As the stock market booms, many new and sidelined investors are getting tempted to jump back into the market. After all, you don’t want to look back in a few years and say, “If only, I had bought stocks then….” However, as past years have shown, the market can fall just as fast as it rises. Therefore before you start investing your hard earned dollars, make sure you consider the following list of items to ensure you are financially prepared and able to trade cost effectively:
– Have at least 3 to 6 months worth of emergency funds, in a FDIC insured high interest savings account. Despite the desire to avoid “missing the boat”, don’t over extend and potentially place yourself in a financially precarious position if the market crashes again. Investing is no sure thing, but cash in the bank is.
– Pay off any credit or high interest debt first. Look at it this way, most credit cards and other high interest debt will carry an interest rate over 10% (after tax). On a pre-tax basis, you would need to earn 13% plus in the stock market to get the same kind of return as paying off your credit card debt. Unlikely in this market, so a smart investing move is to always pay off your credit card debt first.
– Investing in your 401K or Roth IRA. When the market was hurtling down with little respite in sight, I actually supported suspending your 401K contributions, but if you believe that the market is on the way up then now is the time to ratchet up your investments, because you are getting in at a low price. Because all contributions are done on a pre-tax basis and your gains are tax exempt, investing via your 401K or retirement account is the most effective form of long term investing. Even better go for a Roth IRA if you qualify, because not only are the gains tax exempt, so are the distributions when you retire.
If you have ticked off the above points, you are now in a great position to start active investing.But you must start with enough money to make it worthwhile. People say you can start with as little as $100. I don’t think so. Realistically you need at least $2000 to start with to make it worth the time you will spend researching and to ensure transaction costs don’t eat up your returns. Following on the above points, make sure your investment float is not only sufficient, but an amount that you can afford to do without in the short to medium term (i.e. forced to sell) should the markets get worse.
– Read. Research. Review. The old saying, “no work, no gain” applies to investing, despite what you may hear from the pundits on CNBC. You may get lucky and pick a hot stock or tip that delivers once in a while, but over the long term the best investors are the ones who do the most research and know the most about the investments they make. If you do not have the time or expertise to do the research then pay a professional for advice. Just don’t invest blind. When it comes to research, you can search the internet for almost anything you want. Yahoo and Google Finance provide great general stock and market information, but be prepared to pay for premium information. For stocks, I also like to read the annual (10K) report to know more about what the company does. These are free and provide a lot of company and sector specific information. For investing in funds and ETF’s I like to do my research via Morningstar, thanks to its strong comparison tools. Finally, for daily financial news I subscribe to the Wall Street Journal online edition. It contains some great financial information for all types of investors and with subscriptions up to 75% off regular prices, it is a very worthwhile investment. Finally, before you jump into the real market, try some stock simulation games at the finance sites mentioned above.
– Choose the right broker. For the average investor whose portfolio is most likely below six figures, trading costs associated with buying and selling stocks can add up over the year. So before you start investing, picking an online broker with the lowest costs is key. You can start with some of the well established online brokers, who have solid stock research sections and great user interfaces. However, if you are okay with a straight forward interface but want ultra-low costs go with the rapidly growing online discount brokers whose trading costs are about half that of the big guys. The best way to figure what is right for you is to trial these sites (free) and decide which suits your trading style and needs.
– Understand the tax consequences. Before you start investing, spend some time to understand the tax consequences of investing like capital gains rules, wash sales and the like. When you buy and sell stocks can make a big difference in how much you keep after taxes. For example the capital gains loss provision allowed me to write off $3,000 of stock losses against my taxable income, providing I sold the shares before December 31st last year.
The above pointers should give you plenty to get started on. If this is really the beginning of the recovery and you are planning to invest for the long term, then it is a great time to start investing or get back into the market. Like any form of investing, buying stocks is risky, but do your homework and should things return to normal you could be sitting pretty in a few years.