Invest

Knowing how to invest allows your money to grow. If you invest effectively enough, you could potentially live off the earnings from your investments. Read this article to learn more about investing!

10 Second Summary

1. Build up some emergency funds and pay off any high-interest debts.
2. Set your goals and don't be afraid to take risks. Keep your investments diverse.
3. Invest in companies you understand. Buy low and sell high.
4. Open a savings account and invest in stocks.
5. Consider some riskier bets, such as real estate or currencies.

Steps

Setting Yourself up for Success

  1. Build your emergency fund. If you don't have such an account already, it's a good idea to focus your efforts on setting aside three to six months' worth of living expenses just in case — hence, an "emergency fund." This is not money that should be invested; it should be kept readily accessible and safe from swings in the market. You can split your extra money every month, sending part of it to your emergency fund and part of it to your investments.
    • Don't tie up all of your extra money in investments, unless you have a financial safety net in place; anything can go wrong (a Get More Job Security, injury, illness) and failing to prepare for that possibility is irresponsible.
  2. Pay off any high-interest debt. If you have a loan or credit card debt with a high interest rate (over 10%), there's no point in investing your hard-earned cash. Whatever interest you earn through investing (usually less than 10% a year) won't make much of a difference, because you'll be spending a greater amount paying interest on your debt.
    • For example, let's say Sam has saved $4,000 for investing, but he also has $4,000 in credit card debt at a 14% interest rate. He could invest the $4,000 and if he gets a 12% ROI (return on investment — and this is being very optimistic) in a year he'll have made $480 in interest. But the credit card company will have charged him $560 in interest. He's $80 in the hole, and he still has that $4,000 principal to pay off. Why bother?
    • Pay off the high interest debt first so that you can actually keep any money you make by investing. Otherwise, the only investors making money are the ones who loaned it to you at a high interest rate.
  3. Write down your investment goals. While you're paying down any debt and building your emergency fund, you should think about why you're investing. How much money do you want to have, and how soon? Your goals will affect how aggressive or conservative your investments are. If you want to go back to school in three years, you'll want to play it safe with your money. If you're saving for retirement decades from now, you can afford to roll the dice a bit more. In short, different investors have different goals. These goals affect their investment strategy. Are you looking to:
    • Hold your money in such a way that it grows at a rate Understand Cause and Effect of Inflation and Deflation?
    • Have money for a house down payment in ten years?
    • Build a nest egg for retirement many years in the future?
    • Save For College for a child or grandchild?
  4. Determine whether you want a financial planner. A financial planner is a "coach" who knows the playbook. They know what plays to call in different situations and what outcomes to expect. While you don't need a financial planner in order to invest, you'll quickly realize that having someone who knows market trends, studies investment strategy, and can thoroughly diversify a portfolio is a very good person to have on your team.
    • Expect to pay your financial planner either a flat fee or a percentage (1% to 3%) of your investment. [1] If you invest $10,000, expect to pay about $300 annually for an advisor's help. If that seems like a lot to shell out for advice, realize that a good financial planner can help you make money. If an advisor takes 2% of your portfolio but helps you make 8%, that's a pretty good deal.
    • Be aware that many top financial planners will accept only clients with substantial portfolios.

