ENTREPRENEUR

This is a re-posting of an article from Intigril, my site on investing, trading, and personal finance. To view the original article on Intigril, click here.

Image from OmirOnia

Introduction

Buying stocks for the long-term isn’t easy.  In fact, most professionals, academics, and really anyone that knows about investing would probably tell you to buy a basket of mutual funds instead.  It’s easier, more diversified, and considered to be safer.  That, combined with the fact that there are literally thousands of highly paid professionals whose whole reason for being is to research and invest in stocks, means that you’ll be fighting uphill the whole way.  In fact, there’s a whole branch of finance taught in most schools whose sole purpose is to prove that you cannot consistently outperform the market as a stock-picker.

But with all that said, you may still want to learn about how to research and analyze individual stocks.  After all, you may be just as good as all those guys working on Wall Street, and if you’re dedicated, don’t get greedy, and follow some simple rules, you can definitely achieve lasting success.

No single article can turn you into an expert stock investor, but in this article I’ll try to hit some of the most important points, hoping you will continue your research and, eventually, start generating some steady returns.

Diversification

Image from worradmu / FreeDigitalPhotos.net

The most important concept in investing is risk management.  Before I even bring up any ideas on analysis or research, there’s one thing you need to always remember, and that is to diversify.  There are few things worse than having one bad pick wipe out half your portfolio, and believe us, that one bad pick will definitely be there.

Diversification is your friend.  It exists to help you, to save you money, to reduce your risk.  Use it.  Don’t put all your retirement money in the stock market, and with the money that you do put in the market, spread it out over multiple stocks in multiple sectors.  Never place a large fraction of your portfolio in a single stock.  I’d consider 5% the maximum amount that you should put in any one position.

Diversification is extremely important, and it will usually help with preventing large losses.  But there are a few “gotchas” that you need to watch out for.  First, it is possible to over-diversify (the reasoning behind this is technical and gets too far into financial theory, but suffice it to say, you can have too much of a good thing).  If you take on too many positions, you may be putting a pretty big dragnet on any high flying stocks that you’ve chosen.  Finding the right amount of diversification for your portfolio is a fine art, and you’ll need to consistently monitor your positions to find the right level.

Also, keep in mind that owning multiple stocks doesn’t necessarily mean you’re properly diversified.  The main thing to keep in mind when you diversify is that you want to eliminate stock-specific, or industry-specific risk.  That means that buying Ford to diversify away from Toyota is generally not a good idea.

Know the company (fundamental analysis)

Research the business

Image from picaland

When you buy (or short) a stock into your portfolio, you’re inherently taking on the same risks and rewards that the underlying business has.  That means that you better know your companies extremely well.  The most diligent investors on Wall St. literally spend thousands of hours researching potential buys and sells before adding them into their own portfolios, and, for the most part, you can get the same information that they can.

Sure, sometimes they have quick access to CEOs and managers in the company, but the foundation of their research starts with information that you can get just as easily as they can.  One of the best places to learn about a company is the investor relations page of its website.  On that page, you should have access to details about company management, financials, and links to mandatory reports and filings that all publicly traded companies have to make.

The most important of these reports is called the 10-K, which provides more details than you’d ever want about a company.  It will tell you everything from what that company does, to what its sales and profit margins are, to the terms of its leases on its most important real estate.  Company management has to sign off on its accuracy, and oftentimes, the CEO and CFO provide key comments and notes that are incredibly useful for investors.

In addition to reading the 10-K, you can listen in on analyst and management conference calls during earnings season, set up news alerts on the company, and even visit some of its stores to see how sales are doing (when possible).

You can also research what management is doing with their own shares in the company.  Are they buying?  Are they selling?  How much?  Why?  Sometimes the way that company management acts can be an indication of what they expect for the company’s future (just be careful about putting too much emphasis on this, as managers aren’t allowed to trade on any information that hasn’t been made public).

Your goal in all of this research should be to gain as much insight on the company as you can.  Get as much information as you can, and then make an assessment on how you think it will do in the future.

