Making a list will also help if you are saving for your children’s future. For example, do you want to send your children to a private school or college? Do you want to buy them cars? Would you prefer public schools and using the extra money for something else? Having a clear idea of what you value will help you establish goals for savings and investment.
Popular financial goals include buying a home, paying for your child’s college, amassing a “rainy day” emergency fund, and saving for retirement. Rather than having a general goal such as “own a home,” set a specific goal: “Save $63,000 for a down-payment on a $311,000 house. ” (Most home loans require a down payment of between 20% and 25% of the purchase price in order to attract the most affordable interest rate. ) [3] X Research source Most investment advisers recommend that you save at least ten times your peak salary for retirement. [4] X Research source This will allow you to retire on about 40% of your peak pre-retirement annual income, using the 4% safe withdrawal rule. [5] X Research source For example, if you retire at a salary of $80,000, you should strive for at least $800,000 saved by retirement, which will provide you with $32,000 annual income at retirement, then adjusted annually for inflation. Use a college cost calculator to determine how much you will need to save for your children’s college, how much parents are expected to contribute and the various types of financial aid your children may qualify for, based on your income and net worth. Remember that costs vary widely depending on the location and type of school (public, private, etc. ). Also remember that college expenses include not only tuition, but also fees, room and board, transportation, books and supplies. [6] X Research source Remember to factor time into your goals. This is especially true for long-term projects such as retirement funds. For example: John begins saving at age 20 using an IRA (Individual Retirement Account) earning an 8% return. He saves $3,000 a year for the next ten years, then stops adding to the account but keeps the IRA invested in the market. By the time John is 65, he will have $642,000 built up. [7] X Research source Many websites have “savings calculators” that can show you how much an investment will grow over a given length of time at a specified interest rate. While they’re not a substitute for professional financial advice, these calculators can give you a good place to start. [8] X Research source Once you determine your goals, you can use the difference between where you are today and where you want to be to determine the rate of return needed to get there. Make sure you consider both your short-term and long-term goals. [9] X Expert Source Ara Oghoorian, CPACertified Financial Planner & Accountant Expert Interview. 11 March 2020.
What stage of life are you in? In other words, are you near the low end or closer to the peak of your income-earning potential? Are you willing to accept more risk to earn greater returns? What are the time horizons of your investment goals? How much liquidity (i. e. resources that can easily be converted to cash) do you need for your shorter-term goals and to maintain a proper cash reserve? Don’t invest in stocks until you have at least six to twelve months of living expenses in a savings account as an emergency fund in case you lose your job. If you have to liquidate stocks after holding them less than a year, you’re merely speculating, not investing. If the risk profile of a potential investment does not conform to your tolerance level, it’s not a suitable option. Discard it. Your asset allocation should vary based on your stage of life. For example, you might have a much higher percentage of your investment portfolio in stocks when you are younger. Also, if you have a stable, well-paying career, your job is like a bond: you can depend on it for steady, long-term income. This allows you to allocate more of your portfolio to stocks. Conversely, if you have a “stock-like” job with unpredictable income such as investment broker or stock trader, you should allocate less to stocks and more to the stability of bonds. While stocks allow your portfolio to grow faster, they also pose more risks. As you get older, you can transition into more stable investments, such as bonds. [12] X Research source
The Intelligent Investor and Security Analysis by Benjamin Graham are excellent starter texts on investing. The Interpretation of Financial Statements by Benjamin Graham and Spencer B. Meredith. This is a short and concise treatise on reading financial statements. Expectations Investing, by Alfred Rappaport, Michael J. Mauboussin. This highly readable book provides a new perspective on security analysis and is a good complement to Graham’s books. Common Stocks and Uncommon Profits (and other writings) by Philip Fisher. Warren Buffett once said he was 85 percent Graham and 15 percent Fisher, and that is probably understating the influence of Fisher on shaping his investment style. “The Essays of Warren Buffett,” a collection of Buffett’s annual letters to shareholders. Buffett made his entire fortune investing, and has lots of very useful advice for people who’d like to follow in his footsteps. Buffett has provided these to read online free: www. berkshirehathaway. com/letters/letters. html. The Theory of Investment Value, by John Burr Williams is one of the finest books on stock valuation. One Up on Wall Street and Beating the Street, both by Peter Lynch, a highly successful money manager. These are easy to read, informative and entertaining. Extraordinary Popular Delusions and the Madness of Crowds by Charles Mackay and Reminiscences of a Stock Operator by William Lefevre use real-life examples to illustrate the dangers of emotional overreaction and greed in the stock market. You can also enroll in basic or beginner investment courses offered online. Sometimes these are offered free by financial companies such as Morningstar and T. D. Ameritrade. [13] X Research source Several universities, including Stanford and MIT, offer online investment courses. [14] X Research source [15] X Research source Community centers and adult education centers may also offer financial courses. These are often low-cost or free and can provide you with a solid overview of investment. Look online to see if there are any in your area. Practice by “paper trading. ” Pretend to purchase and sell stocks, using the closing prices each day. You can literally do this on paper, or you can sign up for a free practice account online at places such as How the Market Works. Practicing will help you hone your strategy and knowledge without risking real money.
