Getting Started Investing
So you want to get started with investing. Many of us have been here before. The numbers are moving, the charts are going up and down, so many terms you don’t know, and so little time. It almost makes your brain hurt in the beginning.
So where do we begin? It all seems like so much to take in at once, relax, don’t worry. Let’s take this from the top. Before you dive headfirst into this thing we call the market, let’s get a lay of the land first. Take a walk down the many choices you have first.
Imagine the stock market like your local grocery store, each aisle having a different choice of items to buy. Some low quality and some high quality. Walking the grocery store without knowing the aisles will leave you confused, frustrated, and overwhelmed.
So lets step back and get a glimpse at the names of each isle.
- Aisle 1: Individual Common Stock
- Aisle 2: Mutual Funds
- Aisle 3: Exchange-Traded Funds (ETFs)
- Aisle 4: Real Estate Investment Trust
Each aisle has its own level of risk and volatility. Understanding what aisle you’re in will allow you to choose the level of risk you want to take. Now that you know the aisles, you can now venture down each one and choose the brand you like. Each brand has its ingredients, in this case, otherwise called the company’s financial numbers. These financial numbers will tell you how much money the company makes, how much debt the company has, and whether or not the company is profitable. But just like any item in your local grocery store, you have to read the back of the box to get the details; otherwise, you’ll just be making your choices based on how much it cost or hearsay. As you visit this aisle more often, you will eventually learn how to use one or more of these factors to make a solid choice. As a note, the details below are only just a short introduction to these options, and note the full details. This page will be updated with links to more Avid Learner blogs that dive deeper into each option in the future so stay tuned.
Until then, TRANQUILO.
What is the Market?
One of the first things you notice when learning about the stock market is that you constantly keep hearing about this mysterious thing called the market. The market is up today or the market is down today. What exactly are they talking about?
They’re talking about either one of the three major indexes of the market: Dow Jones, Standard & Poor (S&P) 500, or the Nasdaq. Each of these indexes is a group of stocks compiled together to simulate the American economy. On your investment journey, and as an investor, your underlining job is to either match or beat the returns of these indexes.
From the stock market stand point, this is the most basic part of the market. Common stocks are probably the first thing you saw when you heard about the stock market. Common stocks are just pieces of the big brand name companies you see everyday. But fair warning, as a beginner, common stocks can be the most risky isle you venture down. Another way of describing individual common stocks is high risk, high reward (in some cases). Investing in common stocks generally come at no extra charge although some places may charge a fee for buying common stocks called trade commission fees. With the various places to buy common stocks, I would be hesitant to choose a brokerage that charges a fee.
Lets take a closer look – Investing in common stock allows you to experience the ups and downs of a company. While this form of investing can be risky, common stocks have proven to be very successful over time. Notice I said, over time. Throughout history, the market will naturally have highs and lows which can be unpredictable. These can be called times of growth or times of recession. This is the stock market cycle. The stock market cycles are called bull (growth) and bear (recession).
Mutual funds are a combination of many common stocks and/or bonds pooled together. These are often praised as the best option for the common investor. If common stocks are considered high risk, mutual funds are less riskier when compared because it spreads the risk out over several common stocks.
– Investor Tip –
When looking to invest in mutual funds, there are 6 major mutual fund objective types.
- Growth Funds – the objective of growth funds is to provide capital appreciation (increase in stock price) over medium and long term (5 years or more).
- Income Funds – the objective of income funds is to provide the buyer with income over specific intervals. These funds invest in companies that pay a dividend or bonds that provide income.
- Sector/Industry Funds – the objective of these funds allow you to invest directly in a sector or industry that suits you or may be doing well at the moment.
- Cash – Equivalent Funds – these funds invest heavily in securities that are much less riskier. These funds may be filled with investment types such as treasury bills and certificates of deposit (CD)
- Target Date Funds – Allows the investor to balance their needs of growth and stability. These funds are created based on a specific future date range. In the beginning, these type of funds will invest a higher percentage of funds in growth stocks while in the later years of the fund it will begin to shift into safer more secure funds for retirement.
- Bond Funds – invest in bonds that provide regular income from interest paid from the bonds they hold.
***Other funds you may find will be a mix of the 6 listed above designed to fit your individual need or strategy
Mutual Fund Fees
Mutual fund fees are another way to differentiate which mutual fund you want to choose. Some mutual funds charge more fees than others but that doesn’t mean the ones that charge more fees are better. There are two types of mutual funds when it comes to fees:
Loaded Funds: These mutual funds have a sales charges and commission fees that can eat into your profits.
No-Load Funds: These funds have no sales charge or commission fee but they still have administrative fees(usually much smaller). These fees should be no more than 1.5%.
Mutual Fund Management
Mutual fund management is considered one of the most important aspects for mutual funds. There are two types of mutual fund management strategies:
- Active Management
- Indexing (passive investing)
An actively managed mutual fund strategy means the manager will buy and sell stocks and bonds within the mutual fund in an attempt to get the highest return. This strategy could results in tremendous gains for the investor or losses depending on the skill of the manager.
Indexing, on the other hand, means the mutual funds will try to match the overall market performance by picking stocks and bonds. Historically, the overall markets provide a 10% return to investors, and therefore, indexing will work to match that current year’s return. As of note, Warren Buffet, one of the most successful investors ever, touts index funds over actively managed funds and won a million-dollar bet in 2017 as proof.
Exchange-Traded Funds (ETFs)
Exchange-traded funds are similar to mutual funds just as you have learned already but with a few differences. With that being said, let’s dive straight into the differences now.
- Can be bought and sold on stock exchanges
- lower fees
- Transparency of fund holdings
Most ETFs are similar to index funds and hold a basket of stocks that fall into the S&P, Nasdaq, or another type of group. These ETFs will try to mimic the returns of that set group and provide the investor the best opportunity to get the best return.
Real Estate Investment Trust (REIT)
Real estate investment trusts are a way for the stock investor to participate in real estate investing without actually owning individual real estate. There are real estate ETFs and mutual funds and there are also individual REIT stocks.
So why do REITs have their aisle? Great question.
For any company or pool of companies to be considered a REIT, it must be a company that owns, operates, or finances income-generating real estate. Another requirement of a REIT is that it MUST distribute its income as dividends to its shareholders. Receiving a dividend is another way of saying the company will pay you income(dividends) for holding shares of the company. There are three types of REITs you will find on the stock market.
- Equity REITs– these REITs own and operate income producing real estate that people live in or businesses occupy, such as malls, restaurants, etc.
- Mortgage REIT – these REITs lend money to real estate owners and receive income from the interest generated from leading money. These may typically be in the form of mortgage backed securities (MBS).
- Hybrid – these REITs use a mixture of the two strategies above to produce income.
Before investing in REITs, make sure to research what type of REIT you are looking at.
This is not intended as financial advice but for informational purposes only. There are various ways to apply this information either using one or more choices to strategically build wealth. Please continue to my next lesson on stock investing, Part 2, to go into more details about choosing the right individual stock for you. As a reminder, ensure you are in the best financial situation before investing in any of the options stated above as each one poses some form of risk.
Pingback: Dividend Investing for Beginners- 3 Strategies for Success and How to Avoid the Pitfalls