If you’re an individual investor, how do you get started? We’ll assume here that you have your financial house generally in order, three or four month’s income equivalent in a savings account or credit union, some readily accessible account, and now you have another small chunk of money that you can invest in some other instrument. My personal feeling is that individual stocks are not immediately appropriate, because of volatility and lack of diversity. Before starting with individual stocks, I would want a minimum ten to twenty thousand dollar base in a balanced or blend type of mutual fund. By the way, this might be part in an IRA or 401k type of account, and part regular taxable account. At this level though, the main objective is safety rather than a focus on growth.

How do you find the appropriate fund? You can do a lot of reading, but you can also look at charts of mutual fund performance. Yes, past performance doesn’t… and so forth, but at this level, you do want an indication the investment company has been around a while.

You can find charts of fund performance in many of the popular magazines; Kiplinger’s includes a tool (look at the bottom of the mutual fund links, “create your own filter” which lets you search for mutual funds which meet certain criteria you select based on one, three, and five year performance. Remember that five years back from 2006 is 2001, and early 2000 was much better, so even five years doesn’t necessarily show the precipitous drop of 2000.  Find a chart of the Dow Jones Industrial Average for the last five to ten years, so you have a basis for comparing a particular fund’s performance against the market. You can also look on the web sites of the large fund companies like Fidelity and Vanguard and Janus-Henderson and T. Rowe Price. Generally, with a little effort, you can get a chart of past performance of their funds, usually past quarter or so, past one year, past five years, past ten years or life of fund.

Your objective is to select a fund for relatively steady performance, because until you’re comfortable with the ups and downs of investing, you don’t want a fund that might go down so precipitously that you will be tempted to panic and sell just as it hits its lowest point.

When you’ve found a few funds that seem interesting, do a little more research. Search the web site for the fund’s prospectus, which will show in more detail its past performance, and how much is charged as management fees, and whether there is a charge to invest (called a “load”) or whether it is a no-load fund (the investment companies mentioned above generally offer no-load funds), and what the minimum is for further investments.

There are no “hot tips” here, but rather an attempt to introduce you to the world of investing, and give a springboard for further development. First, the requisite disclaimer: this writer is not a “Certified Financial Planner” nor does he have any educational degree relevant to financial planning. In another section you will find personal stories that give some background, but when investing it is always important to get as much information as possible on proposed investments, from as many different resources as possible – “due diligence”.  Always add to this common sense and a reasonable dose of skepticism.

When you are investing in stocks, bonds and mutual funds, you are investing in business, in commerce. The exception, of course, is government bonds, but even there the resemblance to business is sufficient to lump them together for our discussion.

Always the first question to ask is, “what is the risk”? If you give someone else your money, what are the chances that you will get it back, and with a profit? If you buy a stock, you become part owner of a company. If the company does well, perhaps you can sell your stock for more than you paid for it, and your investment will have been worthwhile. Perhaps while you own it, the company management will decide to share profits with the shareholders, and pay a dividend, usually a worthy (but not a necessary) feature of stock ownership. If dividends are paid, they may be paid every three months (quarterly) or every month, or only annually. But you may find that, whether or not the company pays a dividend, at any given time, nobody else is willing to pay the amount you paid for your stock – you can’t sell it for what you paid for it. This is risk, the downside versus the possible rewards on the upside. And of course don’t expect your brokerage to insulate you from any such losses, they are merely intermediaries (in most cases) and your agreement with them clearly says, in the fine print, you are responsible for your own gains or losses.

BONDS

MUTUAL FUNDS

COMMON STOCKS

PREFERRED STOCKS

STOCK RIGHTS

STOCK WARRANTS

Bonds are a somewhat different animal. The company issuing the bonds is borrowing money from you, and promising to repay the amount borrowed, with a certain amount of interest paid to you in some stated way. If you see the stock market moving down, you might think it a good thing to have a promised repayment, plus a “guaranteed” interest payment. But there are several kinds of risks with bonds. First, the stability of the company—well, General Motors is not likely to go bankrupt, is it? Or would Enron? Second, while your money is on loan in a bond, the stock market might go up quite a bit, and you risk missing better returns. Third, while your money is tied up—you put a hundred dollars in a bond, a year later you’ll be getting a hundred back, with some interest, say five dollars– in that year, inflation may have made the purchasing power of that hundred and five worth much less that it was at the beginning of the year. So bonds bear their own form of risk. You can see that government bonds, while not likely to suffer bankruptcy, would still have the latter forms of risks, as would bank certificates of deposit.

