OK, if you've met the requirements for beginning to invest (see my previous entry on the prerequisites to investing), the first step is to select a broker and open an account with them. When I'm choosing a broker, the things I look for are: online trading, low fees, good execution, and a nearby office. It's useful to check out articles like the annual Smart Money list of top brokers. You can also google for "Top rated online brokers", and get lots of similar articles.
By coincidence, the top three brokers on the list this year (2011) were all brokers that I currently use. They are Fidelity Investments, Scottrade, and TD Ameritrade. These all have offices nearby, and they all support online trading. Their fees range from $7.00 to $10.00 per trade.
One of the themes of this blog is that you need to be responsible for your own investing. You can ask a broker for advice, but the sad fact is that no one cares as much about your investments as you do. When you get advice from a broker, that advice is influenced by the products that the broker's company is selling. Another problem with financial advice is that it is often generic, rather than tailored to your specific situation. A third problem with financial advisors is that some of them are incompetent or outright crooks.
If you don't understand enough to do your own investing, then how can you tell the good advice from the bad advice? That's why I recommend opening an account that supports online trading, so you can make your own trades without going through a broker.
Of course, the big question is, how do you get the knowledge to do your own investing? That's what I'll be talking about in the future. For now, one resource you can use is Investopedia. It's got a handy dictionary of investment terms, and regular articles on different topics.
In the next few entries in this blog, I will describe a simple investing strategy that works in all different kinds of market conditions.
Tuesday, May 10, 2011
Tuesday, April 12, 2011
The Prerequisites to Investing
You might think that all you need to start investing is some money. But it's not that simple. When you invest, you put money at risk. That's a fancy way of saying you might lose the money. For example, if you buy stocks or bonds, those investments can become completely worthless if the company goes bankrupt. Even a company that is doing OK can see its stock dramatically drop when the business climate changes.
So when is it safe (and worthwhile) to take this kind of risk? That's what these prerequisites are really about. Here's the list of what you should have before you begin investing:
The insurance prerequisites are necessary to cover unexpected but potentially catastrophic events. Without health insurance, for example, your entire savings and investments could be wiped out by a sudden illness. Many jobs provide insurance as one of the employee benefits, but if you are self employed, or your job doesn't provide insurance, then you should purchase insurance for yourself (and your family) before even considering investing.
This brings us to the home. Why own a home before starting to invest? The reason is that a home is really your first and your best investment. It not only provides you a return on your investment, it also gives you a place to stay, and saves you the rent you would otherwise pay. On top of that, the government subsidizes your investment by giving you a tax break on the interest payments on your mortgage.
Your equity in a home is the value of the home minus the amount of the mortgage. So if you bought a $300,000 home, and borrowed $250,000 to buy it, then your equity is $50,000. Over time your equity increases as you pay off the mortgage. Substantial equity is at least 20%. So in the example of a $300,000 home, you should have at least $60,000 in equity before considering investing.
There are lots of things to consider when buying a home, I could write another column just on that topic. But there is one thing which is so vital to your financial health, that I have to mention it here. Never buy a home using a variable rate mortgage. The standard mortgage is a 30 year fixed rate, and that is the way to go (or a 15 year fixed rate if you can afford it).
With a fixed rate, you know what your costs are in advance, and you can determine if you can afford the home. As long as the payments are within your means, and you plan to stay in the area for a while (five to ten years), the home should be an excellent investment. The equity in your home provides you with a margin of safety against the normal fluctuations in home value.
So when is it safe (and worthwhile) to take this kind of risk? That's what these prerequisites are really about. Here's the list of what you should have before you begin investing:
- A steady income that provides you with enough to live on plus a little more. See Getting Started (rule #1).
- No credit card debt, or other "bad" debt. See Getting Started (rule #2) and Good Debt and Bad Debt. It's OK to use a credit card as long as you pay off the balance each month. Then you aren't really incurring debt.
- Substantial equity in a home. I'll say some more about this below.
- Savings that amount to six months of your income (your combined income if you are married).
- Health insurance, and also Life insurance if you are married.
The insurance prerequisites are necessary to cover unexpected but potentially catastrophic events. Without health insurance, for example, your entire savings and investments could be wiped out by a sudden illness. Many jobs provide insurance as one of the employee benefits, but if you are self employed, or your job doesn't provide insurance, then you should purchase insurance for yourself (and your family) before even considering investing.
This brings us to the home. Why own a home before starting to invest? The reason is that a home is really your first and your best investment. It not only provides you a return on your investment, it also gives you a place to stay, and saves you the rent you would otherwise pay. On top of that, the government subsidizes your investment by giving you a tax break on the interest payments on your mortgage.
Your equity in a home is the value of the home minus the amount of the mortgage. So if you bought a $300,000 home, and borrowed $250,000 to buy it, then your equity is $50,000. Over time your equity increases as you pay off the mortgage. Substantial equity is at least 20%. So in the example of a $300,000 home, you should have at least $60,000 in equity before considering investing.