This is why many investors buy the stock of products that they know and use. [16] X Research source Consider the products you own in your home. From what’s in the living room to what’s inside the refrigerator, you have first-hand knowledge of these products and can quickly and intuitively assess their performance compared with that of competitors. For such household products, try to envision economic conditions that might lead you to stop purchasing them, to upgrade, or to downgrade. If economic conditions are such that people are likely to buy a product you are very familiar with, this might be a good bet for an investment.
The direction of interest rates and inflation, and how these may affect any fixed-income or equity purchases. [17] X Research source When interest rates are low, more consumers and businesses have access to money. Consumers have more money to make purchases, so they usually buy more. This leads to higher company revenues, which allows companies to invest in expansion. Thus, lower interest rates lead to higher stock prices. In contrast, higher interest rates can decrease stock prices. High interest rates make it more difficult or expensive to borrow money. Consumers spend less, and companies have less money to invest. Growth may stall or decline. [18] X Research source The business cycle of an economy, along with a broad macroeconomic view. Inflation is an overall rise in prices over a period of time. Moderate or “controlled” inflation is usually considered good for the economy and the stock market. Low interest rates combined with moderate inflation usually have a positive effect on the market. High interest rates and deflation usually cause the stock market to fall. Favorable conditions within specific sectors of an economy, along with a targeted microeconomic view. [19] X Research source Certain industries are usually considered to do well in periods of economic growth, such as automobiles, construction, and airlines. In strong economies, consumers are likely to feel confident about their futures, so they spend more money and make more purchases. These industries and companies are known as “cyclical. ” [20] X Research source Other industries perform well in poor or falling economies. These industries and companies are usually not as affected by the economy. For example, utilities and insurance companies are usually less affected by consumer confidence, because people still have to pay for electricity and health insurance. These industries and companies are known as “defensive” or “counter-cyclical. ” [21] X Research source
Decide how much money will be invested in stocks, how much in bonds, how much in more aggressive alternatives and how much you will hold as cash and cash equivalents (certificates of deposit, Treasury bills, etc. ). [22] X Trustworthy Source U. S. Securities and Exchange Commission Independent U. S. government agency responsible for regulating the securities industry, which includes stocks and options exchanges Go to source The goal here is to determine a starting point based on your market expectations and risk tolerance. [23] X Trustworthy Source U. S. Securities and Exchange Commission Independent U. S. government agency responsible for regulating the securities industry, which includes stocks and options exchanges Go to source
Select stocks that best meet your investment needs. If you are in a high income tax bracket, have minimal short- or intermediate-term income needs, and have high risk tolerance, select mostly growth stocks that pay little or no dividends but have above-average expected growth rates. Low-cost index funds usually charge less in fees than actively-managed funds. [24] X Research source They offer more security because they model their investments on established, well respected indexes. For example, an index fund might select a performance benchmark consisting of the stocks inside the S&P 500 index. The fund would purchase most or all of the same assets, allowing it to equal the performance of the index, less fees. This would be considered a relatively safe but not terribly exciting investment. Advocates of active stock picking turn their noses up at such investments. [25] X Research source Index funds can actually be very good “starters” for new investors. [26] X Research source Buying and holding “no-load,” low-expense index funds and using a dollar-cost-averaging strategy has been shown to outperform many more-active mutual funds over the long term. Choose index funds with the lowest expense ratio and annual turnover. For investors with less than $100,000 to invest, index funds are hard to beat when viewed within a long time period. See Decide Whether to Buy Stocks or Mutual Funds for more information whether individual stocks or mutual funds are better for you. An exchange-traded fund (ETF) is a type of index fund that trades like a stock. ETFs are unmanaged portfolios (where stocks are not continuously bought and sold as with actively managed funds) and can often be traded without commission. You can buy ETFs that are based on a specific index, or based on a specific industry or commodity, such as gold. [27] X Research source ETFs are another good choice for beginners. You can also invest in actively managed mutual funds. These funds pool money from many investors and put it primarily into stocks and bonds. Individual investors buy shares of the portfolio. [28] X Trustworthy Source Investor. gov Website maintained by the Securities and Exchange Commision’s Office of Investor Education and Advocacy providing free resources about investing. Go to source Fund managers usually create portfolios with particular goals in mind, such as long-term growth. However, because these funds are actively managed (meaning managers are constantly buying and selling stocks to achieve the fund’s goal), their fees can be higher. Mutual fund expense ratios can end up hurting your rate of return and impeding your financial progress. [29] X Trustworthy Source U. S. Securities and Exchange Commission Independent U. S. government agency responsible for regulating the securities industry, which includes stocks and options exchanges Go to source Some companies offer specialized portfolios for retirement investors. These are “asset allocation" or “target date” funds that automatically adjust their holdings based on your age. For example, your portfolio might be more heavily weighted towards equities when you are younger and automatically transfer more of your investments into fixed-income securities as you get older. In other words, they do for you what you might be expected to do yourself as you get older. [30] X Research source Be aware that these funds typically incur greater expenses than simple index funds and ETFs, but they perform a service the latter investments do not. It’s important to consider transaction costs and fees when choosing your investments. Costs and fees can eat into your returns and reduce your gains. It is vital to know what costs you will be liable for when you purchase, hold, or sell stock. Common transaction costs for stocks include commissions, bid-ask spread, slippage, SEC Section 31 fees [31] X Trustworthy Source U. S. Securities and Exchange Commission Independent U. S. government agency responsible for regulating the securities industry, which includes stocks and options exchanges Go to source , and capital gains tax. For funds, costs may include management fees, sales loads, redemption fees, exchange fees, account fees, 12b-1 fees, and operating expenses. [32] X Trustworthy Source U. S. Securities and Exchange Commission Independent U. S. government agency responsible for regulating the securities industry, which includes stocks and options exchanges Go to source
Dividend discount model: the value of a stock is the present value of all its future dividends. Thus, the value of a stock = dividend per share divided by the difference between the discount rate and the dividend growth rate. [33] X Research source For example, suppose Company A pays an annual dividend of $1 per share, which is expected to grow at 7% per year. If your personal cost of capital (discount rate) is 12%, Company A stock is worth $1/(. 12-. 07) = $20 per share. Discounted cash flow (DCF) model: the value of a stock is the present value of all its future cash flows. Thus, DCF = CF1/(1+r)^1 + CF2/(1+r)^2 + . . .