MUTUAL FUNDS

Mutual funds provide a convenient way of investing in shares of a variety of businesses. As such, they provide a bit of “padding” around the risk of an individual stock (or bond, in the case of bond funds), but they can and do vary in value as the stock market moves up and down. Index funds, of course, generally move with the market index they model. Other mutual funds are managed to attempt to make money regardless of the overall market, and some do more or less succeed in that. But every fund, in its prospectus as it shows its past results, includes a statement to the effect that “past performance does not guarantee future results”, and every investor should take that statement to heart, even as he closely examines an investment’s history.

COMMON STOCKS

When you purchase common stocks, generally you may expect the purchase to come with the right to vote on matters the issuing company’s board wishes to bring before the stockholders at its annual, or at a specially called, meeting. You may receive dividends, if the board decides to issue them. The board is always balancing the use of profits between rewarding stockholders with dividends or reinvesting for growth of the company, so low or no dividends may be either a bad thing or a good thing for the company.

You have the right to sell the stock. That is, you have liquidity in your investment. But you have no guarantee that you can sell the stock for the amount you paid for it.

You have residual rights. If the company is dissolved, after all creditors are satisfied, any remaining value may be distributed to the shareholders of common stock – but you’re last in line.

PREFERRED STOCKS

A company may issue one or more types of preferred stocks, usually paying an attractive dividend. These stocks sell more or less at a par value, often a hundred dollars a share, but maybe twenty-five or fifty dollars. After issue, the market will determine the exact dollar value. Most are callable. At a set date, or perhaps after a grace period (usually five years) the issuing company can call them back in, giving the holder the stock’s par value. This may result in some capital gains or losses, but you usually pay close enough to par value that capital gains may not be too significant. There may be special cases where this is not true, so always try to be aware of any other circumstances that might influence a high discount to par value when you are purchasing a preferred stock.

Dividends are set as a percent of par value, and the preferred dividend must be paid in full before any dividend can be paid to the holders of common stock. For most issues, dividends are cumulative. This means if a dividend is missed, it is still owed to the preferred stockholder, and must be paid as soon as the company is able to do so, whereas for the holder of common stock, if a dividend is missed, it’s just too bad.

Some preferred issues are convertible to common stock. Because (if the common stock price goes up) this could be a real benefit, the dividend probably will be lower than would be the case for a straight preferred issue.

STOCK RIGHTS

Purchasing a common stock may or may not include certain rights, such as the right to buy any new issue of stock at a set price, usually under the market price. This right may be only for a brief period of time (one month, perhaps) after the new issue.

STOCK WARRANTS

Warrants give the right to buy stock at a fixed price for a period (perhaps ten years or more). This is usually a higher price than the stock is selling for at the time of the warrant issue, so if the stock doesn’t go up it’s not a good deal, but if the stock price does go up substantially, the warrant holder could buy at the warrant price and sell at the market price for a capital gains profit.

<br>Where to go from here? Scan the annotations in the <a href=”https://www.whystudymoney.com/index.php/weblog/category/Reference%20Library/” title=”Reference Library”><b><u>Reference Library</u></b></a> category of this site, and look for books such as these in your local library.

I’m again’em! And my financial structure had a couple within it. My objection centers on two notions. I think most investments would have better returns (there’s a reason insurance companies can afford deluxe buildings), and they are generally very inflexible instruments.

I’ll argue against an illustration in Patrick Astre’s book, This is Not Your Parents’ Retirement: A Revolutionary Guide for a Revolutionary Generation (yes, a 2005 copyright, but while the marketplace has grown and changed in detail, fundamental questions about classes of products like annuities, remain). A couple (or an individual- whatever) in early middle age plans on leaving the workforce at something like 55 years of age. In some occupations, such as military service, police, fireman, this would be a realistic goal, certainly a possibility. But from full-scale salary, there will be quite a reduction when this occurs. At 62 to 66, Social Security benefits will be added to pension, so the goal is to “kick up” income in the gap. Astre’s suggestion is to pay into an annuity that will then, at the set time (say, 55, that’s what we’re working toward), start paying out on a monthly basis so that the proceeds are exhausted as Social Security begins to pay.

The alternative would be to pick a solid mutual fund, do the numbers based on a 5% growth rate, and handle it yourself.

Weighing on the side of the annuity, if you fund it from a lump-sum payment, it’s a known quantity, almost risk-free, almost guaranteed (nothing’s guaranteed except death and taxes, and we’re working on death). If you pay it by monthly payments, you regard it as a primary payment, and are likely to keep up the payments in almost every circumstance.