Evaluate performance

Image from simonok

After you’ve done your investigative work, your next step should be to assess how the company has been doing in the recent past.  Take a look at its balance sheet and income statements for the past year and compare it to the past five years.  Has its debt gone up?  Have profit margins dropped?  Have they been gaining or losing cash?  Taking a look at the cold, hard numbers is sometimes the best way to determine where a company is going.

Some of the data you should look at include:

• Debt-to-equity ratios (many times, when debt starts to grow, you want to be cautious)
• The current and quick ratios (does the company have enough cash to pay off its immediate debts)
• Profit margins, return on equity, and return on invested capital for the past 5 years (an upward trend is always good)
• Growth in sales and profits over the past five years (have they been selling more while keeping their costs down)

The list above is just a starting point.  There are a large number of different ratios, fractions, and numbers that you can examine, but in the end, your goal is to find out one thing: how’s business?

Know the stock (technical analysis)

Image from wax115

After you’ve determined if the stock you’re looking at has a good underlying business or not, you need to figure out if the stock itself is a good buy (or short).  It’s entirely possible to have a good business that’s not a good stock.  The first thing you may want to do is value the business and determine if the stock’s current price is overvalued or undervalued.  You can either use a method of discounted cash flow valuation, or the P/E ratio, or preferably, both.

By first finding the true value of the company’s stock, and then looking at the P/E, you can find out if the market is overvaluing or undervaluing the stock both in terms of absolute dollar amounts, and with respect to how it has done so in the past.  If a stock’s current P/E ratio is low compared to its historic average, it could mean that the stock is a good buy (however, it could also mean that the underlying business is in trouble, this is where your fundamental analysis can help you make a judgment).

In addition to valuing the stock, you should also take a look at the company’s earnings per share, or EPS.  If this number is high compared to historical values and the company’s competitors in the same industry, it may mean that the company is doing well compared to its share price.

Some investors also like to look at chart patterns to determine whether it’s a good time to buy or sell the stock.  Though I wouldn’t suggest trading stocks based on patterns alone, you could use chart analysis to time when you plan to get into, or out of, a new position.  Some patterns like moving average crossovers and MACD crosses may help you get a better price on your trades.

When it comes down to it, you should always keep in mind the fundamental saying: “buy low and sell high.”  It’s your job to determine what “high” and “low” mean for any given stock, but as long as you follow this rule, act greedy when others are fearful and fearful when others are greedy, you’ll make a hefty profit.

Dividends

Dividends are some of the most important things when it comes to buying stocks.  A dividend is a payment from the company to you to provide you with a share of the company’s profits.  Believe it or not, most of the value in owning stocks comes from dividends, not price appreciation.  Owning stocks that pay dividends is extremely important.  In fact, many investors only own dividend-paying stocks.  You may want to consider doing the same.

Dealing with losses

Image from Nutdanai Apikhomboonwaroot / FreeDigitalPhotos.net

Inevitably, no matter how much research and analysis you do, you’ll run into a stock that will go against you.  It’s important to have a plan in place for when this happens.  You have a few different options.  You could always use options to limit your losses while holding onto your underlying stock.  You can learn more about this possibility in other articles on this site.

You can also choose to do what’s called “dollar cost averaging,” in which you invest a small and steady amount continuously, buying more shares when prices are cheap, and less shares when prices are high.  Though dollar cost averaging can potentially lower your cost basis, it’s not without its disadvantages.  The last thing you want to do is catch a falling knife and invest more money when your pick is going against you.  That’s why I recommend the use of stop losses.

Stop losses automatically get you out of your position after you’ve lost a certain, pre-set limit.  It’s only natural for us to fall in love with the stocks we buy, and when they start going against us, our natural intuition is to hold on to them, hoping they’ll rebound.  By always using stop losses, you take emotion out of the picture, and you implement a systematic way to always limit your losses.

The most important thing with dealing with losses is to actually have a plan in place before they occur.  If you wait to figure out how to deal with your losses until they actually happen, chances are you won’t do what’s best for your portfolio.

Shorting

Image from iprole

Shorting a stock involves borrowing that stock from your broker and selling it on the market in hopes that the price will drop, allowing you to buy it back at a cheaper price and pocketing the difference.  Shorting definitely has its merits, but shorting an underperforming company is significantly different from buying a strong, solid company.  It also comes with several drawbacks, including the possibility of having to pay any dividends that have been issued while you’ve been short, having to buyback the stock immediately if the lender of the stock wants it back, dealing with possible bans on shorting (as was the case with financial stocks during the financial crisis), and maintaining proper hedges and controls on your short position, particularly in light of your entire portfolio.

