Getting Started in Investing
Farm Business Management Update, August 1998
By Benjamin Kyle Burkhart and David M. Kohl of the Department of Agricultural and Applied Economics, Virginia Tech
Did you ever hear a radio advertisement touting a "tremendously explosive investment opportunity"? Or for one of those "once in a lifetime" investments? Those investments are all fine and dandy, but how do you just get started?
A considerable amount of information is available regarding analysts' top picks in the stock market. But the level of complexity of information can be intimidating to a beginning investor. To invest in the markets, you don't have to be an astute analyst who crunches numbers and examines charts all day. In fact, you don't even have to have a lot of money to start investing. Our purpose is to provide you with a basic primer to begin investing in the stock market. You will be able to answer the questions: How can I choose a stock? How do I make a transaction? How do I keep track of my stocks? Should I "diversify?"
Lesson 1: Develop an Investment Plan
Before you begin analyzing the stock market, you must analyze yourself. Start by writing down your goals, both personal and financial. As you list your goals, consider the following questions: At what age do you wish to retire? Do you plan to pay for college for your children? Do you want a steady income from your investments or a growing portfolio? How much risk are you willing to accept?
A good way to begin investing is to budget it into your yearly or monthly expenditures. If you can set aside a small portion of your earnings from each paycheck for investment, you will never see the money and be well on your way to developing a healthy investment portfolio. Some employers will even deduct a specified amount from your earnings each month for investment, so that you are not tempted to spend it.
Lesson 2: Setting up the Account
Brokers can set up a variety of accounts for you based upon your investment plan, which includes deciding if you want all earnings reinvested or sent to you. Stocks can yield dividends, and you may choose to reinvest all earnings. A broker can set up accounts that avoid taxes, provide a steady income, or grow. The right broker, however, can help you determine the right account.
Before setting up any investment account, you should decide on a broker. Three types of brokers are full service, discount, and deep discount. Full-service brokers, such as Dean Witter, provide personal interaction with their customers. They conduct extensive research and give professional advice to clients or prospects. Their transaction fees are higher, but you are really paying for service and convenience. At a full-service brokerage house, you can always contact your broker over the phone, by e-mail, or in person.
Discount brokers can buy and sell stocks for you at a much lower rate than full service brokers. However, you lose some of the personal touch. The main difference between a full-service and a discount broker is the amount of information or advice you receive. A discount broker may provide you with only limited information.
The deep discounter's rates are very low, sometimes less than 1 percent. They simply make trades for you. They do not offer information on trends, nor do they offer any type of analysis. If you feel comfortable and have the time to research all of your own investments, these deep discounters may be your preferred method for investing.
When selecting a broker, remember: you get what you pay for. The lower the rate is, the less service provided.
After making a trade, a brokerage firm will send you periodic updates on your investment. These statements will allow you to determine whether your investments are gaining or losing money.
Lesson 3: Stock Categories
Many stock categories are available. The right broker can help you choose a stock that fits your plan. Blue Chip stocks are great for beginners because they are well established and have a long track record of steady performance. Other technology and small-cap (newly established) stocks have the potential to skyrocket or to crash and burn. If a stock is classified as having high growth potential, it usually carries high risk, in both appreciation and depreciation. Stocks can provide you with a certain level of income by paying dividends, and they can appreciate or depreciate in value over time. But the best kind of stock to choose is a stock familiar to you.
You can purchase two types of stock: common stock, which represents general ownership in a company, and preferred stock, which gives preferential treatment to the shareholder. Preferred stock shares are more expensive and usually pay a set dividend. Dividends are paid to preferred stock holders first. If a company were to liquidate, preferred stock holders would be the first to be compensated.
Lesson 4: What about Risk?
Before choosing a stock, know your risk tolerance. Age and personality can help you determine how much risk you can withstand. A young person can generally handle greater risk because, as the Rolling Stones song indicates, time is on your side. If you are a person who can tolerate a stock losing value and want the possibility of appreciation, risky stocks may be for you. However, if you are willing to accept subtle, steady growth, a conservative approach may be more appropriate. Remember that all investments need to at least cover the rate of inflation, or you risk the loss of purchasing power.
Lesson 5: Diversify!
All investments carry a certain burden of risk. However, the key to managing that risk is to diversify your investments. Simply follow the old adage, and don't put all your eggs in one basket!
A good rule of thumb is to diversify your funds into three different categories: growth stocks or mutual funds, conservative investments, and precious metals. By subtracting your age from 100, you can estimate the percentage you should consider putting in risk or growth investments such as stocks, which have good potential for a significant increase in value. You should keep at least 10 percent of your investment in precious metals, because they have a tendency to hold value in inflationary times or during natural disaster. Keeping the rest in conservative holdings such as Treasury bills or corporate bonds will guarantee that you will continue to make some money, even if your stocks decline in value.
One of the best ways to get started in stock investing is through an IRA. You can make yearly contributions of $2,000 and possibly reduce the amount of taxes you pay. Also, you can trade stock in an IRA without paying taxes on gains. IRA's can be started at investment firms or banks.
Mutual Funds have built-in diversification. Investing in a mutual fund is putting confidence in the investments and portfolio management of an investment firm. Mutual funds may hold 50 or more stocks. Therefore, you get a wide array of potential strengths and a return on your money--all in one package. "Front Load" mutual funds require a fee prior to investing while "Back Load" mutual funds charge a fee upon withdrawal. Other, "No Load" mutual funds require no fee, but may have an annual charge. Mutual funds may allow you to add incremental increases to your investment account and set up an investment plan. Thus, if you want to make an initial investment of $2,000 in a fund and then add $200 to it each month, you have that option.
A Little Advice
You can't take the luxurious, tropical vacation without the long trip. The same holds true with investing. Here's a little advice:
Start planning today for your future. You can invest a little at a time that will be worth a lot someday. Write down your plan, choose your broker and capitalize on Einstein's eighth wonder.
Contact the author at Sullylab@vt.edu.
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