When people come into a chunk of cash whether from an inheritance, a bonus, a large sale, a big commission, a TAX REFUND (hint, hint), or whatever means, they usually think of three things:
- I can finally buy [insert whatever you've been drooling over] or
- I can finally pay off [insert annoying/threatening creditor] or
- I really need to invest this for the long haul.
This article is written for that third group. The problem is, many of us (me included) have said that before but wound up spending the money on either #1 or #2. But today’s the day. Today we get that brokerage account opened and begin investing that bonus, tax refund, or big commission check into our future. Today is YOUR day.
First of all, what exactly IS an investment anyway?
An investment is an asset—such as a stock or a bond— that an investor buys in order to build wealth over time. The value of an investment can rise or fall based on a number of factors, from supply and demand to the state of the overall economy. Investors buy investments with the intention of selling them later for a higher price.
Some investments, such as real estate property, precious metals, fine art, and collectibles, are assets that the owner possesses and, in many cases, can physically use. The types of investments that this guide covers are investment products—nonphysical assets such as stocks and bonds, which for most investors are more convenient and easier to sell than physical assets such as real estate.
Why should I be investing?
Investing is the most effective way to build your wealth at rates that exceed those of inflation, the economic phenomenon that causes the prices of goods and services to rise over time. Inflation doesn’t change the amount of money you have, but it does erode your purchasing power, the amount of goods and services you can buy with your money. Since 1925 or so, inflation in the United States has averaged 3% per year, while the average savings account has paid an interest rate of about 2%. Today that “average” appears great since rates are in the basement, but there ARE some banks offering decent money market rates.
During that same period of time (since 1925), the return, or the annual rate of growth, of U.S. stocks has averaged about 10% (pre-tax). If those trends continue:
- Due to inflation, in 30 years you’d need $2,427.26 to equal the purchasing power of $1,000 today.
- $1,000 kept in a savings account would grow to $1,811.36 after 30 years, trailing the effect of inflation.
- $1,000 invested in stocks today would grow to $17,449.40 over 30 years, easily allowing you to outpace the effects of inflation over that time period.
Types of Investments
Though there are many types of investments (real estate, physical gold or silver, art, businesses, etc.), there are four major “paper” investment products. Paper investments are generally what people thing of when they talk of “investing” in general.
- Stocks: Investments in a specific publicly traded corporation, such as Apple, Caterpillar, Goldman Sachs, or PepsiCo. These “publicly traded companies” issue shares of their stock to the general public. Each share represents a fractional percentage of ownership in the company.
- Bonds: Loans that investors make to corporations and governments. The corporation or government then makes fixed interest payments to the bond investor over a set period of time, called a term. At the end of the term, the investor also gets back the original investment amount, called the principal.
- Mutual funds: Investments that pool money from many investors and invest it in a specific set of stocks or bonds. A type of mutual fund called an index fund attempts to mimic the performance of a specific market index, a group of investments that serves as a benchmark for the performance of other investments. For instance, an S&P 500 index fund tries to replicate the performance of the S&P 500, a well-known index of 500 of the most widely held U.S. stocks.
- Exchange traded funds (ETFs): ETF are funds that track indexes (as index mutual funds do) but are bought and sold like stocks. I’ve written an entire series on investing in exchange traded funds. Check it out!
- Options: These are a little trickier for investors because you’re making offers to buy or sell in the future based on what you believe the market will do. But with a little training and lots of practice from companies like options house or optionsXpress (now owned by brokerage giant, Charles Schwab), you can learn the ins and outs and begin making your own trades.
How Investing Builds Wealth
Investing builds wealth in two main ways:
- Growth: Growth investors aim to buy investments that will increase in value over time, so they can then sell the investments later for a higher price.
- Income: Income investors aim to buy investments that provide regular cash payments. These payments can take several forms. For instance, some stocks pay pidends, a portion of a company’s earnings paid directly to the company’s shareholders. Most bonds pay interest, periodic cash payments that investors receive in exchange for buying the bond.
Some investments provide only growth; others provide only income. Some, such as pidend-paying stocks, provide a mixture of growth and income.