Point being, unless you really know what you’re doing, try to avoid shorting stocks.

Final tips

When you find a stock that you’d like to buy or short, you may want to think about scaling into and out of positions.  Consider buying (or shorting) only a small portion of it to start with, and slowly buying more if the position goes in your favor.  By avoiding investing all of your money at once, you set yourself up to avoid large losses.

Before you invest your first dollar, it’s important for you to commit yourself to being disciplined, developing a plan for finding new stocks, limiting your losses, and avoid getting emotional.  You’ll undoubtedly experience highs and lows when investing, and as long as you don’t let them control your judgment, you can make consistent profits over the long run.

That wraps up my guide to stocks.  Hopefully you feel a bit more comfortable with stocks, the stock market, and investing in general.  At this point, you should keep reading and doing more research to understand if investing in individual stocks is the right process for you.  If not, there are always mutual funds and options, which you can learn about from other articles on this site.

Good luck!

This is a re-posting of an article from Intigril, my site on investing, trading, and personal finance. To view the original article on Intigril, click here.

Image from guitargoa

Introduction

Image from Sujin Jetkasettakorn

The wild and seemingly random fluctuations in the market may make you think that a stock’s price is nothing more than a lottery number, but you’d be surprised at just how much goes into determining a stock’s price at any given point.

A stock’s price has to start somewhere, and that somewhere lies in the IPO process that I told you about back in part 1.  Do you remember how I said that when a company wants to sell shares of itself to the public, it usually hires an investment bank to do the dirty work?  Well, part of that dirty work is determining what a stock’s initial price should be.  This, in itself, is a difficult process.

Initial due diligence and research

Image from jannoon028

Consider the fact that, in an IPO, the investment bank will buy all of the newly issued shares in a company, and will then re-sell those shares to the public.  In doing so, the bank has to make sure that it prices the shares low enough that it can find buyers on the first day, but not so low that it loses money in the transaction.  In order to find just the right price for this new company’s stock, the bank goes through a long period of due diligence.

It meticulously pours through the company’s records to see what its sales figures look like, how much money it’s making, what the growth figures look like, who the customers are, what the expenses are, and a variety of other factors that can let the bank predict the company’s future performance.  Once it has all of this information, the bank can create a model to determine the market value of the company – or what it will be worth once its shares are sold.

There are a variety of models used to determine a company’s market value, but most of them will basically take the company’s earnings numbers, predict how fast they’ll grow, discount these future profits back to present day value, and come up with a number that represents the company’s true worth.

Once the bank has done this background work, it contacts potential buyers around the world to have pre-sales meetings, answer questions about the new company, and gauge the level of interest in the company’s newly offered shares.

After it has all this information, the bank combines its estimates about the true value of the company with its knowledge of buyer interest in the new shares (and, at times, contracts that guarantee the sale of shares) to determine the number and price of shares in the new company.

Once it does so, it will create and buy all of these shares from the company in preparation for the IPO.  At this point, the company now has a bloated bank account and the bank has millions of shares that it’s ready to sell to the public on day 1.

Public buyers

Image from Ambro

With these new shares ready, and the bank already having contracted with one of the major exchanges I told you about in part 2, trading in the new company is good to go.  On day 1, the bank will sell its shares to the public.  If it did its job well, it will have excited enough buyers to quickly and fervently scoop up shares in the new company, making itself a hefty profit.

But how do buyers know if they’re getting a good deal or not?

Well, a lot of that has to do with buyers’ own analysis and research, as well as any analysis and research that the investment bank has provided.  When a company first goes public, there’s not a lot of information for analysts to go on – they can check sales figures, growth prospects, customer base – essentially the same things that the bank had to check when first coming up with a price.  With this information, buyers can create their own model of a company and can determine if it is currently a good buy.

At the beginning, it can be difficult to tell whether a new company’s shares are a good purchase or not.  No one really knows where the stock is going to go, so buying at the start can be risky.  That’s why many investors tend to wait until a company has traded for some time before they decide to get in.  After a bit of history, investors will have more information and can improve their estimates for the company’s future performance.