Weighing against the annuity, if you fund it with a lump-sum payment, the moment you are committed to it, your lump-sum becomes perhaps close to three quarters of the size the lump was. The sum the annuity company says they are working with may still be the size of your deposit, but the cash value you can withdraw has suffered a severe case of the shrinkage. Typically, the cash value goes back up as you hold the annuity toward its term, but if you absolutely need the money in the interim, the penalty can really hurt. Further, when the payout starts, you are being paid from dividends and interest and your own principal, but the payments might well be taxed as regular income (this should be checked with a tax expert, not the annuity salesman and not me; I’m not a tax expert).

Suppose you try to achieve the same thing with a mutual fund. The pros include flexibility, access to your money at almost any time, and the opportunity, if you choose the fund wisely, to do better than the annuity would in final payout. Against that is the need for greater discipline (keep your hands off the money, you don’t need it to pay for the swimming pool) and the fact that mutual funds do go up and down in value, which means you should be keeping your eyes on your investments (always a good idea anyway). Why did I say to calculate 5% growth above, when many people say the market will generally grow 10%? Well, we’ve just seen several years when the market didn’t grow 10%. On this point it’s instructive to look at some mutual fund performance charts. Most charts would be like Fidelity Investment’s (simply click on any of the funds listed to see what I mean).

Look at the 10-year or life-of-fund columns, Look at the 5year column, and you can see which ones were hit hardest by the 2000 dot.com crash. These returns also do not consider any taxes you may or may not have to pay (it’s probable you’ll have to pay at least a 15% tax on your fund’s earnings).

So, which would you opt for- put your money in annuity jail for low risk inflexible usage, or put your money in somewhat more risky mutual funds, for probably higher rewards?

At the beginning of this article I said I was against annuities as a general principle, although I had some of my own. One was a small tax sheltered annuity from my work, paying a modest return but better than a bank CD or some such. At retirement, I moved it into a higher income investment.

My second annuity is a variable annuity. I had a mutual fund IRA that was becoming mediocre in its performance, I felt, and I was approached by an acquaintance from church who gave me a presentation on the benefits of his variable annuity. My mistakes were several—first, I was comforted by his presentation that the investments that formed the annuity were, if not great, at least OK (I should be equating OK with mediocre); second, when I received my copy of the annuity document, I should have immediately read and understood it; and third, at the time I didn’t realize the taxation aspect. My income tax on income from the annuity will be at a rate perhaps 10 to 15 percent higher than it would have been had I retained the mutual fund IRA.

Now, none of the issues mentioned above are disasters. I won’t throw eggs at the salesman’s porch. I probably won’t need the money any time before it can be paid out without penalty. What bugs me most is the feeling I could have done a lot better.

For another view on annuities, look at this article from the Motley Fool web site.

The assumption here is that you have a base of liquid savings, generally no credit card debt (pay off each card each month) and a stable base of mutual funds that are doing at least fair for you. Now you feel ready to open a brokerage account and look at buying stocks.

If you are reading this, you’re probably already fairly comfortable with working on the Internet. If you have children who use the same computer that you do, however, I urge you to be extremely paranoid about the security of your computer. A youth will go to a music-sharing site, thinking “Wow- free music”, and wind up with spyware lodging itself on your computer, transmitting keystrokes (like your username and password) back to a Chinese or Ukraine or even American crook specializing in identity theft- and your only clue is a little extra activity by your computer, which may not even be noticeable.

That said, if you practice good Internet hygiene, Internet trading is a fine way to do business.

You can go to a local brokerage (in-town) house, and buy stocks that way.  Which stocks? Whatever the broker is pushing that day, if you don’t have other orders for him or her. Will they be good stocks? Surely, for the broker, maybe, for you.

You can go to an on-line brokerage, and there are a number. You see the ads on TV just about every day: Schwab, E-Trade, Fidelity, Vanguard, many others. Look at the commission structure, but remember that under a value approach to stock picking, and with a somewhat limited portfolio, you won’t be doing a lot of buying and selling; a dollar difference in trade commission might only add up to perhaps thirty dollars over a year of modest investing (such as a buy and sell a month, for example). That means you look at other factors as well; where are your mutual fund accounts? What investing information do they seem to offer?

With a brokerage decided upon, which stocks do you want to buy? There are plenty of suggestions in the media; perhaps a department store chain opens a new store near you and you’re impressed. Should you buy that stock?  You can see the difficulties of simply choosing which stock to buy.

You need to analyze what you expect to happen with a stock. You may buy a stock expecting its price to go up by a certain percentage by this time next year. You’re looking for growth. You may buy a stock that pays a dividend on a regular basis, so you’re looking for income. Nice if you get both, and nicer if there is also a growth in the dividend. By the way, mutual funds usually simply re-invest dividends so that your number of shares increases. Brokerage accounts usually include a cash account where dividends can build up (usually parked in a money market account earning a little interest of its own) until you hopefully use them to purchase yet more stock, thus building your portfolio over time.