Mastering Investing Basics

  1. Know that the riskier the investment, the higher the potential payoff. That's because investors demand higher payoffs for taking greater risks — very much like an oddsmaker. Very low-risk investments, like bonds or certificates of deposit, usually come with very little return. The investments which offer the highest potential returns are usually much riskier, such as emerging markets, small company stocks, penny stocks or commodities. In short, very risky bets carry with them a high chance of failure and a low chance of fantastic returns, while very conservative bets carry a low chance of failure and a high chance of small returns.
  2. Diversify, diversify, diversify. Your investment nest egg is perpetually at risk of shriveling away with improper management. The goal is to keep your money working for you long enough to multiply substantially. A well-diversified portfolio limits your exposure to risks so that your investments have the necessary time to create real gains. Professionals diversify by type of investment (stocks, bonds, commodities, real estate, cash, etc.), as well as by industry and economic sector.
    • Think of diversifying like this: If you own just one stock, your whole financial future depends on one company. If it performs well, you win; if it doesn't, you lose. Putting a significant amount of your portfolio in company stock is especially dangerous, because your financial health is already heavily dependent on the company at which you work. If the company performs poorly, you could both lose your job and a large portion of your nest egg. However, if you diversify across 100 stocks, ten bonds, and 35 commodities, you have significantly limited your potential loss: even if ten stocks were to become worthless or several of your commodities crash in price, you would still be all right.
  3. Always buy or sell for a definable reason. Before you decide to invest a single penny, lay out the reason(s) for doing so. It is not enough to see a stock steadily gaining over recent months and decide you want in on the action. That's gambling, not investing; you're relying on chance instead of following a strategy. The most successful investors always have a theory about why their investments are in good position to succeed (although the future is always uncertain).
    • For example, ask yourself why you're planning on investing in a stock index like the S&P 500. Go on: Why? Because betting on the S&P is essentially betting on the American economy. Why? Because the S&P is a collection of 500 leading US stocks. Why is that good? Because the American economy is recovering from recession and major economic indicators look hopeful. (This is just an example of appropriate reasoning.)
  4. Invest for the long run, especially in the case of stocks. A lot of people look at the stock market and think they see an opportunity to make a quick buck. While it's certainly possible to make a killing in stocks in a short time, it's not very likely. For every person who makes a lot of money quickly in stocks, more than one loses money quickly. Again, when you pump money into an investment for only a short period of time hoping for a big return, you're speculating instead of investing. It's only a matter of time before speculators make a bad call and lose it all.
    • Why is day-trading in the stock market not a strategy for success? Two reasons: market unpredictability and fees.
    • The market is essentially unpredictable in the short term. Guessing what a stock is going to do on a daily basis is next to impossible. Even great companies with excellent prospects can have down days. The long-term investor has the upper hand over the short-term investor, because the market is more predictable over the long term. Stocks have historically returned about 10% in the long-term (very loosely defined as ten years or more). You can't be nearly as certain that you'll earn 10% during any given day, week or month. So why risk using short-term strategies?
    • Each buy or sell order also comes with fees and taxes. Simply put, investors who buy and sell every day pay much higher fees than investors who just let their money grow. Those fees and taxes add up, eating into any profits you may reap.
  5. Invest in companies and sectors you understand. Invest in what you know, because you're positioned to recognize when a company is doing well and when it's not. A corollary to this is something that billionaire investor Warren Buffet once said: "Buy stock in businesses that are so wonderful that an idiot can run them, because sooner or later one will."[2] Some of Buffett's best-returning assets include companies like Coke, McDonald's, and Waste Management. [3]
  6. Arbitrage. Arbitrage is a low risk and potentially high return strategy used by many professionals, including Warren Buffett. You buy an asset at a low price and simultaneously sell the same asset at a high price, locking in the difference as your profit.
  7. Hedge. Hedging is the equivalent of an investment backup plan. A hedge is meant to offset a possible loss in one security by investing simultaneously in another security likely to move in the opposite direction. It may be counter-intuitive to bet both for and against a given scenario, but it could substantially lower your risk. Lower risk is good. Understand Single Stock Futures and Short Sell are great hedging options available to the investor.
  8. Buy low. Whatever you choose to invest in, try to buy it when it's "on sale." In other words, buy when few others are buying. In real estate, for example, you want to purchase property in a "buyer's market" when there is a large number of houses for sale compared with the number of potential buyers. When people are then desperate to sell, you have greater room for negotiation, especially if you can see how the investment will pay off when other buyers don't.
    • An alternative to buying low (since you never know for sure what "low" is) would be to to buy at a reasonable price and then sell higher. When a stock is "cheap" (for example, when it's 80% below its 52-week high), there is always a reason it's cheap. Stocks don't drop in price like houses do. A stock typically drops in price because there is a problem with the issuing company. Houses drop in price not because there is a problem with the house but because there is a lack of demand for houses.
    • If the entire market drops, it is possible to find certain stocks that fall simply because of the overall "sell-off" and not because the company itself has slipped in value. To find these good deals, one must do a lot of valuation. Try to buy at a discount price when the valuation of the company shows its stock price should be higher.
  9. Weather the storms. With more volatile investment vehicles, you may be tempted to sell what you own. It's easy to get spooked when you see the value of your investment plummet. If you did your research properly, however, you probably knew what you were getting into, and you decided how you would handle swings in the marketplace. When the stocks you hold plummet in price, update your research to find out what is happening to the fundamentals. If you still have confidence in the stock, hold on to it or, better yet, buy more at the lower price. However, if you no longer have confidence in the stock, or the fundamentals have changed, you may want to sell. Bear in mind that if you're selling out of fear, others may be, too, resulting in a dropping price. Your exit could be someone else's opportunity to buy low.
  10. Sell high. When the market bounces back, that's the time to sell investments you want to be rid of, especially if they're cyclical stocks. Roll the profits into another investment with better valuations (buying low, of course), and try to do so under a Perform a 1031 Exchange that allows you to re-invest the full amount of your profits (rather than having it taxed first). In the U.S., examples would be Perform a 1031 Exchange (in real estate) and Roth IRAs.