So how will they use this information to influence stock prices? Go to the next page to find out.

Read ahead: How investors analyze company performance to buy and sell stocks »

This is a re-posting of an article from Intigril, my site on investing, trading, and personal finance. To view the original article on Intigril, click here.

Image from Travel Aficionado

History

Image from Wikipedia

The date – May 17, 1792.  The place – New York City, 68 Wall Street, outside under a buttonwood tree.  The event – 24 stock brokers have just signed an agreement to create the ancestor of what is today’s largest stock exchange by total company value.

That’s right, you guessed it, it’s the birth of the New York Stock Exchange (NYSE), and if you’re curious as to what it actually means to buy and sell stocks, how they’re sold, and who’s selling them, you’re in the right place.  In the last article, I showed you what a stock actually is – a share of ownership in a company.  It’s important to keep in mind that, officially, each share of stock is represented by an actual piece of paper that outlines the details (company name, proof of ownership, etc) of the stock that you own.  These days, these records may be held electronically, but back in the ol’ days, they were actual products that were bought and sold for money.

Anyone that wanted to buy or sell stock would instruct their broker to go down to the physical location of the stock exchange and come up with a favorable deal.  These brokers would then exchange stock certificates for cash and either provide them to their clients or hold them until their clients needed them.

Trading today

Today, things are a bit different.  The NYSE has expanded, and though there’s still some human interaction left in the trading process, most deals are done electronically on a vast computer system.  In addition, the NYSE isn’t the only player in town anymore.  The NASDAQ is a fully electronic exchange that matches buyers and sellers and provides a centralized location for trading stocks (not to mention other financial products).  It’s the second largest exchange in the US, and it’s known for housing mostly tech stocks.  These are the two big exchanges that you should know about, though it may also help to keep in mind the American Stock Exchange, which is the third largest exchange, though these days it doesn’t focus too much on stocks.

There are a lot more brokers now, too.  And you’ll probably never see a stock certificate in your life, but the basic idea is the same.  Exchanges provide a way for buyers and sellers to trade stocks quickly and easily.

So who’s doing all the trading?

Image from Redwood Photography

The total market value of all of the companies in the NYSE alone is around $18 trillion (after they merged with the electronic exchange Euronext).  On top of that, there are around 2 billion shares traded every day, amounting to hundreds of billions of dollars of transactions.

Who’s doing all this trading?

Well, obviously there are a lot of individual traders, but the majority of trading is done by banks and institutional investors – or the big companies that are hired to manage your pension funds, 401(k)s, the endowment funds of big schools like Harvard and Yale, sovereign wealth funds that manage the money of entire countries, hedge funds, mutual funds, and any other large organizations that are entrusted with the savings of millions of working professionals for safekeeping.

These companies are all employing their own investment strategies, analyses, calculations, opinions, and most importantly, emotions, to try to find stocks that will help them grow their capital.  If any single of of them puts in a large order to buy or sell stock, it will flood the market and can significantly move prices up or down.  In the next post, I’ll talk about what makes up the price of a stock, but for now, it’s enough to know that these guys play a big roll in the whole process of supply and demand.

Market making

Image from watcharakun / FreeDigitalPhotos.net

There’s one last thing you should know about stock trading, at least for now.  When most individuals place an order to buy or sell a stock, they’re actually going through an intermediary – or a market maker.  These are people (or companies) that are required to “provide a market” for stocks buy buying and selling at the prices that they quote the public.  In exchange, they get preferential treatment in the markets whenever they place their own orders.

Market makers will always sell stock at a slightly higher price than they buy it, which brings them a small profit on every transaction they do.  Good traders or computer programs that do this thousands, or millions, of times a day can generate huge amounts of money, so market making is a pretty lucrative business.

When you put in an order to buy or sell a stock, chances are it’s going from you to your broker to a market maker who may or may not match you up with another buyer or seller in the market.  If there’s no match, the market maker will just take your order and wait until later in the day when he can offset his new position, and in a market that’s trading billions of shares a day, that’s usually not too hard to do.

What’s next?

