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WiseStockBuyer

How much money do I need to start investing?

May 18, 2012 by Karl Leave a Comment

This kind of question’s becoming increasingly common as more and more people consider private investment in the equity markets as a viable option. It’s no wonder that stock market speculating has become more and more popular in recent times. You’ve now got access to more information than ever before which gives you the opportunity to analyse stocks quickly and in great depth as well as enter and exit your investments efficiently. With the pitiful interest rates offered by banks nowadays as well the idea of getting your money working for you is particularly tempting, particularly if you can do it from the comfort of your own home.

So then, can I invest $100 in the stock market?

Will I have a chance of making big profits that way? The truth is, if you think that you can start with $100 and make large profits in a matter of days, weeks or even months then you’re going to be sorely disappointed. After all, if things were that simple wouldn’t everyone be doing it? In order to elaborate on the question further it’s necessary to look at some of the factors involved in investing. One of the fundamental mistakes that people make is they believe long-term profitability in market speculation is primarily a factor of analysis skills. If they go through a bad patch their natural thought is to study more, learn more and analyse deeper until they know enough to predict the markets accurately. The truth is that success on the markets is actually mainly dependant on the psychological approach a person takes. There’s been many an investor with a massive knowledge of fundamentals, an in depth knowledge of technical analysis and access to a large investment fund who has nevertheless ended up broke. The fear that stops you from making a good investment because you’ve suffered a couple of losers in a row, the greed that makes you stake too much on the next one because you’ve won a couple in a row or even the anger that causes you to make investments that you shouldn’t do because you want revenge on the markets, these are the real financial killers and getting them under control is one of the most critical requirements of successful investing. If we accept that psychology is critically important then it stands to reason that money management is a massive part of that in investing. So back to our questions. Can I invest $100 in the stock market? Will I have a chance of making big profits that way? The same principles apply from a technical standpoint whether you’re investing $1 or $1,000,000. The market can only go up, down or sideways and you open and close your investments in the same way. If the differences between the two approaches is purely psychological then it would seem that a good way to learn the psychological discipline required would be to start with a small amount so any mistakes you make do as little damage as possible and become easier to learn from and move on. Unfortunately it’s not quite that simple and there’s certain factors that work against you that will make it extremely difficult to get anywhere with just a $100 investment. Firstly, you need to consider the brokerage commissions you pay for your investments. If you start with such a tiny amount of money then inevitably the fee’s are going to eat into your bottom line more and more. Since investing is basically a numbers game anytime that your edge is eroded away it makes it that little bit harder. The second factor to consider is that you will actually limit the stocks open to you if you’re only investing $100. Lots of the bigger companies in the world are priced at more than $100 a share, sometimes significantly more. In many cases these can be some of the safe and dependable stocks that you might actually consider investing in, particularly if your investment represents a significant amount of your available cash. Even if you do manage to find some cheaper stocks that are worth investing in you’re forcing yourself into essentially putting all of your eggs into one basket. If you start with a slightly larger fund it might seem like you have more at risk initially but the flipside is that you can spread your investment which if done correctly can actually keep your money more secure whilst still giving you the opportunity to invest in some slightly higher risk markets with larger potential upsides. I’ve obviously laid out two sides to the same argument here. Psychologically it’s far easier to start with a small amount because if you jump straight into the market with your life savings then you’re making something that’s already difficult 10 times harder because you know you can’t afford to lose. On the other hand you want to be investing enough so that you can diversify your portfolio properly, can afford to take some risks and can comfortably afford to pay the commissions required to your brokerwithout eating into your bottom line too much. The obvious answer is to take the middle ground and get saving until you can afford to comfortably risk an amount that gives you the best of both words.

Some alternative ideas for those those with a small amount to invest

If you don’t have enough money for a diversified stock portfolio, there is the option to buy into an index ETF or mutual fund. This would give you exposure to a major stock index such as the S&P 500 or the Dow Jones Industrial Average. Generally speaking ETFs have much lower fees than mutual funds and can be purchased just like any regular stock. ETFs don’t usually have minimum account sizes either. Here are some links to popular Index ETFs. SPDR Dow Jones Industrial Average ETF (DIA) SPDR S&P 500 (SPY)

Final words

Either way please just remember that Rome wasn’t built in a day. Successful investing takes time, patience, hard work, discipline and a little heartache along the way. If you’re in it for the long haul then forget about big profits for a second and make sure you’re in a position where you can approach the markets correctly both financially and psychologically.

Filed Under: Education

What Is the Difference Between Stocks and Bonds?

May 16, 2012 by Karl Leave a Comment

When it comes to investing, few topics are more confusing to the majority of investors and the general populace than the difference between stocks and bonds. Fortunately, the answer to this question is not as complicated as it might seem.

This article will briefly outline a stock and a bond and then explain the key differences between the two from an investor’s perspective.

What Is a Stock?

A stock, simply put, is a share of a company that:

  1. represents partial ownership of the corporation, and
  2. can be bought and sold

Technically, stock refers to the equity (the value of ownership interest in a corporation), and pieces of stock are called shares. It is not uncommon, though, for the word ‘stocks’ to be used in exchange for shares.