There are lots of things to consider when buying a home, I could write another column just on that topic. But there is one thing which is so vital to your financial health, that I have to mention it here. Never buy a home using a variable rate mortgage. The standard mortgage is a 30 year fixed rate, and that is the way to go (or a 15 year fixed rate if you can afford it).
With a fixed rate, you know what your costs are in advance, and you can determine if you can afford the home. As long as the payments are within your means, and you plan to stay in the area for a while (five to ten years), the home should be an excellent investment. The equity in your home provides you with a margin of safety against the normal fluctuations in home value.
Friday, December 17, 2010
Good Debt and Bad Debt
You might think from my last post (see Getting Started - Rule #2) that I believe that all debt is bad. But that's not the case. Sometimes it's OK, and even a good thing to go into debt. How can you tell good debt from bad debt?
The difference between good debt and bad debt lies in what you plan to do with the money. If you are borrowing money to pay for ordinary expenses, like food and clothing, then that is a bad thing. On the other hand, borrowing money to buy a house can be a good thing.
What's the difference between these two cases? For one thing, the house has a long term value that generally goes up over time at about the rate of inflation. The last 10 years have been an exception to this rule, where the prices have shot up and then fallen, but in general this is true. A second difference is that a house provides a service to you over the long term. It gives you shelter and saves you from having to pay rent.
When you put up money today to receive something of value in the future, then this can be an example of good debt. I say "can be" since it all depends on the cost of the loan and the amount of value you expect to receive. You have to do the math to figure out if it is really worth it or not.
Another example of potentially good debt is when you borrow money to go to college (or for any type of education or training). If the training you receive provides you with more income in the future, then you can use that extra income to pay off the debt.
The last example is buying a car. If you can't afford to buy a car, and you need one to get to work, then taking out a loan to buy a car makes sense. The car also provides a service to you, while it lasts, but unlike a house, the value of the car declines over time. In cases like this, you need to make sure that you will have the loan paid off before the car's useful life is over. The other thing about cars is that they will start to cost you money for maintenance as they get older. So it's best to pay off a car loan over a 3-5 year period (for a new car), so that when the big ticket maintenance items start to happen, you will already be paid off.
So, to sum it up, debt isn't good and it isn't bad. It's what you do with the money that counts.
The difference between good debt and bad debt lies in what you plan to do with the money. If you are borrowing money to pay for ordinary expenses, like food and clothing, then that is a bad thing. On the other hand, borrowing money to buy a house can be a good thing.
What's the difference between these two cases? For one thing, the house has a long term value that generally goes up over time at about the rate of inflation. The last 10 years have been an exception to this rule, where the prices have shot up and then fallen, but in general this is true. A second difference is that a house provides a service to you over the long term. It gives you shelter and saves you from having to pay rent.
When you put up money today to receive something of value in the future, then this can be an example of good debt. I say "can be" since it all depends on the cost of the loan and the amount of value you expect to receive. You have to do the math to figure out if it is really worth it or not.
Another example of potentially good debt is when you borrow money to go to college (or for any type of education or training). If the training you receive provides you with more income in the future, then you can use that extra income to pay off the debt.
The last example is buying a car. If you can't afford to buy a car, and you need one to get to work, then taking out a loan to buy a car makes sense. The car also provides a service to you, while it lasts, but unlike a house, the value of the car declines over time. In cases like this, you need to make sure that you will have the loan paid off before the car's useful life is over. The other thing about cars is that they will start to cost you money for maintenance as they get older. So it's best to pay off a car loan over a 3-5 year period (for a new car), so that when the big ticket maintenance items start to happen, you will already be paid off.
So, to sum it up, debt isn't good and it isn't bad. It's what you do with the money that counts.
Sunday, August 29, 2010
Getting Started (rule #2)
The first rule was aimed at getting you started on the road to having some money to invest. The second rule is aimed at keeping you on track.
(2) You should never carry credit card debt
It's OK to have a credit card, and to use it. Credit cards are very handy things to have, and you should have at least one. But you should always pay the full balance on the card each month. If you do this, then you will never be charged any fees or interest.
If you treat your credit card like this, then you aren't really going into debt, you are just paying your bills on a monthly basis. If your credit card charges an annual or monthly fee anyway, then you should cancel that card and get one with no fees.
Interest and fees seem like little things at first, but they add up over time. Think of them as little vampires sucking away at your money. Just like a little savings can add up to a lot of money over time, these recurring fees add up. And these fees are coming right out of your disposable income.
Disposable income is the money you have left over after you have paid for your necessities, like food and rent. This is the money that is available to you to spend on things that you enjoy, like music and movies. Savings also have to come from your disposable income. So anything else that is coming from your disposable income is an evil that should be eradicated. If it's not fun, and it's not helping you save then why tolerate it?