At this point, you know what stocks are, why companies sell them, why people trade them, and how they’re bought and sold.  But the most important part is yet to come.  In the next article, we’ll tell you what stock prices mean and why they can move so far up and down in such short timespans.  Read on!

This is a re-posting of an article from Intigril, my site on investing, trading, and personal finance. To view the original article on Intigril, click here.

Image from guitargoa

What the heck is a share of stock?

Want to know what stock is?  Simple – it’s a share of ownership in a company.  When you buy a stock, you’re buying a very, very, very small piece of ownership in a company that has decided to sell itself, in part of in whole, to the general public.  That’s it.  Seriously.  If a company has sold one billion shares to the public, and you own 1 share of stock in that company, then you own a billionth of that company.

Cool, I’m an owner!  What do I get?

Just because you own a few shares of Coke, it doesn’t mean you can just waltz into a grocery store and grab some soda.  But don’t fret.  As a stock owner, you’re entitled to something much more important – a claim to some of Coke’s profits.  But again, there’s a problem.  You can’t just call up the manager of Coke’s bank account and demand a wire transfer tomorrow.  Only Coke’s board members can authorize a payment to the company’s shareholders, you.

As a shareholder, you get to vote on who gets on Coke’s board of directors, but let’s be honest, as an individual investor, you don’t care about who’s on Coke’s board.  The only thing you’re looking for is your share of Coke’s earnings (paid out as a dividend) and a higher stock price so you can sell your stock at a profit.

As an owner of the company, though, there’s one thing to keep in mind.  If the company goes bankrupt, chances are, you won’t actually get any money that the company has.  By law, the company first has to repay any debts that it owes.  After it does that, then you can get paid, but if the company went bankrupt, what’s the likelihood that it will have anything left over for you?

Why do companies sell stock?

Image from twobee / FreeDigitalPhotos.net

Imagine you had started a great company producing flying alarm clocks (let’s just go with it).  You’ve been able to set up a factory to produce and sell thousands of alarm clocks in California, but now you’re getting orders in from the rest of the country and you can’t keep up with them.  You need to open more factories, you need to pay more workers, you need to set up supply chains and coordinate with distribution centers.  What do you do?

You could take out a loan from the bank, or, you could sell some (or all) of your ownership in the company to raise money for growth and expansion.  If you decide to go that route, you’ll generally contact one of the big Wall Street banks to take care of the dirty work for you – figuring out how many shares to sell and at what price, finding buyers for your stock, complying with SEC guidelines for reporting, etc.  Of course, the big Wall Street bank will charge you a fee for all of their work.

The bank will then buy all of the shares that you’ve decided to offer themselves.  Then, at some point in the future, they’ll resell those shares to the general public in an initial public offering, or IPO.  Once they’re out in the public, your company is no longer involved in the process.  Now, your job is to keep growing the company so that its new owners make a nice, hefty profit.  If you do a good job, more people will want to buy shares in your company, driving up the stock price, and keeping your shareholders happy.  If you don’t, more people will sell your stock, causing your stock price to tank, which may eventually lead to your new bosses outing you and in favor of finding a new CEO.

But ultimately, this IPO will be a pretty good deal for you, too.  As the founder of this hugely successful flying alarm clock company, you’ve probably kept a large chunk of shares for yourself.  Now that these shares are trading freely on the market, you’ll be able to sell them for a pretty penny and cash out, if you want.  Just keep in mind that as part of the IPO, you’ll be prevented from selling your shares for a specific period of time – usually six months.

Back to reality

Hopefully, you now have a better idea of what all the fuss is about.  Stocks and the stock market are a major part of everyone’s daily lives, at least in some small way.  Now that you know a bit more about what a stock is, you’re ready to get into the details.  In the next post, we’ll talk about how stocks are traded and who’s buying and selling them.  Read on!

This is a re-posting of an article from Intigril, my site on investing, trading, and personal finance. To view the original article on Intigril, click here.

Invest in the market.

Traditionally, one of the best ways to build long-term wealth has been by steadily contributing money to a portfolio of diversified stocks over the course of many years.  And you know what?  If you haven’t already started, now’s the time.

