Every beginner investor ought to have a good understanding of how investing works and how stocks, bonds and funds can be combined to create a safe, diversified portfolio with plenty of long-term growth potential. Even when working with a financial professional or personal adviser, it is a good idea to read up on the investing process. If you do not have time for a lengthy read like Investing for Dummies, this guide will teach you investment basics, how to analyze investments, and provide some good positions for safe, reliable returns.
When beginning to invest, it is important to have a goal in mind, as this creates a reasonable time frame for you to expect certain returns. Fixed-income investments like bonds are especially useful in portfolios with timetables, because certain maturity dates and guaranteed yields make up the backbone of a strong, safe portfolio. Different investment strategies will be used for different goals over different periods of time. If you are looking for strong returns over a short period, you will need to take on more risk in your positions and you will need to be heavily invested in stocks. When investing for a very long-term goal like retirement, your portfolio can afford to be more balanced and safe. Make sure you have a good idea of how you would prefer to invest your money before you continue.
To begin investing, you will need to deal with a professional brokerage firm, whether online trading alone or in-person trading with an adviser. Dealing with a personal broker will cost you more per trade, but it is often worth having a professional trader to discuss ideas with if you do not plan to trade very often. If you want to be more hands-on and trade more often and you are confident in your own ability, there are now plenty of online discount brokerages that charge much smaller transaction fees compared to traditional brokers. These fees run as low as 5 dollars per trade at some discount brokerages, but make sure the service you use is known for good customer service. Trade King, for example, advertises 5 dollar trades and has a good reputation for reliable service. Scottrade has 7 dollar trades and is a more reputable brand name platform with strong customer service and the option to meet with personal brokers at local offices.
Once you have a goal and an investment service, you can begin investing in assets. Beginning with stocks is a good idea to understand the basics of trading and investing. To begin with, you most likely will not have a great deal of money to invest in high volumes. However, investment returns have to do with percentages over time, so you can still get good returns with a small portfolio. Stay away from advertised penny stocks, because buying more stock in a lesser value position does not mean there is more potential for improvement, because a certain percentage move is just as likely in stocks of any price. In fact, in higher priced stocks there is generally more volume and liquidity, meaning it is easier to exchange on the market due to there being more buyers and sellers. This allows for greater changes in percentage that you can capitalize on, where as you may not be able to sell a penny stock at its reported market price. When investing with a smaller portfolio, it is important to be sure about your trades, because commissions can cut into profits. If you are working with 1000 dollars, for example, invest in only a few positions, so that a significant 2 or 3 percent move in price will make the trade profitable.
So what makes a good stock? There are many ways to analyze stocks on the market. Financial professionals make a great deal of money analyzing positions in different ways, but these techniques are generally not difficult to understand beyond basic knowledge of accounting methods and economic principles. The major trends of analysis are value and growth investing. Both attempt to find stocks with more potential to grow in value than the market as a whole. Markets are often used as benchmarks for portfolio success in this light; if you can beat the return of the market, you are investing well.
Growth investing is the simplest to understand. Investors who believe in growth choose stocks that have the most potential for growing their business models. These investors will often stay away from big name companies if they have already saturated the market and are unable to grow revenues further. The best companies, however, are able to grow revenues continually even after becoming major international players, so just because a company is big does not make it a bad growth stock. However, these investors do generally prefer stocks that represent new startup businesses or emerging markets that have not yet realized their potential. Emerging market stocks are most commonly cited in growth portfolios. Large companies from nations that are growing economically stronger are often highlighted as poised stocks, especially in nations like Brazil, Russia, India and China, commonly known as BRIC. South Korea, Indonesia and Argentina also deserve honorable mentions as strong emerging markets. Basic economic principles often drive trends in this arena of investing, as analysis of business models and growth potentials are usually more important than studying the numbers.
Value investing, on the other hand, creates returns by finding stocks that are currently undervalued by the market, in the hopes that a correction will increase the value of the stock. Analysis in this arena is generally number driven, as investors use public accounting measures and ratios to understand a stock’s comparative valuation. The biggest number that investors will cite is the P/E, or price to earnings ratio. This ratio is only valuable as a comparative measure in a stock’s industry or sector. If the P/E ratio of a particular stock is much lower than other stocks’ P/E ratios in its sector, this is a major indication that the stock is undervalued by the market. Nevertheless, these measures are not foolproof, so more investigation is necessary. Another ratio commonly cited by value investors is the Price to Book ratio, or P/B, as well as the Price to Sales ratio, P/S. The price to book ratio measures a stock’s market cap, or total value of all its shares at the market price, against its equity value, or the amount the company could fetch for selling all its individual parts. Stocks generally trade for more than book value, and a ratio close to 1 or below can be a major indicator of low valuation. Price to sales is similar, measuring market cap against revenue. Low P/B and P/S ratios are the major selling points of stocks for value investors.
Both of these methods of stock investing are risky, as both growth and value positions might never increase in value or might alternatively decrease in value. If you are far from confident in choosing what to invest in yourself, you can choose to put your money into mutual funds, where a professional manager will pick stocks for you. Putting money in a mutual fund will allow you to be much more diversified with less money, as your assets are pooled with others to create large portfolios with diverse assets and lower risk. Lower risk generally means lower returns, however, and fund management fees can greatly cut into potential returns. Most funds do not return as much as the market does annually.
Alternatively, it is possible to invest in fixed-income like bonds, or debt assets, for reliable returns. Bonds are debt obligations issued by companies or the government in order to finance projects. Corporate bonds often have much higher yields, but carry more risk than government bonds due to risk of failure. Government bonds, on the other hand, are incredibly safe investments and are often insured and guaranteed. Buying bonds will allow you to plan exactly how great your returns will be, because they pay a specified yield at their maturity dates. This arrangement allows investors to safely plan for long-term goals with more or less guaranteed returns, but it is harder to exchange bonds and retrieve your money than it is investing in stocks. The safety of particular bonds is measured by ratings agencies, which give high ratings to the safest positions, but they are far from foolproof. Now you know the basics, you do not need to read Investing for Dummies to get started. Try practicing analysis and strategies before you invest your own money.