Stocks are originally issued as a way for a corporation to finance itself by raising money and avoiding taking on debt. This is called equity financing. A corporation could issue stock, for example, to raise money for more employees so that it can expand and generate more revenue.

After they are initially released, stocks are sold on secondary exchanges. The two main secondary exchanges in the U.S. are the New York Stock Exchange and NASDAQ. Corporations do not typically generate income from these transactions, since their shares are resold again and again.

The main reason why investors become involved with stocks these days is to turn a profit by purchasing the stock at a certain price and selling it at another price. This is done because the investor believes the value of a stock will rise because the corporation is profitable (or will be in the future) and has upside growth potential.

An investor can also short-sell a stock by essentially betting that the value of a company will drop in the near future. The difference between the original price and the lower price represents the investor’s profit.

To recap:

  • A stock is a piece of a corporation that signifies partial ownership (equity) in the company
  • Stocks are issued as a way to finance a company without going into debt
  • Stocks are traded on secondary exchanges like NYSE and NASDAQ

What Is a Bond?

A bond is another tradable security that is built on debt instead of equity. A bond:

  1. represents an obligation to repay borrowed money, and
  2. makes the owner a lender instead of an owner

Bonds are essentially loans. When a corporation or a government entity (like a city) issues a bond, it raises money from investors, who then become lenders. In exchange for giving the corporation money, investors receive a promise that they will receive their initial investment at a certain time in the future, plus any interest that has accumulated on the bond.

For example, let’s say a corporation wants to raise $100,000. It can do this by issuing 10,000 bonds worth $10 each. When an investor buys one of these bonds, he or she will receive $10 when the bond reaches maturity, or, the date at which the bond can be redeemed. If this bond has a maturity of 5 years, the investor will receive $10 five years from now, plus interest accumulated over five years. If the interest rate is 2%, and the interest is compounded (calculated) each year, the owner will receive $11.00 – a return of 10%.

Bonds are a form of debt financing, which raises money for a corporation or public entity by creating liabilities. This is different from equity financing because debt must be repaid. The value of a bond, or its yield, is determined by how likely it is to be repaid and the coupon, which is the interest rate that the bond holder will be paid over the life of the bond.

There are many different types of bonds (i.e. a bond issued by a city is a municipal bond) but all share the same basic characteristics.

To recap:

  • A bond is a loan to a corporation or public entity
  • Bonds must be repaid by the bond issuer and represent debt
  • The value of a bond is basically determined by the interest rate

How Are They Different?

A stock and a bond have several practical differences investors need to know.

Ownership versus Creditorship

The first involves the notion of ownership versus creditorship. When someone buys shares of a stock, he or she is a partial owner of a corporation and may or may not have voting rights. When someone buys a bond, he or she becomes a creditor of the corporation.

Fluctuations in Value

Another crucial difference is how stocks and bonds fluctuate in value. A stock’s value, or stock price, is determined by a mixture of fundamental factors, like earnings per share (revenues divided by the number of outstanding shares) and a valuation multiple, like the price-earnings (P/E) ratio. Supply and demand and other financial/economic factors also play major roles, so assessing stock price doesn’t follow a clear-cut formula.

Bonds, on the other hand, fluctuate in value primarily on the market interest rate, the length of the maturity, the investor’s discount rate (a rate that determines how much a certain amount in the future is worth to you now), and the par value, or face value of the bond. Investors can look to interest rates as a key indicator of how much a bond will be worth in the future.

Risk versus Reward

Stocks and bonds also differ based on risk versus reward.

Generally speaking, stocks carry more risk than bonds. This is because stocks can fluctuate dramatically for a wide variety of reasons, many of which may not be clear at all to the investor.

Bonds, on the other hand, are priced partially based on risk, so an investor can find bonds that suit their tolerance for risk. Buying a bond that has been rated as investment grade means you are more than likely to receive your investment back at maturity, plus interest, unless the corporation or public entity fails. Historically, bond markets are also less volatile than stock markets. Perhaps the “safest” investment in stocks or bonds is found with bonds issued by the U.S. Treasury. These bonds routinely have the lowest risk because the full faith and credit of the United States government is behind them.

Stocks may have greater risk, but they also offer greater rewards. A bond’s return, by comparison, rarely outstrips a stock. A municipal bond, for example, has returned an average of 4.2% since 1925, compared to an average return of 5.3% for Treasury bonds, 5.8% for corporate bonds, and 10.7% for stocks.

Where and How They Are Traded?

Finally, stocks and bonds are traded differently. Stocks are originally issued by corporations in initial public offerings (IPOs) in what are called primary exchanges. They are then sold and re-sold in secondary changes like the ones mentioned above.

Bonds, by contrast, are usually offered at public auctions for government bonds and over-the-counter (OTC) markets that are decentralized for corporate bonds. Investors wishing to buy and sell bonds typically do so through brokers, or those authorized and licensed to trade on an investor’s behalf.