While we are on the topic of fees and interest, it is also a good idea to get a no fee checking account, for the same reason. Most banks will give you some way to avoid fees, either by maintaining a minimum balance in the account, or by setting up an automatic deposit into a saving account.
One other type of scam to avoid is the so called "free credit report" service. These services may be free to start with, but they all convert to a service that charges a monthly fee. If this happens to you, cancel the service immediately.
(2) You should never carry credit card debt
It's OK to have a credit card, and to use it. Credit cards are very handy things to have, and you should have at least one. But you should always pay the full balance on the card each month. If you do this, then you will never be charged any fees or interest.
If you treat your credit card like this, then you aren't really going into debt, you are just paying your bills on a monthly basis. If your credit card charges an annual or monthly fee anyway, then you should cancel that card and get one with no fees.
Interest and fees seem like little things at first, but they add up over time. Think of them as little vampires sucking away at your money. Just like a little savings can add up to a lot of money over time, these recurring fees add up. And these fees are coming right out of your disposable income.
Disposable income is the money you have left over after you have paid for your necessities, like food and rent. This is the money that is available to you to spend on things that you enjoy, like music and movies. Savings also have to come from your disposable income. So anything else that is coming from your disposable income is an evil that should be eradicated. If it's not fun, and it's not helping you save then why tolerate it?
While we are on the topic of fees and interest, it is also a good idea to get a no fee checking account, for the same reason. Most banks will give you some way to avoid fees, either by maintaining a minimum balance in the account, or by setting up an automatic deposit into a saving account.
One other type of scam to avoid is the so called "free credit report" service. These services may be free to start with, but they all convert to a service that charges a monthly fee. If this happens to you, cancel the service immediately.
Friday, July 16, 2010
Getting Started (rule #1)
This is going to be a column of investment advice. But before you can invest, there are a few things you should take care of first. To start with, you will need to have some money to invest. This means (unless you happen to fall into a pile of money):
(1) You need to make more money than you spend
Another way to put this is that you need to spend less money than you make. It means the same thing, but it can be a more useful way to think about it, since you have more control over what you spend.
Here are two basic strategies for achieving this goal. Which works best for you will depend on your personality, but don't be afraid to try both approaches. First, for the more organized type, you can create a budget. The second approach is to use a set aside. Let's talk about budgets first.
Budgets are really very simple. Just list your expenses by category: food, rent, car and gas (transportation), clothes, utilities, entertainment (movies and eating out), etc. Estimate how much money you spend in each category per month, and compare that to your monthly income. Be sure to include the expenses that only come up occasionally, like insurance and car maintenance.
Then add up the expenses and compare that to your monthly income. If there is no money left for saving, or if your expenses are greater than your income, then you need to look for areas to cut back. Some expenses are pretty fixed, like rent, and others are more flexible. Those are the areas to look for cuts in.
The second approach is to use a set aside. In this system you put a fixed amount of money into a savings account each month (or each paycheck). Then you just have to make sure that the rest of your income will last you for the whole month. This system can work well for people who don't like the budgeting approach. Payroll deductions like 401K's work this way, and are very popular.
The main trick with the set aside is to make sure that it is enough money to cover the occasional expenses. If you spend all your other income each month, then expenses like car insurance will have to come out of savings. The set aside needs to add up to more than these expenses in order to have true savings.
(1) You need to make more money than you spend
Another way to put this is that you need to spend less money than you make. It means the same thing, but it can be a more useful way to think about it, since you have more control over what you spend.
Here are two basic strategies for achieving this goal. Which works best for you will depend on your personality, but don't be afraid to try both approaches. First, for the more organized type, you can create a budget. The second approach is to use a set aside. Let's talk about budgets first.
Budgets are really very simple. Just list your expenses by category: food, rent, car and gas (transportation), clothes, utilities, entertainment (movies and eating out), etc. Estimate how much money you spend in each category per month, and compare that to your monthly income. Be sure to include the expenses that only come up occasionally, like insurance and car maintenance.
Then add up the expenses and compare that to your monthly income. If there is no money left for saving, or if your expenses are greater than your income, then you need to look for areas to cut back. Some expenses are pretty fixed, like rent, and others are more flexible. Those are the areas to look for cuts in.
The second approach is to use a set aside. In this system you put a fixed amount of money into a savings account each month (or each paycheck). Then you just have to make sure that the rest of your income will last you for the whole month. This system can work well for people who don't like the budgeting approach. Payroll deductions like 401K's work this way, and are very popular.
The main trick with the set aside is to make sure that it is enough money to cover the occasional expenses. If you spend all your other income each month, then expenses like car insurance will have to come out of savings. The set aside needs to add up to more than these expenses in order to have true savings.
Subscribe to:
Posts (Atom)