Types of investing markets
Investment products are traded—bought and sold—on exchanges, also called markets. For instance, stocks are sold on various stock exchanges, such as the New York Stock Exchange (NYSE), the NASDAQ, and the American Stock Exchange (AMEX). Bonds are also sold on various exchanges; ETFs are generally sold on the AMEX.
Though professional traders and market makers at the exchanges facilitate some of the pricing and trading of investments, a substantial portion of trading occurs electronically. The U.S. government’s Securities and Exchange Commission (SEC) enforces strict legal standards that govern the investment products traded on each exchange.
How investors buy investment products
As an in pidual investor, you don’t buy and sell investment products directly on the various exchanges. Instead, you buy them through middlemen, such as online brokers, brokerage houses, and other financial professionals who are called registered representatives. First, you set up an investment account and fund it. Then you can place orders through your online broker or brokerage house to buy or sell specific investments. When these orders are executed (filled or completed), the cash in your investment account converts into a certain amount of the investment product bought, and investments sold convert back into cash in the account. As investments in the account rise or fall in value, the account balance adjusts accordingly, usually once per day.
What are the minimums at various brokerage accounts?
Here’s a table of the minimum starting investment required at several of the largest and most reputable online discount brokerages (click the brokerage’s name for more information):
|Broker||Minimum Starting Investment||Stock Commission||Notes|
|Scottrade||$500||$7.00 per trade||Well established, 30 year old company with local branches in dozens of cities, probably near you.|
|E*trade||$500||$9.99 per trade||Popular and well known for their “talking babies” ads and their long history in the business.|
|TradeKing||None||$4.95 per trade||Highly rated broker that has won awards its trading tools and customer service over multiple years.|
|tradeMONSTER||$2,000||$7.50 per trade||Ranked by Barron’s magazine as among the best of the best in online brokerage houses.|
|Zecco||None||$4.95 per trade||A deep discount brokerage that allows you to trade from your Facebook account. Trading from Facebook?|
|Sharebuilder||None||$4.00 per trade (on automatic plan)||No account minimum, no investment minimum, no inactivity fees and an easy automatic investing program.|
|optionsXpress||None||$9.95 or $0.01/share for over 1000 shares||Now owned by charles SCHWAB, optionsXpress has a dramatically stronger offering for investors.|
|optionshouse||$1,000||$3.95||This is basically the least expensive online brokerage for most traders and investors.|
In reality, it doesn’t take a lot of money to get started at most of these brokerage houses.
Don’t let the importance of stock commissions slip past you. Commissions can have a dramatic effect on the returns you generate when starting your investing career. With a company like optionshouse, a $3.95 commission on a $500 stock purchase is only 0.79 percent but for a $9.99 trade it becomes almost TWO percent. It doesn’t sound like a lot of difference but over the course of time, there’s absolutely NO reason to give your hard-earned money away to a brokerage house when you get nothing in return.
Names and symbols of investment products
All investment products have a given name and are represented by a symbol.
- The symbols used to represent stocks, mutual funds, and ETFs are called ticker symbols and consist of 1–5 letters. For instance, the ticker symbol for Starbucks stock is SBUX.
- The symbols used to represent bonds are called CUSIPs and usually consist of nine numbers and letters. For example, a bond issued recently by the New York City government had a CUSIP of 649660JR9. Stocks also have nine-digit CUSIPs, but these are rarely used since ticker symbols are simpler to remember.
Shares and amounts of investment products
Some investments, such as bonds and mutual funds, are bought and sold in dollar amounts. Others, such as stocks and ETFs, have a specific share price that changes constantly as the supply and demand for the shares shifts throughout the trading day. Mutual funds also have a specific share price, but it changes only once per trading day— after the markets close and the value of all the mutual fund’s holdings is recalculated.
Is investing too scary to handle on your own?
Consider using and investment advisor from a great company like WiserAdvisor. These guys hand pick the best financial advisors, putting them through the ringer to make sure they’re legit, then funnel their contact information to you. It cost you nothing to get their list of pre-screened financial advisors and the best news is that YOU get to make the final decision which one to use.
Whatever you do
Don’t let the opportunity to begin investing for your future pass you by again.