I’m sure many of you, like me, had a teacher (particularly an English teacher) who, when correcting papers in high school, liked to say, “You have to know the rules before you break them.” While grammatical structure of a report and investing methodology may seem worlds apart, they do share this common wisdom. There are an endless number of books detailing fancy trading techniques, special charting software which promises to give an edge and any number of different products, programs and people all claiming to have the answer. Some are legit, some are not, but if you really want to start investing it’s absolutely necessary to understand the basics first. Please read the disclaimer at the bottom before continuing to read this article.

It’s standard practice when writing these articles to give a little background on the author. Without going into a complete resume, let me just say a couple things. I started studying investments at the age of 12. By 16 I was actively day trading stock options, and since that time have continued to study and practice investing in areas ranging from real estate to forex. I am, however, not a licensed investment advisor. I have no professional background in this area, and anything I say is purely from my own experience, which is limited. Please read this for informational purposes only. Should you find something interesting, feel free to research it yourself. I’ll do my best to be accurate, but I have no experience teaching this and you should verify all statements with your own research. If you have questions, or need clarification on something I write, just shoot me an email at JDNPI@aol.com. So, without further ado:

Investing Basics

So you’ve got a little extra money coming and have decided it’s time to start planning for the future? Excellent, welcome to the exciting world of investing. This is a very broad topic, so I’d like to start off with a personal checklist you can perform to see if you are ready to invest, and what kind of investor you think you are.

Things to consider

First, are all you debts paid off?

If you have credit card, school loan, or any other type of debt, it is probably best to pay that off before you start investing. For example, if you have credit card with, say, $5000 at a 10 percent interest rate and student loans of, say $5000, at a six percent rate, you’re already paying at least $800 a year in interest. Because of taxes on capital gains, you would likely need $10,000 earning around 12 percent to just break even. While this is possible, it’s not guaranteed, whereas paying off your credit cards nets you a guaranteed return of eight percent, which is pretty good. Figure out your debt and how much it’s costing you. If you can’t make a hell of a lot more than the amount of yearly debt payments, then hold off until you’ve paid the debt off, and pay it off as quickly as possible. (These rates are actually a little low, because of compounding of interest) I should make a quick note here that I will be speaking from an American viewpoint, please adjust things based on your own country’s rules.

Second, are you willing to risk your money?

This is the question that sometimes stops people before they get started. “I can`t afford to lose my money.” This is actually dangerous thinking however, because by not investing you are risking your money. Inflation is eating away at the cash under your mattress whether you like it or not.

Investing has inherent risk; there’s not a way around it. The saying, of course, is “no risk, no reward,” but that doesn’t mean we can’t put some controls on our risk. CDs (certificates of deposit), savings accounts, money market accounts and other investments which guarantee a rate of return are available to help hedge some of our risk. The return on these investments typically range from one percent to maybe five percent. They vary in liquidity, risk and return, but generally are the safest investments. Again, “low risk, low return”.

I think I should insert a quick note about the “Rule of 72″ here. Generally, if you divide 72 by an interest rate, it will calculate the length of time an investment will take to double. So if you’re getting a 6 percent return, your money will double once every 12 years or so. (Taxes and fees affect these numbers, so consider all sides before computing.)

Stocks

Stock is a piece, or share(a.k.a. equity), of a company. When you buy stock, you are technically buying a share of ownership in that company’s assets and profits. There are many types of stock. Blue chips are a well known example. Blue chip stocks have generally been around for a long time, are huge companies (AT&T, McDonald’s, IBM, etc.) with consistent earnings and are therefore considered safer than smaller, younger companies with less history of success. They aren’t guaranteed, but they tend to be more reliable then the “XYZ BioTech” firms that make big news, run up way past their value and then crash and burn, taking investors with them. (Please watch the movie Boiler Room some time if you ever feel the urge to invest in something that sounds good, but you don’t know anything about the company; save your money and your nerves and let it go.) Here are some recent blue chip indexes.

There are 1000s of stocks. Trying to decide which ones to choose can be a daunting task. Before you try, I recommend learning how to read financial statements. Get a good understanding of indicators like P/E ratios and basic info that is readily available for most stocks. There are many, many, many ways to pick stocks. If I had to recommend a style, I would suggest following Warren Buffet’s strategy of buying undervalued companies with strong long term potential, not just front-page news potential. One thing Mr. Buffet suggests is that you make a card with 20 squares in it, and punch one out for every investment you make. When the last hole is punched you can’t invest any more. It’s a good idea, but a little too conservative for me.

One more thing: some stocks pay dividends. There is a whole section of investing that deals with “dividend capturing,” but chances are you’ll never need to know it. Point is, if you own a stock that pays dividends of, say, 85 cents, then you’ll get 85 cents for every share you own annually. (There are lots of statistics on dividends as well.) I’m pretty sure most blue chip stocks pay dividends.

Bonds

Bonds are a popular investment as well. So what is a bond? A bond, in a way, turns you into the bank/credit card company. You are lending money in exchange for a specified payment of interest from the borrower (a sort of “IOU”). This may be a company, a municipality or even the federal government (i.e. Treasury Bonds). Again risk equals reward. Government bonds are safer than, say, junk bonds. Bonds are bought based on time. There are three month, six month, one year, three year, 10 year, etc. The longer the term, the better the rate you’ll be offered. Here’s some recent pricing on U.S. Treasuries:

These are very safe, but as you can see, the returns are pretty low too.

The reason bonds are often considered to be a good hedge against risk is because they will respond conversely to market trends. In other words, if the market goes down, bonds will go up.

Mutual Funds

A mutual fund is collection of investments, consisting of stocks, bonds and sometimes money market holdings. Mutual funds allow for diversification, which tends to reduce risk. The “don’t put all your eggs in one basket” rationale drives this argument. Mutual funds allow an investor to buy several different investments at the same time. This could be tech stocks, drug stocks, Asian stocks and just about any mix you can imagine. Many companies sell mutual funds, and within mutual funds you can select a level of risk you’re comfortable with, based on “aggressiveness.” Mutual funds offer a number of advantages and can be an easy way for an investor to diversify their portfolio. Mutual funds are also numerous in type. Some have heavy fees, while others may be “no-load” funds. Be sure to read the fine print and run the numbers before buying anything. Personally, I’ve never owned a mutual fund, so I’m no expert, but that doesn’t mean you shouldn’t. There’s plenty of info on the web, just search “mutual funds” and you should get most of the info you need.

I think that’s enough to get started with. Do some research on your own and get familiar with some of the terms associated with these investments. It will be good knowledge to have and will help you whether you decide to trade on your own, use a broker, or both. It’s always better to know what you’re talking about, especially when money is involved. Never sit down to gamble if you don’t know the rules; the guys you play against will love you for giving them all your money, but chances are you’ll leave broke and broken. Like GI Joe says, “Knowing is half the battle.”

Disclaimer

This is for information and entertainment purposes only! Do not taking anything I say as a basis for investing. I am not a professional financial advisor of any kind. I can not be held responsible for any information within this article or any liability for actions you take. Please do your own research!