Investing Information: The basics to get you started

Posted on Aug 1st, 2009 | Investing

If you’re not a rich person who has (or pretends to have) an inside track on the next “great” stock, you might think you’re out of the investing game. Not so fast. You’ll have to do the homework, but it doesn’t take a million dollars or a job on Wall Street to get started.

Before you begin

You don’t have to be an insider to invest, but before getting started, it’s a good idea to save three to six months worth of living expenses. Investing isn’t risk free, and setting aside some fall-back money should be a top priority anyway.

How much

An initial investment of $50, and an additional $50 each month, should get the ball rolling. Evaluating your risk tolerance is a good first step: how much money are you comfortable losing if the investment goes bad? There are plenty of options that represent lower risk and lower returns (bonds, certificates, money market deposit accounts), and higher risk and higher returns (stocks, mutual funds).

The Bottom Line

Despite the recent economic setbacks, the financial assets (which include many major investment vehicles) of U.S. households and nonprofits totaled $40.8 trillion at the end of 2008–nearly $2 trillion more than they totaled in 2004.

What to invest in

The basic intent of investing is to multiply your money. There are many common investment vehicles.

Stocks
A publicly held company divides itself into shares–-proportional pieces representing the company’s value. Stocks pay off by increasing in value over time or through dividends paid when the company is doing well. The stock market is known for its ups and downs, and while it can be one of the riskiest forms of investing, it also represents high earning potential.

Mutual funds
Mutual funds combine stocks, bonds and other assets into one professionally managed pool. This diversification helps manage the risk factor and decrease the chance of losing it all. The earnings probably won’t be as dramatic as some single stocks, but the risk is also lower.

Bonds
When you buy a bond, you’re essentially lending money to the organization or agency that sold it. Bonds are sold to raise money relatively quickly. A bond is purchased for a set price and earns a fixed interest rate until being redeemed at a predetermined maturity date. Generally, bonds give lower returns than stocks, but they’re also considered less risky.

Insured investments
Vehicles like certificates and money market deposit accounts are also invest¬ments. They traditionally earn less than other investments, but they are insured, so there’s no risk of loss.

Real estate
Real estate can be an investment. But, like other investments, there’s the risk that it will lose value. Historically, the return on residential real estate is low–-close to 0% after inflation from 1890 to 1990 and only about 3% after inflation from 1987 to 2007 (which could make it slightly more profitable than certificates and bonds, because those interest rates aren’t usually much higher than inflation). Also, the expenses don’t stop with the initial purchase. Taxes, insurance and upkeep all factor into the cost.

Still, buying a house can be a wise use of your money. It builds equity, is a financial asset, and can be a good long-term investment. Rental property and commercial real estate can also generate profit.

Why are you investing?

Before starting, you need to determine your goals. For example, are you saving for the future and retirement, or are you looking to supplement your income? Determining these goals will give you direction, and a licensed investment representative will be able to help you structure your investments to meet them.

Investing for retirement is an important part of your financial future. Common retirement options like 401(k)s and Individual Retirement Arrangements (IRAs) will help ensure you’re taking advantage of years of compounding.

Investing for income is another popular goal, but investing to turn a profit in the short term usually involves a higher amount of risk. The steadiest success with the stock market generally comes in the long term, because short-term market fluctuations are smoothed over with a long-term increase in average market value.

Stocks have an impressive historical record. In the 82 years from 1926 through 2007, the S&P 500 Index (an index of 500 stocks chosen by Standard & Poor’s that represent the overall market) had an average return of 10.36% annually. Overall, there were 59 years that had a positive return and 23 years with a negative return. As we’ve seen recently, there are no guarantees with the stock market, but history shows you’ll improve your return over a long period of time, making the risk of the stock market worth it.

When to start

As you can see, starting early has its benefits. But what about other ways to have time on your side when it comes to investing?

“Timing the market” is a popular term for the concept of buying low and selling high–-getting an investment cheaply and selling it when it hits its highest value. But there’s no solid evidence that market timing works. Basically, it’s just guesswork, and you might guess wrong. It’s usually better to buy in and sit tight for the long haul.

Other terms are bull and bear markets, and both types of markets represent the potential for making money. In a bull market, prices are rising or are expected to rise. Conversely, in a bear market, prices are falling. In either market, it’s important to thoroughly evaluate investments before jumping in. To learn more about investment evaluation, visit the “investing” section at brassmagazine.com, fool.com/investing, or finance.yahoo.com/education.

Where to go

The two primary ways people start investing are through full-service brokers and discount brokers. Consider both carefully before deciding which one to go with.

Full-service brokers offer advice and financial planning, and do the research for you. This service will cost you though. Discount brokers let you do the research and don’t offer the financial services of a full-service broker. They are usually much cheaper. Be sure to check with your financial institution, as many offer investment services. Regardless of what broker option you choose, investing can pay off.