The earlier you start with investing, the more the power of compounding can help you.  Yes, the market can drop dramatically, yes, the past decade has seen two huge recessions, yes, things look bleak.  Guess what?  It’s still the perfect time.  The more time you give yourself to grow your money, the richer you’ll be.  If you can stay disciplined and follow an intelligent plan.

Stocks are a great way to invest.  So are mutual funds.  In fact, if you’re interested in long-term investing, mutual funds may even be the safer way to go, and we’ll soon have a guide to getting started with mutual funds.  But if you’ve got the time and the will to do a little work, you can take control of your own investments and build your own personal mutual fund.  The best part?  You won’t have to pay a “professional manager” on Wall Street to make the same trades that you can make yourself.

Are you ready to get started?

Good.  Let’s roll.

My guide to stocks

1. The beginner’s introduction to stocks
2. How does stock trading actually work?
3. What goes into a stock’s price?
4. Investing in stocks for the long run

This is a re-posting of an article from Intigril, my site on investing, trading, and personal finance. To view the original article on Intigril, click here.

Image from kenteegardin / seniorliving.org

Your plan

Over the past 7 articles, we’ve given you a lot of information on how to manage your finances. If it all seemed a bit overwhelming, this article should help clear things up. Below, we’ll provide you with a summary plan that should help you make sense of it all.  If you take care of the items below, you’ll be on solid financial ground and you’ll be able to start generating even more money right away.

1. Get your insurance needs out of the way

   If you’re working for a company, you probably have the option to sign up with its insurance providers to handle almost all of your insurance needs (medical, dental, vision, life, disability, etc). Hopefully, you got everything squared away when you were first hired, but if you didn’t have that chance, contact your HR representative and see what you can take care of now. Go out and buy home owner’s or renter’s insurance if you don’t already have it.

   If you’re not working for a company, there are a variety of providers that will sell you independent insurance coverage, you may have to pay more than if you were getting it through a group plan, so shop around and find the plans that best suit your needs.

2. Figure out your expenses

   Calculate what you’re going to need to survive each month. Add to that any monthly debt you need to pay off. This is the minimum amount that you should be depositing into your checking account each month. Ideally, you’ll have quite a bit more than this coming in, but try to shoot for at least 2-3 times your monthly expenses.  If you’re having problems scrounging up enough to meet that amount, it’s time to make some changes.

3. Deal with your debt and your tax-free retirement accounts

   In step 2, you calculated the amount that you’ll need to cover your debts. Pay those off on time every month. With any money that’s left over, figure out how much of it you’d be willing to give up each month and then have it automatically withdrawn from your paycheck and deposited into a tax-free retirement account (401K, Roth 401K, 403B, etc).

4. Build up your emergency fund while keeping your checking account healthy

   Whatever you have left should go towards building up your emergency fund. It may take you several months to a year of saving before you’re able to build up your account all the way, but stick with it until it’s done.  You’ll sleep easier, and that has to be worth it.

5. Plan for the future

   At this point, you’ll have be on a solid financial foundation. Your next step is to look at what you’re going to need for the future. If you expect to buy a new car, put a down payment on a house, or make another large purchase, you should set up a separate savings account that you’ll contribute to every month as you save up specifically for that purchase. If you don’t see any big expenses coming up, you should start trading or investing. The guides on this site will help you get started with growing your money.

After a year or two of going through this plan, you should be able to reduce your debts, maintain a solid emergency fund, have enough in your checking account to take care of expenses, and be on track for an early retirement.  On top of these basics, if you can cover all of your expenses with a good credit card that provides cash back or other rewards while managing to pay off your full balance every month, you’ll be all set.

More resources

• If you want some more help when it comes to money, we’d recommend buying The Wealthy Barber. This is one of the best books on personal finance, and it’s actually a pretty good read (unlike most other financial books). If you’re serious about getting your finances in order, reading this book is mandatory. It’s the best $10 you’ll spend.
• You should also check out Ramit Sethi’s blog, I Will Teach You To Be Rich.  It has a whole slew of great articles on personal finance, and if you like a snarky comment here and there, you’ll enjoy his writing style too.
• Passive Panda is also a nice, new(ish) resource that can help you improve your financial situation by providing you with new ideas to generate income and make money.
• Get Rich Slowly is another good resource for personal finance articles.

