Finance: Tips On Becoming A First Time Stock Market Investor

Learn the basics of how to invest in the stock market.

So, you're ready to dive in and become the next Gordon Gekko. Alright! Time to get on the wait list for that Rolls Royce Phantom, right? Not so fast. Stock picking is tricky business and is, frankly, not for everyone. Many newcomers have discovered just how fast their life savings can evaporate, and that's a lesson you probably don't want to learn first-hand.

But let's start on the other end; your financial situation. Before you plunk a single cent into the stock market, you should take a hard look at your other assets, debts and financial obligations. If you have thousands of dollars in revolving credit card debt (i.e. you don't pay your balance in full each month), the wisest investment you can possibly make is to pay that off first. Why? Since credit cards typically charge some 15-20% interest, any investment you'd make instead would have to have a guaranteed return of at least as much - and there's no such thing.

Other types of debt, such as mortgages and student loans, are less of an emergency. Mortgages are tax-deductible (as opposed to credit card debt) and student loans generally have generous terms. Some like the peace of mind that comes from being entirely debt-free, but it's not really important once you've cleaned out the credit cards. Car loans is a gray area - if you got a good deal, it's ok, but if the dealer slammed you with a high interest loan you're wise to pay it off.

Next, make sure you have a sufficient cash cushion for emergencies. Remember, the stock market goes up and down. If you get laid off or have a sudden big expense dropped in your lap, you may have to sell your stock at the worst possible time. By keeping 3 to 6 month's worth of living expenses in a savings account or money market fund you can handle the curveballs life throws at you without the added grief of losing money in the stock market.

Last but not least, do you have the nerves for stock investments? If the market takes a sudden plunge and you see thousands of hard-earned dollars disappearing into a black hole, will you panic and sell at a loss? Will you be stressed out at the expense of work and family? Will you check the online stock tickers every hour to track your investments? If you said yes to any of the above, you may want to stick with treasury bonds, Certificates of Deposits (CDs) and other safe investments where you have a modest but guaranteed return on investment. You probably won't make as much money in the long run, but at least you'll sleep well at night.

Ok, now that we have the fundamentals out of the way, let's focus on the actual investing. If you are fresh to the game, you may not want to jump off the deep end and try to pick the next Microsoft out of the thousands of publicly traded stocks. By investing in an index fund or a stock mutual fund, you can be part of the stock market drama without having to lift a finger once you've mailed in your check.



Index funds are pre-packaged baskets of stocks that follow the market ups and downs in lockstep. The S&P 500 index funds, for example, invest in the 500 largest US companies. That's it. There is no team of bean counters and analysts working the phones all day long trying to catch the latest trends. The fund simply buys shares of those 500 companies and does absolutely nothing else. When you buy into the fund, the fund buys a tiny bit more of each other 500 companies, and when you sell your share of the fund, it sells a tiny bit of each company.

This is obviously not very exciting, but it has the advantage of low cost (since there are no analyst salaries to pay, the fund companies can offer very low management fees). Another advantage is that your odds of long-term gains are pretty good. History shows that someone who plunked down money in this type of fund in the 1950s and sat on his hands through ups and downs would have an average annual return in excess of 10% by now.

You can also buy index funds with a more narrow scope, such as small-cap (smaller companies), but the principle remains the same. The smaller index funds are typically more volatile (higher possibility of bigger gains or bigger losses) which can be an option if you feel that a specific section of the market has better potential than others.

Another route is the regular stock fund, where you pay a bit more in fees to have the analysts try and beat the market. Some succeed and reward their investors handsomely, others lose a big gob of dough even though the rest of the market is heading up. The most important thing to realize here is that last years winner isn't necessarily this years winner. In fact, if a fund brags about having returned so-and-so much last year, they probably took great risks to achieve such spectacular results. That's the bummer about risk; the more you stand to gain, the more money you'll lose if the fund manager is wrong. Simply put: avoid the hotshots and seek out the mature funds with competent, experienced managers and a track-record of moderate but consistent gains.

If you decide to try your own hand at stock-picking, get an online discount broker such as Ameritrade, E-Trade, Scottrade or Sharebuilder. These offer cheap trades (less than $30) while many also provide basic research tools. If you pick a broker that doesn't offer research tools, don't fret - there are tons of free websites that will help you get started. However, no tool will replace your most important asset: your mind.

Getting good at identifying strong companies with good growth potential takes years and requires a lot of homework. Tons of books have been written on the subject, most of which are fads and shortsighted baloney. Start with down-to-earth books like Investing for Dummies and the like, and don't forget to tap the power of the Internet. The Motley Fool (www.fool.com) is a great place to start for beginner do-it-yourself stockpickers.

Full service brokers charge considerably more for each trade, but they also offer investment advice. Many of these guys are brilliant and earn a lot of money for their clients, but you pay accordingly and have no guarantee that their "hot tip" won't go belly-up next week. As a rule, a small-time beginner eager to learn is best off with a cheap online discount broker where trial-and-error is simple and won't hurt very much. A well-heeled investor with a busy schedule may be better off handing the money over to a broker and make it her problem to make the pile grow.

Finally, a word about fees. Whenever you invest, the house always takes their cut whether you're up 20% or down 20%. Over the years, that half-percent makes a big difference. Whether you're shopping for a fund or a broker, compare the fees with others. Do your homework, watch the fees and keep your cool when the market doesn't, and you're off to a great start in stock investing. Good luck!

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