How to get started investing

Let’s say you’ve decided to start investing. How do you get started? This article describes the basics of investing, and gives some hints on how to get started.

Before you start investing, however, make sure you have the following covered. If you can’t put check marks against all of the following, then you aren’t ready to start investing yet.

• You have no high-interest debt (such as credit card debt). If you do have high-interest debt, pay it off first.
• You have an emergency fund covering expenses for a few months. If you don’t have an emergency fund, put your investment money into an emergency fund first. This will cover your living expenses if the worst happens – such as you lose your job, or your car gets totaled in an accident.
• You are contributing to a retirement plan (such as a 401(k) plan). Yes, this is a form of investing, but investing for retirement takes precedence over investing for the shorter term. You will want to balance your investments.

What investing is (and isn’t)

What is investing? There are really two ways that you can put your money to work for you. The first is “savings”. This covers things like putting money into a savings account or certificate of deposits. The thing about saving is that the money you put in (called the “principal”) cannot lose value. If you put in $1000, you will definitely get back at least $1000 (unless you, for example, withdraw from a CD before the term is up).

With investing, your principal (which, remember, if your money) can lose value. You could put in $1000 and get back only $500. This sounds like a bad deal, but people invest because they have the potential to get higher returns than savings.

For example, a typical savings account (such as ING Direct or HSBC Direct) currently pays between 4% and 5%. But on average, stocks have returned about 10%. But the risk with stocks is that 10% is a long term average. They might go up or down over the next week, month, year or decade. So investing should really only be done with money that you can (a) afford to lose completely and (b) won’t need for a long time (several to many years).

Investing Options

What can you invest it? There are three main options: individual stocks, bonds and mutual funds.

When you invest in a stock you are buying part of a company. Most of us will only ever by a tiny fraction of the total company, so we have no say on how the company is run. But if you did have enough money and went out and bought most of the stock of a company, you would become the owner of that company. That is how company takeovers (and buy-outs) often work. When you buy a stock, you hope to make money in two ways: first, you hope that the price of the stock will go up so when you sell it you’ll have made the difference between what you paid and what you sold it for, and second, you might get payments from the company – called dividends - a few times a year.

Bonds are almost the opposite of stocks. Whereas buying a stock is buying a part of the company, when you buy a bond you are loaning money to the company. In exchange for the loan, the company will (normally) pay your interest. As well as companies, the federal, state and local governments also issue bonds. People often thinks of bonds as less risky than stocks, and as a way of diversifying (that is, decreasing risk). This can be true, but not necessarily. In the same way that you could be a very risk stock, you can buy very risky bonds. But there are also very low risk bonds (the lowest risk probably being US Treasury bonds, which are more like savings accounts).

The third type of investment is mutual funds. Buying a mutual fund is like buying stock in many companies at once, without the hassle and cost of actually buying the stocks individually. Mutual funds come in two flavors: those that try to beat the market by actively buying and selling stocks, and those that try to track exactly how the market performs. The later are called index funds. As well as index funds that track the overall market (such as the S&P index), there are index funds that track specific industries (say, the retail industry) or other more specialized groups of stocks. You can also buy mutual funds that invest in bonds.

Getting Started

Buying a stock or fund is an easy process, but the difficult part is deciding which stock or fund to buy. Researching and understanding companies is complex enough, plus then you need to figure out if you think the stock will go up in the future. If you do want to research individual stocks, try a finance site such as money.msn.com, finance.google.com or finance.yahoo.com. Each of those sites has plenty of tools for finding stocks and understanding the company. Each stock has a stock symbol which you’ll see all over financial sites. For example, General Motor’s stock symbol is GM. Enter GM into the appropriate search box on a finance site and you’ll get all sort of information about the company.

Investing in individual stocks takes a lot of research. Unless you have time to learn how to research companies, it is best to start by investing in a broad market index fund, such as one that tracks the value of the S&P 500 index. Today, many index funds trade just like stocks. For example, the Vanguard Total Stock Market Index Fund is also available as a stock: Vanguard Total Stock Market Index (stock symbol: VTI). Funds that trade as stocks are called Exchange Traded Funds, and you can research them at the ETF area of financial sites.

To buy a stock, you’ll need an account at a “brokerage”. Some common low-cost brokerages are TD Ameritade, E-Trade and Fidelity. These companies typically charge about $8 to $16 per trade (a trade is a buy or sell). You can sign-up online, transfer money electronically from your bank account, and start buying.

Remember that stocks are best held for a long period of time. Don’t worry if the stock declines after you buy it -- over the long term, stock market indexes have performed quite well. That is no guarantee that they will in the future, but if you wanted a guarantee you’d keep your money in savings account or treasury bonds.

A note on taxes

Unless you are investing in stocks and mutual funds inside your 401(k) or similar retirement plan, you’ll have to pay taxes. You’ll owe income tax on dividends paid by the companies (due each year), and you’ll owe “capital gains” tax on any growth in the value of your investment (due only when you sell the investment).