And finally, if you’re ready to start making extra money every week by trading options, there are a ton of articles on Intigril just waiting for you to read them, learn, trade, and be free.  Good luck with your personal finance goals, and we hope to see you trading soon!

This is a re-posting of an article from Intigril, my site on investing, trading, and personal finance. To view the original article on Intigril, click here.

Image from yochim

Growing your money

Image from sheelamohan

By this point, you’re familiar with all of the boring parts of personal finance. Unfortunately, you need to have all of that boring stuff taken care of before you can get to the really exciting parts – how to use the money you have to make more of it, or how to “make your money work for you.”

Believe it or not, one of the worst things you can do is to let all of your money sit in a savings or checking account. That’s why in Part 2 of this series, I told you to only keep as much as you needed for your average expenses (plus a buffer) in your checking account. At first glance, this may not make sense. Why shouldn’t you keep all of your money safe and sound in bank deposits?

Well, the main reason is, that money could be making you even more money if you used it the right way. If you leave it in a savings or checking account, it won’t be doing that for you.

How does it work?

If this is a new concept for you, don’t worry, we’ll go through how this works, and we’ll even give you a few resources to help get you started.

You’ve probably heard the expression “it takes money to make money.” Well, it’s true. Companies have to pay their employees so they can provide a product or service that their customers will buy. Banks take the money you deposit with them and use it to provide loans. And everyday workers use their hard-earned salaries to invest or trade. That last point is what we’ll focus on in this article.

As an individual investor or trader, your best bet at getting rich is to slowly and steadily grow your money through the power of compounding. Sound scary? It’s not (and as an up-and-coming trader, you’re going to learn to love it). All it means is that over time, you can use the money you’ve made to make even more money. Essentially, compounding is a wonderful thing that helps you grow your money faster and faster and faster. All you have to do is help get the process started, and stay consistent.

Risk

Image from ddpavumba / FreeDigitalPhotos.net

Before you can get started, though, you have to know about risk. Why risk? Well, it’s the most important consideration in growing your money – the more “risk” you take, the more money you can earn or lose. If you put your money in no-risk investments, you won’t lose it, but you also won’t make a lot. If you put your money in higher risk investments or trades, you stand to make a lot more, but you could also lose a lot more too, so part of learning how to grow your money is figuring out what you’re comfortable risking.

With that said, it’s very important to not put any money in risky trades or investments if you can’t afford to lose it. This article is for people that have taken care of their basic expenses, have saved for emergencies, and are have a solid payment plan in place for their debt.

The choices at your disposal

Now lets go over some of the different choices you have, how risky they are, and how much money you can expect to make from them.

Bonds (fixed income)

Bonds are essentially loans from you to someone or something else. When you buy a bond, you’re loaning money to a company, town, city, state, or country in exchange for the promise that you’ll get paid back more than you lent out. You can buy a bond that will pay you back in as little as a few days, or as long as a few decades. The amount you get back depends on a few things – the interest rate in the economy, the chance that whoever you lent the bond to goes bankrupt, and when your bond is set to repay you.

more…

Stocks

Everyone has heard about stocks. Even if you have no idea what they are, you’ve seen plenty of stories about the “markets” rising and falling, new companies going public, and stock shares. Stocks (and funds, which you’ll read about next) are some of the most popular financial instruments for everyday people to grow their money.

more…

Mutual funds

One of the problems with owning individual stocks is that it’s too easy to lose money. One bad headline in a company that you own and the stock could go down 30%, wiping out your capital along the way. That’s where mutual funds, or plain old “funds”, come in. Funds are groupings of stocks that are combined together to form a single investment. When you buy into a mutual fund, you’re actually buying into many different stocks at once. The idea is that a combination of many different stocks can help to offset losses in any one, particular stock.

more…

401(k)s

If you work for a company, chances are you have access to a 401(k), which is essentially just a retirement account that invests in mutual funds. The company that administers the 401(k) will give you a choice of a few funds, and you can control how much of your money goes into which funds.

