Your Best Investment Part 2

Alright, hopefully I've convinced you that investing in the stock market should be essential for beginning professionals. So how do you get started? First, you're going to need some way of purchasing stocks. The best way for individuals these days is to buy them through online brokers. Before Al Gore invented the internet, people who wanted to buy stocks would have to go through actual brokers, which meant a phone call and significant commissions. Now you can purchase a stock yourself instantaneously online, still with trading fees, but not as high. In addition, individual investors these days are able to research the companies they buy via tools online brokerages and other investing sites offer. The internet has truly revolutionized investing in the stock market by making it easier for individuals to follow their investments, which is another reason to get into stocks. Some of the better online brokerages are TDAmeritrade, Scottrade, and Charles Schwab. (I didn't mention E-Trade, because even though that baby in the commercials is damn cute, they are not doing well as a company and may be going bankrupt...not where you want to put your money!)

Before we get started, we have to go over the principle of diversification. I had mentioned it in a few of my earlier posts, and it's quite a simple idea. The more varied your investments are, the less chance you'll be seriously hurt if one of your investments goes sour. We talked about index funds the last time, which are a great way to diversify. Remember also that I recommended your retirement money should just be in index funds. Then you can leave some nonretirement money to invest in individual stocks. Because of the concept of diversification, ideally the more companies you have in your portfolio, the better. But the problem is that you can't have too many stocks, because then it becomes difficult to do the research in order to actively manage them. A good start would be to pick about 5 companies, and then go up as you feel comfortable.

Another consideration before you buy stocks is how much you should buy. Because a broker will charge you a fee each time you buy or sell stocks, it's important to think about how much your total yield would be with each stock purchase. Most online brokers these days will charge you a fee of $10 per transaction, so ideally if you make a profit on your investment, subtract $20 ($10 for the purchase and $10 for the sale). That doesn't seem like a lot, and it's not really significant in the long term, but I bring it up because it factors into the minimum you should put into each company, which is in my opinion, $500, more or less.

How did I come up with $500? It's kind of a personalized number, but the concept here is that when you invest in individual stocks, you need to plan out as much as you can beforehand, especially when to buy and when to sell. You need to have a goal of making a certain yield on each of your investments. The goal I use is 20%. Why? Because I told you before that on average, the stock market gives you a 9% annual return. So you need to pick a number higher than that to make buying individual stocks worth more than just investing in the Dow Jones index. In addition, the best investor in the world, Warren Buffet, has averaged about a 20-25% return. So I pick 20%, and let's say you put $500 into a company. A 20% yield would be $100. Minus the $20 transaction fee and then taxes, it comes out to be around $50, which I feel like is the minimum profit I'd be OK with. That's how I think about it, and you can come up with something different, but the important idea once again is that you need to plan it out beforehand.

So if you were to buy a minimum of 5 stocks in order to diversify your portfolio, and you think my thought process behind the $500 minimum is legit, you would need at least $2500 to get started. This minimum is very important, because a lot of people get caught up with buying "penny stocks," since they can't afford anything else. Penny stocks are cheap because they represent bad companies, ones that often are not profitable and are just pure speculation, which makes penny stocks very risky. Save up the $2500, or whatever minimum you come up with, so that you can invest in GOOD companies.

Not investing in penny stocks ties into the last point of this post--don't use the stock price by itself to decide whether or not to buy. Let's look at an example. Let's say you're choosing between two stocks. One costs $10 per share, and the other $100. If you are going to invest $500, it's easier to lean towards buying the $10 share. But think about it--if both stocks go up, say 5%, it really doesn't matter if you have 50 shares, versus 5. Overall, your yield is $25, 5% of your total. The stock price by itself is really irrelevant (unless it's more than you can afford to put in, but most stocks are under $500). What's more important is how it represents the value of a company. I'll go over how to assess that in the next post.

Until then, make you make some moolah.