Making Safe Investments

  1. Invest in a savings account. Savings accounts, while not traditionally thought of as investment vehicles, offer a low- or no- minimum balance. They are liquid, meaning you can withdraw and use your money freely. However, they may come with limitations on how often the account can be accessed. They offer low interest rates (usually lower than inflation), but they're predictable. You're not going to lose money in a savings account, but you're not going to gain much either.
  2. Try a money market account (MMA). MMAs have higher minimum-balance requirements than savings accounts but will pay more interest. [4] MMAs are liquid but also may impose limits on how often the account can be accessed. The interest rates of many MMAs are in line with current market interest rates.
  3. Start saving with a certificate of deposit, or CD. Investors can stow money in a CD for time periods ranging from a few weeks to many years, during which time the investor cannot access the funds. The longer the CD, the higher the interest rate. CDs are offered by banks, brokerage firms and independent salespeople. They are low-risk but offer very limited liquidity. CDs are most useful as a hedge against inflation, especially if you're not planning to use your cash for anything else during the CD's term.
    • Invest in bonds. A bond is basically debt assumed by a government or company to be paid back with interest. Bonds are called "fixed income" securities, because steady income will be generated for investors regardless of market conditions. [5] You'll need to know the par value (amount loaned), coupon rate (interest rate), and maturity date (when the principal will be paid back) for any bond you buy or sell. The safest bond that investors can currently buy is a US Treasury security: T-bond, T-note, T-bill, or Treasury Inflation-Protected Security ("TIPS").
    • Here's how a bond works. Company ABC issues a five-year bond worth $10,000 with a coupon rate of 3%. Investor XYZ buys the bond, giving his $10,000 to Company ABC. Every six months, Company ABC pays Investor XYZ 3% of $10,000, or $300, for the privilege of using his/her money. After five years and ten payments of $300, Investor ABC gets back his/her original loan of $10,000.
  4. Invest in Stocks. Stocks are usually purchased through brokers. You buy pieces (shares) of a company, which entitles you to decision-making power (usually through voting to elect a board of directors). You may also receive a fraction of the profits, which are paid out as dividends. Dividend reinvestment plans (DRIPs) and direct stock purchase plans (DSPPs) are often available. Such plans allow investors to bypass brokers' fees and buy shares directly from the issuing companies. This type of plan is offered by hundreds of major corporations. [6] Stock market dabblers can thus invest as little as $20 or $30 per month and can also buy fractional shares (less than a full share) of stock.
    • Are stocks really considered "safe" investments? It depends! If you follow the advice in this article and invest long-term in good companies with good management, stock can be considered reasonably safe and potentially quite profitable. If you choose to invest short-term and fail to research companies carefully, you're not really investing, you're gambling, and you might as well play the slot machines.
    • Try out mutual funds. These are collections of stocks and/or bonds bundled together by a fund manager. They feature diversified portfolios at a fraction of the price an individual investor would have to pay to own each of the portfolio's securities. The funds pass along to their investors all interest, dividends, capital gains and value changes associated with the funds' securities. Funds charge management fees for their services.
  5. Invest in retirement accounts. These are a popular option for those planning ahead. Two of the most common options are the 401(k) and the IRA.
    • Your classic Set up a 401(k) is set up through your employer. You determine how much of your paycheck you want deducted every payday — before taxes — and it goes automatically into your retirement account. Sometimes the employer will even match your contribution. (It's free money!) The contributions are then invested for you in stocks, bonds, or a combination of the two. (Your choice.) The amount an investor can contribute to his/her account each year is periodically revised upward. Recently the annual limit was $18,000.
    • A [[Open a traditional IRA or a Roth IRA. An IRA is an Individual Retirement Arrangement (or Account). This is a retirement plan to which you can contribute up to $5,500 yearly. With a traditional IRA, the investor does not pay taxes on contributions at the time they are first earned. Instead taxes are due at the time the contributions (and their earnings) are withdrawn in retirement. With a Roth IRA, contributions are taxed at the time they are earned and then grow tax-free in the future. Retirement withdrawals from Roth IRAs are tax-free. All IRAs generate compound interest. That means the interest you make gets re-invested into your account, perpetually generating more interest. A 20-year-old who makes a one-time contribution of $5,000 to her Roth IRA will have $160,000 (assuming 8% return) by the time she retires at 65 without ever lifting a finger.[7]