more…

Options

Options are our favorite financial instrument, and they’re what I specialize in. Options are an incredibly flexible class of securities that are known as “derivatives.” What this means is that they’re only valuable because they tie back to a security that actually has real value (like a stock). Said differently, their value is derived from the value of something else. You can have options on all sorts of different underlying securities, but on this site, when I talk about options, I mean stock or stock index options.

more…

Other advanced financial instruments

Options aren’t the only derivatives out there that you can trade. There are also futures, swaps, CDOs, and a variety of other exotic instruments that big banks create. In addition to derivatives, you can also trade commodities (things like corn, soybeans, or coffee), as well as precious metals (like gold and silver). Learning how to trade each of these is similar to trading options – if you do decide to get into them, learn how the markets work, understand the little quirks that go along with each instrument, and practice, practice, practice.

Real estate

Real estate is a tougher investment to do properly. Many people used to think that the price of a house could never go down, so as long as you continued to borrow money from the bank to buy and sell houses, you could make money forever.

more…

Getting started

Image from Ambro / FreeDigitalPhotos.net

Now that you know what’s available to you, how do you get started? First off, you’ll need a broker – someone that can execute your trades and take care of the logistics. They’ll charge you, so make sure to find the cheapest broker that you can find that still provides you with the level of service you’re looking for.

You should also start familiarizing yourself with whatever it is you want to invest in. Interested in bonds? Read up about their peculiarities. Interested in options? Figure out how puts and calls work. Want to build up long-term wealth with minimal effort? Find out which mutual funds are the best fit for you.

Once you’ve learned what you need to get started, go slowly. If you’re investing in stocks or bonds, figure out the right asset allocation and don’t go beyond that. If you’re trading options, figure out a strategy that works for your trading style and try some virtual trading before putting real money in. In any case, be consistent, and don’t get discouraged from a few losses. It’s all part of the process of growing your money.

That’s it for the personal finance series. In the next, and final post, we’ll wrap it all up, give you some good resources to learn more, and get you on your way to achieving financial stability so that you can then go on to be a trader and achieve financial independence. Read on!

This is a re-posting of an article from Intigril, my site on investing, trading, and personal finance. To view the original article on Intigril, click here.

Did you know:

• Half of all Americans have less than 1 month’s worth of savings¹
• The average graduating college senior leaves school with $23,186 in debt²
• The personal savings rate at the start of the Great Recession was 1.3%³
• A majority of people live paycheck to paycheck – including those that make 6-figures⁴
• Only half of all current workers participate in a retirement savings plan⁵
• In the US, the average savings for someone that is 50 years old is $2,500⁶
• 97% of Americans that reach the retirement age of 65 retire with less than $100,000⁶

Do these statistics scare you? I certainly hope so.

Start planning now

Image from Stuart Miles

Most Americans don’t know much about managing their personal finances, much less managing investments and building long-term wealth in the market. But the truth of the matter is, with a little planning and discipline, it’s not that difficult to build up long-term wealth.

Think living it up now is more important than building up some money for your future? Hope you like working into your 70s, or even your 80s.

I believe that anyone can achieve financial independence through the use of options. But before you can start trading, you need to know the basics of managing your money – which is really as simple as saving a little bit and making sure you have enough to cover your expenses. To give you a hand, I’ve created a 8-step guide for getting your personal finances in order. If you read through these tutorials, and then slowly start investing with stocks and options, you’ll be well on your way to quitting that job of yours years before you thought you’d be able to.

Let’s get started.

My guide to managing your personal finances

1. Plan for the unplannable with an emergency fund
2. Handle expenses with your checking account
3. Get rid of that nagging debt with some simple planning
4. Use your credit cards for everything – wisely
5. A different take on those big purchases
6. Insure yourself properly
7. Turn today’s income into an early retirement by growing your money
8. Wrapping it up with your five step financial plan

¹http://www.businesswire.com/portal/site/google/?ndmViewId=news_view&newsId=20090825005344&newsLang=en
²http://www.finaid.org/loans/
³http://www.mydollarplan.com/effects-of-the-recession-on-americans-personal-finances-how-long-will-they-last/
⁴http://www.cnbc.com/id/32862851/
⁵http://www.census.gov/compendia/statab/2010/tables/10s0539.pdf
⁶http://www.smartmoneyadvice.com/retirement-statistics.html