What you should know before investing
Let me first start by saying that I am by no means a financial advisor and pay someone else to handle my taxes. What I want to share in this post is my experience with investing. If you want solid advice about investing or taxes make sure to speak with a professional. With that said, here’s my story.
I was tired of earning less than one percent on my savings and CD accounts. I was always curious about investing in the stock market, but it was intimidating, and the thought of throwing large sums of money at something I didn’t understand seemed pretty stupid. So I set out to learn about investing in the stock market without risking my main retirement funds.
I decided to start small ($1,000) with funds I had accumulated from a former employer’s 401k plan. When I switched jobs, I had to roll it over into an IRA, and it was just sitting there earning nothing for years. Why not invest it in the stock market instead? Here’s what I learned.
There are tax advantages (yay!)
If you buy stock in a qualified small business and don’t sell the stock for five years or more, you don’t have to pay tax on the capital gains when you sell it. I also learned to the difference between a traditional IRA and a Roth IRA. In simple terms, a traditional IRA is pre-tax funds, and the Roth is post tax. In other words, once you retire and begin taking withdrawals you’ll pay taxes on the traditional IRA but not the Roth. I chose a Roth IRA, so I won’t have to pay on any gains later on.
It takes time
Be prepared to lock your money away for at least five to ten years. Since you’re tying up your money for a long period of time, link your investments to your long-term financial goals, such as saving for your child’s education or your retirement. You’ll need to learn to be patient. The value of your investment savings will rise and fall. When I first started, I watched the stocks daily, and every time it dipped, I thought of selling. I had to stop looking at the performance so often because I was going crazy. I began checking them every other week and to my surprise started to see real gains. I had to accept that the market fluctuates often and a down day doesn’t mean much in the long run.
Don’t be overly cautious
Choosing a stock can be difficult – especially if you over analyze it. I decided to take the Warren Buffet approach and invest in things I understood or used. This turned out to be great advice. As a consumer, I was able to get an idea of how the company was performing where it counts. For example, I was always a fan of Southwest Airlines, and when I learned they would be flying out of Atlanta, home of the busiest airport in the world, I decided to buy some of their stock (ticker symbol: LUV). At the time, the stock was trading at $14/share. As of this writing, it’s trading around $56/share. The gamble paid off.
Diversify, diversify, diversify
Don’t put all your eggs in one basket. If you put all your money in one investment and that company or market fails, you’ll lose all your money. There isn’t a better example than the unfortunate people who trusted Bernie Madoff unknowingly invested in his Ponzi scheme.
You should diversify your investment portfolio and spread portions across various companies and asset classes. Put some money in lower risk investments, such as government or corporate bonds, and some money in higher risk investments, such as equities or real estate.
Not everyone, including myself, has large sums of money available to buy chunks of stocks when the timing is right. Instead, I keep an eye on some of my favorites, and when I can afford to, I buy a handful at a time. Another way is to look for investments, such as mutual funds, that allow you to contribute on a monthly basis rather than investing in one lump sum. Doing so allows you to minimize your losses when the market is down. It also allows you to buy more shares at lower prices if the market is falling.
Consider investing through a fund
It’s a good idea for beginners to invest their money in mutual funds. Mutual funds are managed by fund managers who use their knowledge and expertise to buy and sell shares or bonds that maximize contributors’ returns. Buying directly, instead of through a fund, can be expensive and especially risky for beginners who don’t know the market. The majority of my retirement is through mutual funds, and I’ve learned to appreciate the value of professional management.
You don’t have to be a high roller to be a successful investor. It’s easier than ever to buy your own stocks and gain experience in the process. Be patient and invest for the long haul. Here are some of the most popular firms to use:
- E-Trade (etrade.com)
- TD Ameritrade (tdameritrade.com)
- Scottrade (scottrade.com)
- Charles Schwab (schwab.com)
For me, I’ve gained a much better understanding of how investing works and I now have more informed conversations with my financial and tax advisors.