financial goals. If you don’t know what to do, start by owning only one index fund, target date fund or balanced fund that has a four or five star rating.
Index funds, like the Vanguard Index 500 fund, (VFINX) own stocks from one of the major stock benchmarks such as the S & P (Standard and Poor’s) 500 which includes some of the country’s largest companies. Index funds generally have very low expenses and are considered to be managed passively, unlike most mutual funds which are managed actively.
Target date fund or lifestyle funds, such as Fidelity Freedom 2015, (FFVFX) are designed with a specific date in mind to maximize returns.
Balanced funds, such as American Balanced Fund (ABALX), own stocks and bonds with both growth and income in mind.
Mutual funds are a great way to get started with basic stock marketing investing, but they are not the only way.
Mutual funds or individual stocks, which are right for you?
You’ve heard that guy at work brag about buying Google (GOOG) at $85 per share as an IPO (initial public offering) in 2004. He tells you it traded as high as $716 near the end of 2007, and now, even with the stock market being in a tizzy, Google trades in the $300s. Who wouldn’t want to get in on that kind of action? And wouldn’t it be cool to tell people “I own the Gap” (GPS). It may knock their designer socks off!
When you start buying individual stocks, you essentially become your own mutual fund. You don’t pay expenses like you do with mutual funds; that’s because you are the manager of your portfolio. And because of that, you need to do some work that you wouldn’t do when you just own mutual funds.
Owning individual stocks initially takes time because you need to do research to figure out what to buy. Some people say you should buy what you know. In other words, you should buy Nike (NKE) if you wear their shoes. There are a few problems with this idea. One is that you may end up buying stocks of not very profitable companies that have falling stock prices. Also, you may end up with a portfolio that is not diverse and is skewed toward one particular sector such as consumer goods. So you may need lots of time to read about stocks that would be good for you to invest in. That sort of information can be found on the Internet, weekly and monthly business magazines, and financial shows on TV. But you have to know where to look for reliable information.
Buy low; sell high is the way to make money in the stock market. But one flaw with that idea is that when you buy a stock you don’t actually know that you are buying it at a low point. People who invested in individual stocks at the start of 2008 thought they were buying low, but then stock prices plummeted. So you are basing your decision to buy a stock on its previous performance, the current market and your sense of intuition. As you start purchasing several stocks, you always want to keep diversification in mind. Don’t own Wal-Mart (WMT) if you also own Target (TGT).
In any case, when you buy a stock, it is prudent to decide from the start when you will sell it, not necessarily by a specific date but rather by a certain high point or a certain low point if its price starts to drop. This means you will want to spend time, perhaps daily, to monitor your stocks performance. When you own many stocks, this involves more time.
How do you buy individual stocks?
Owning individual stocks can be time consuming and is possibly riskier than owning mutual funds. But if you feel comfortable that you are ready for this roller coaster ride, then you need to set up an account with a broker. Brokerage companies such as Edward Jones, provide full service which means they will advise you on stocks based on your own personal situation but this assistance does not come without a price tag. If you are truly confident that you can make your own decisions about what individual stocks to buy, then you may do fine using discount brokerages such as Fidelity or Ameritrade which simply facilitate stock trades online for you at a fee generally less than $15 per trade regardless of the dollar amount of the trade.
Stock market investing is fun if you have the stomach for the daily ups and downs. It can be lucrative, but no stock can promise that. Recent failures of long time successful companies such as Ford (F)which traded as high as approximately $40 in 2000 and in late 2008 was trading for $3! But if you are careful, knowledgeable and can ride out the “bumps” for the long term, you could create great wealth for yourself by becoming a stock market investor.
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