Investing in Riskier Bets

  1. Consider investing in real estate property. There are several things that make real estate riskier than investing in a mutual fund, for example. For one, the value of properties is cyclical, and many people who invest in real estate tend to invest at the height of the market, thereby almost guaranteeing a short-term loss (especially considering agent fees, taxes and insurance). In addition, investing in real estate ties up your money until you can resell the property. It's not usually easy to liquidate your investment quickly. It often takes months, if not years, to find a buyer when you no longer want to own the property.
  2. Invest in Real Estate Investment Trusts (REITs). REITs are mutual funds for real estate. You can invest in a bundle of properties. Sometimes these bundles take the form of real properties (equity REITs), sometimes the form of mortgages or mortgage-backed securities (mortgage REITs), and sometimes combinations of the two (Hybrid REITs). [8]
  3. Invest in currencies. Currencies can be tricky, because they usually reflect the strength of the economies that use them. The only problem with that is that the relationship between the economy as a whole and the factors which influence it — the job market, interest rates, stock market, as well as laws and regulations — aren't often straightforward and can change very quickly and incomprehensibly. [9] Furthermore, investing in a foreign currency is always a bet on one currency relative to another with which it can be exchanged. These components add to the difficulty of investing confidently in foreign currencies.
  4. Invest in gold and silver. While owning a bit of each of these precious metals may be a good way to store your money and keep up with inflation, the overly bullish can get burned by going all-in. Just look at a chart of gold prices since 1900 and compare it to a chart of the stock market over that same period. The stock market has a pretty definite trend, but the same cannot be said of gold. Still, many believe gold and silver to be worthwhile investments and repositories of value (as opposed to "fiat" currency). These metals are not subject to tax, are fairly easy to store and are very liquid (can be bought and sold easily).
  5. Invest in commodities. Commodities, like oranges or pork bellies, can be a good way to diversify your portfolio if it's large enough. Commodities don't pay interest or dividends and aren't usually expected to outstrip inflation. They just sit there and can present big price fluctuations based on seasonal and cyclical factors. [10] Timing them right is exceedingly tough. If you have only $25,000 to invest, stick with stocks, bonds, and mutual funds.

Tips

  • Learn Pick Stocks and Other Investments With Fundamental Analysis and technical analysis. Fundamental analysis can help you decide whether a stock is worth buying. Technical analysis is intended to help you decide when to buy or sell.

Warnings

  • Avoid watching news about the stock market. By the time news reports are presented, it is usually already too late to take action. News reporters tend to get overly excited when the stock market rises and panicky when it falls. This in turn may influence you to buy high and sell low, exactly the opposite of what you should do. One can learn, however, to get a feeling for how the market interprets news and then make buy-and-sell decisions based on so-called sentiment.

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Sources and Citations

  1. ↑ http://www.forbes.com/sites/lawrencelight/2012/07/26/how-much-do-advisors-cost/
  2. ↑ http://en.wikiquote.org/wiki/Warren_Buffett
  3. ↑ http://blogs.wsj.com/wealth-manager/2010/02/24/warren-buffett-is-going-to-waste/
  4. ↑ http://www.bankrate.com/brm/green/investing/investing1-4a.asp
  5. ↑ http://www.fool.com/school/basics/basics05.htm
  6. ↑ http://www.fool.com/investing/brokerage/how-to-invest-20-100-and-1000-and-more.aspx
  7. ↑ http://www.getrichslowly.org/blog/2008/04/02/the-extraordinary-power-of-compound-interest/
  8. ↑ http://www.investopedia.com/terms/r/reit.asp
  9. ↑ http://www.thestreet.com/story/10408392/1/how-to-invest-in-currencies-look-for-growth-understand-the-risks.html
  10. ↑ http://online.wsj.com/news/articles/SB10001424127887323681904578643822549165446
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