To recap:

  • A stock represents ownership; a bond represents creditorship
  • Stocks and bonds use different factors to determine their value
  • Stocks are inherently riskier, but carry more upside profit potential
  • Stocks are bought and sold on stock exchanges; bonds are bought through OTC markets

Stocks and bonds are very different, but both, in the end, are tradable securities that represent the potential to grow your investment over time.

Filed Under: Education

Should I Invest In the Stock Market or Pay Off Bills?

May 10, 2012 by Karl Leave a Comment

Which came first, the chicken or the egg? If you can definitively answer this question of circular reasoning, you can probably answer the question of whether you should invest extra money or pay off debt first.

It’s largely a matter of opinion, however there are guidelines that make sense in this eternally burning question and there is actually some math that will help as well. Regardless of whether you invest any extra money or use it to pay off your bills, there are some considerations that should be taken into account before you do either.

Prioritize

There are three things that should be taken care of before you use any extra money for investing or paying off debt.

  1. Be Current – If you are behind on any bills or delinquent in any kind of financial way, get current on these things firstrisk of loss. Your credit rating can be negatively affected by delinquencies, not to mention the possibility of repossessions or foreclosure. Make sure your financial house is in order and stable before you take any more drastic measures.

  2. Have a Safety Net in Place – This has long been a standard recommendation from wise financial counselors (there are many who are unwise). The rule of thumb is that you should have three to six months worth of savings in reserve just in case of emergencies. Layoffs, medical emergencies, and other unexpected things will happen in life. If you don’t have a safety net in place, Mr. Murphy says it is even more likely to happen.

  3. Get Rid of High-Interest Debt – Before you go worrying about whether you should make extra payments on your mortgage, pay off the ridiculous revolving credit accounts that you have. Credit cards from retail stores or major credit cards with interest rates in the high teens to high twenties have got to go before anything else. The amount of the debt is irrelevant. The interest you are paying over time on these credit lines makes zero sense from a financially sound standpoint.

Do the Math

After you have taken care of the basics outlined above (and if you haven’t, then the rest of this article should be for future reference only), then it actually becomes a question of math to determine where your extra funds should flow.

With each financial decision you need to make, the basic question is obviously “which is better for me?” The way to decide this from a strictly monetary standpoint is by determining the after-tax return for an investment versus the after-tax expense for a debt.

Each debt that is paid off is in fact a gain for you in the long run because of the interest which is eliminated. As an example, if you have a mortgage on your home, your rate is probably somewhere in the 4.5-7.5% range.

You may be below or above this range, but the majority will fall somewhere in here. At face value, paying off your mortgage will save you this percentage of interest each year on the amount that you owe on your home. However, this is not necessarily the case.

Because of the tax deduction on mortgage interest, your effective interest rate is actually less than what you think it is by probably a percentage point or two.

If your effective rate winds up being, say, 4.5% yearly, then when deciding between paying this off and investing you have to determine if your investment will have returns at a rate greater than 4.5%. It is really just that simple.

Finding an investment that has returns at a greater rate than an effective mortgage rate is not that difficult if you do some homework. Any investor worth his salt expects to make a better return than this. Traders expect even higher rates of return.

I will rarely enter a trade if I don’t expect at least a 10% return from it, and I look for a 20% return usually. Even conservative investments should outpace most effective mortgage rates.

If the interest you are looking at is on a loan that does not have tax advantages, then the comparison becomes less advantageous to the investment argument. If you are comparing an interest rate that is less than 10%, you should be able to justify investing or trading, unless you are new to the game and need to learn more.

Once the interest rate breaks the 10% mark (this mark is arbitrarily set by my own opinion), then investing becomes less of an option, while trading (well) remains an option to at least 12-15% in my opinion. These levels will differ depending on your experience and level of comfort.

Lower Your Stress Level

While all of this sounds well and good from a mathematical point of view, we are all still human and emotions and stress m

no debt sign

ust be taken into account. Not everyone will comfortable with the idea of investing as opposed to paying off bills or debt, let alone the rates of return that I’ve suggested above.

Well-being needs to be taken into account above pure numbers. If you decide that based on the math the investing or trading route is the way you should go, but you can’t sleep at night worrying about whether your investments will tank on you, you should pay off your debt instead.

The market will still be open when you are out of debt. Psychological peace of mind is essential to your health, as stress is a top killer because it causes so many other health issues.

Assess your situation both by the numbers and according to your level of comfort before you make any serious decisions. There is an answer, but it is completely dependent on you.

Take the Free Money and Run

One last note on investing: If your job offers you matching funds on a 401(k) or other similar option, fund it fully. This should not be an option. debt calc

Your money is usually taken pre-tax, and if your company is matching your funds then you are getting a 100% return on that money before it even enters the market.

While I don’t necessarily endorse mutual funds per se, doubling your money before the fund managers ever get their hands on it certainly increases your potential for earning versus losing by quite a bit.

Filed Under: Stock investing

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Hey! I'm Karl and I have been a keen investor for over a decade. Learn more about my experiences and say hello!

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