- CFn/(1+r)^n, where CFn = cash flow for a given time period n, r = discount rate. A typical DCF calculation projects a growth rate for annual free cash flow (operating cash flow less capital expenditures) for the next 10 years to calculate a growth value and estimate a terminal growth rate thereafter to calculate a terminal value, then sum up the two to arrive at the DCF value of the stock. For example, if Company A’s current FCF is $2/share, estimated FCF growth is 7% for the next 10 years and 4% thereafter, using a discount rate of 12%, the stock has a growth value of $15. 69 and a terminal value of $16. 46 and is worth $32. 15 a share. Comparables Methods: These methods value a stock based on its price relative to earnings (P/E), book value (P/B), sales (P/S), or cash flow (P/CF). It compares the stock’s current price ratios with an appropriate benchmark and the stock’s historic average ratios to determine the price at which the stock should sell.
You can select a discount broker, who will simply order the stocks you want to purchase. You can also choose a full-service brokerage firm, which will cost more but will also provide information and guidance. [34] X Research source Do your own due diligence by checking out their websites and looking at reviews online to find the best broker for you. The most important factor to consider here is how much commission is charged and what other fees are involved. Some brokers offer free stock trades if your portfolio meets a certain minimum value (e. g. Merrill Edge Preferred Rewards), or if you invest within a select list of stocks whose companies pay the transaction costs (e. g. loyal3). Some companies offer direct stock purchase plans (DSPPs) that allow you to purchase their stock without a broker. If you are planning on buying and holding or dollar cost averaging, this may be your best option. Search online or call or write the company whose stock you wish to buy to inquire whether they offer such a plan. [35] X Research source Pay attention to the fee schedule and select the plans that charge no or minimal fees.
Remember that bear markets are for buying. If the stock market drops by at least 20%, move more cash into stocks. Should the market drop by 50%, move all available discretionary cash and bonds into stocks. That may sound scary, but the market has always bounced back, even from the crash that occurred between 1929 and 1932. The most successful investors have bought stocks when they were “on sale. "
Typically these benchmarks are based on the performance of various market indexes. These allow you to determine whether your investments are performing at least as well as the market overall. It may be counter-intuitive, but just because a stock is going up does not mean it is a good investment, especially if it is going up more slowly than similar stocks. Conversely, not all shrinking investments are losers (when similar investments are doing even worse).
Investments that do not meet expectations should be sold so your money can be invested elsewhere, unless you have good reason to believe your expectations will soon be met. Give your investments time to work out. One-year or even three-year performance is meaningless to the long-term investor. The stock market is a voting machine in the short term and a weighing machine in the long term.
Circumstances and opinions change. This is a part of investing. The key is to properly process and assess all new information and implement any changes according to the guidelines set in the previous steps. Consider whether your market expectations were correct. If not, why not? Use these insights to update your expectations and investment portfolio. Consider whether your portfolio is performing within your risk parameters. It may be that your stocks have done well, but the investments are more volatile and risky than you had anticipated. If you aren’t comfortable with these risks, it’s probably time to change investments. Consider whether you are able to achieve the objectives you set. It may be that your investments are growing within acceptable risk parameters but are growing too slowly to meet your goals. If this is the case, it’s time to consider new investments.
Avoid stock tips. Do your own research and do not seek or pay attention to any stock tips, even from insiders. Warren Buffett says that he throws away all letters that are mailed to him recommending one stock or another. He says that these salesmen are being paid to say good things about a stock so that the company can raise money. Don’t pay too much attention to media coverage of the stock market. Focus on investing for the long term (at least 20 years), and don’t be distracted by short-term price gyrations. [37] X Expert Source Ara Oghoorian, CPACertified Financial Planner & Accountant Expert Interview. 11 March 2020.