Back to the central problem: which stocks should you buy? It would be nice if there were a pre-screener for you, so that you weren’t simply throwing darts at a newspaper stock listing. Or listening to Mad Money Cramer screaming stock advice at you on one of the cable channels. And there are! Some of the on-line brokerages offer tools that will let you see which stocks have gone up or down in price over some past time periods (remember, Past Performance Does Not…).

Better yet, there are newsletters that build exemplary portfolios, many newsletters claiming their chief writer is a star stock-picker, making huge gains, yada, yada. But some newsletters really are good, and do provide useful advice.

Newsletter portfolios, I believe, are to be tempered by your own judgment. I have one stock that has, over many years, done very well for me, and it is not a part of the portfolio of my favorite newsletter. However, I have bought stocks recommended by the newsletter, after looking at the individual company’s information (about every company has a website with investor information), and seeing what other information I could determine about the industry. I look at the discussion about the company, and see if the writer’s expectations make sense, in light of what else I know about the industry sector, the economy, the world… In other words, even for what you think is good advice, check it out. Do your own due diligence.

One factor I give at least token consideration to is whether a stock I am considering buying is in any of the mutual funds I own. It’s not a major consideration, for my stock portfolio is small enough that one stock price movement (hopefully upward) will have more impact on my stock portfolio, than the same stock movement would have on a mutual fund with far more stocks in it than my own portfolio.

At what point should an individual expect to have to use professional money management for his portfolio? Money management builds in its costs, so it would seem to have to earn more than it costs. Where would that point be? If you have any thoughts on that, register for this site (you will never be spammed from here), and leave your comments.

In dealing with the trading and purchase of stocks through a brokerage, you may consider using margin. There is not a great mystery to using margin, it is simply borrowing other people’s money (usually, the brokerage’s). As always, when you consider borrowing money, there are good times to do it and bad times to do it. And as always, TANSTAAFL (There Ain’t No Such Thing As A Free Lunch).

You need always to keep in mind that a margin loan is accumulating interest every day; and if you look at the interest rates charged, especially in the smaller amounts, you will probably find them somewhat steep (nothing compared to what credit card rates are usually set at, but still…). Typically, the more money you borrow on margin, the lower the interest rate, but it is still a very real factor.

When you use margin, you are promising that you can pay the money borrowed back to the brokerage, by giving them the stocks in your account. If your account has 50,000 dollars worth of stocks, the brokerage may be willing to lend you (give you margin) of perhaps 40,000 dollars more. The brokerage would have a formula for this, and it would also depend on the quality (whatever that means to the brokerage) of the existing holdings.

If you borrowed the full amount allowed, and the value of your holdings dropped substantially, the brokerage might issue what is termed a margin call. They are simply asking you to pony up the cash so that the value of your stock holdings is more than what you have borrowed (however their formula works). If you have a lot borrowed, and the value of your stocks goes down dramatically, you can see the potential for disaster. Let’s look at some illustrations. Here we’re showing only gross generalizations.

In this example, there are a number of factors to consider. First, will the market in the particular securities you have purchased go up? How confident are you in your judgment of that factor? Second, how long will it take for the stock to go up? If it takes a year to go up 10 percent, and you are paying 10 percent margin interest, it doesn’t take a Fulbright scholar to see you haven’t really gained much. How about another example?

In this example, it looks like your sales proceeds of  $18,000 isn’t too disastrous, but remember that $10,000 is borrowed (margin), and so has to be paid back. That’s why the value of holding at close is less than $8,000.

The above examples, of course, do not include any applicable fees, commissions, or charges, all of which would impact your profit or loss on your investments.

There are some advantages to using margin:

Competitive interest rates — Certainly compared to credit card rates, and perhaps many bank or credit union rates. It is also worth noting that margin is essentially a line of credit, and can be used for other purposes than buying securities.</li>

Repayment flexibility — There may be no set repayment schedule as long as the required level of equity is maintained in your account. Interest charges on outstanding balances are posted to your account monthly. Any cash dividends (not enrolled in dividend reinvestment) and interest received may be expected to be automatically applied to your margin balance.</li>

Convenience — As mentioned above, you may be able to borrow for any purpose, at any time. Once you have been approved for margin borrowing, there are no additional forms to complete, application fees to pay, or loan officers to consult.

As the tone of this discussion may imply, it is the opinion of this author that margin can be a useful tool when the market is in a fairly stable upward trend, and you are fully aware of the pitfalls of using margin. Most of the books mentioned in the Reference Library discuss the stable household as one that is not burdened with a lot of debt. Using margin debt should be done only when you are very confident (based on knowledge, not wishful thinking) that margin’s usefulness will clearly outweigh its costs. Caveat emptor!