Plan to invest only what you can afford to tuck away for years. Even if the stock market crashes the day after you buy your first investment, you stand a much better chance of recovering your dollars if you have five or more years to stay invested, instead of having to cash in investments next month or next year.
Thursday, February 28, 2008
First Steps in Bond Investment
If you’re in or near retirement and consider safety, or reduced risk, a priority, you can buy a bond. Corporate bonds are sold in increments of $1,000, and municipal bonds (tax-free) in increments of $5,000.
Before you buy a bond, determine how long you want to hold the bond, which tells you what maturity date you’re after; how safe the bond you want to own must be; and how much interest (yield) you need.
Short-term U.S. government bonds are the safest, but highly rated municipal bonds and corporate bonds can be almost as safe. To determine if the extra risk is warranted, compare the rates paid by the bonds you’re considering with the rates paid by treasury bills. Because Treasury bills are the safest investment, if other bonds aren’t paying much more, there may be little reason to take on the additional risk. If you’re not sure, comparison-shop. If a bond isn’t issued by the U.S. government, check the issuer’s financial position by its quality rating with Moody’s or Standard & Poors.
Can a bond issuer meet its bond and other debt obligations on time, in full? That’s the question that is analyzed closely by rating agencies such as Standard & Poors and Moody’s Investors Service. Before buying a bond, checking a bond’s rating should become a routine part of any purchase. Ask the broker or bank you’re buying from to see the rating. The consensus, especially for beginning investors, is to steer clear of anything not rated A or above by Standard & Poors or Moody’s.
Be sure to find out how low the bonds or underlying bond investments have dipped in terms of performance over the years. You can then gauge your own exposure, although if you hold a bond until maturity, the mountains and valleys of performance don’t matter.
If you’re buying a government bond or bond fund, you may also want to consider whether you want taxable or nontaxable investments. This decision depends on your tax bracket and your perspective regarding how much you plan to invest and earn over the years.
Before you buy a bond, determine how long you want to hold the bond, which tells you what maturity date you’re after; how safe the bond you want to own must be; and how much interest (yield) you need.
Short-term U.S. government bonds are the safest, but highly rated municipal bonds and corporate bonds can be almost as safe. To determine if the extra risk is warranted, compare the rates paid by the bonds you’re considering with the rates paid by treasury bills. Because Treasury bills are the safest investment, if other bonds aren’t paying much more, there may be little reason to take on the additional risk. If you’re not sure, comparison-shop. If a bond isn’t issued by the U.S. government, check the issuer’s financial position by its quality rating with Moody’s or Standard & Poors.
Can a bond issuer meet its bond and other debt obligations on time, in full? That’s the question that is analyzed closely by rating agencies such as Standard & Poors and Moody’s Investors Service. Before buying a bond, checking a bond’s rating should become a routine part of any purchase. Ask the broker or bank you’re buying from to see the rating. The consensus, especially for beginning investors, is to steer clear of anything not rated A or above by Standard & Poors or Moody’s.
Be sure to find out how low the bonds or underlying bond investments have dipped in terms of performance over the years. You can then gauge your own exposure, although if you hold a bond until maturity, the mountains and valleys of performance don’t matter.
If you’re buying a government bond or bond fund, you may also want to consider whether you want taxable or nontaxable investments. This decision depends on your tax bracket and your perspective regarding how much you plan to invest and earn over the years.
First Steps in Stock Investing
If you’re willing to roll up your sleeves and do the research necessary to invest in individual companies, a stock may be a good fit for your new portfolio. The key is to avoid excessive risk. The best way to minimize risk is to buy a solid company — one that is essentially a blue chip or a largercompany growth stock.
Look for a stock with consistent performance that appears to sustain and even increase over time. The Dow Jones Industrial Average is the index of blue chips, listing the likes of IBM, Kodak, McDonald’s, and Sears. These stocks tend to hedge investors’ first exposure to equity investing by paying dividends that offset any lackluster performance. You may also want to seek out a value stock — a stock that has been underperforming its peers, but that seems poised to turn things around. An index called “Dogs of the Dow,” which is compiled by Dow Jones and printed in The Wall Street Journal, lists specifically those stocks that are on the outs. Of course, none is guaranteed to become the next best stock to own.
You have to judge for yourself by looking at a company’s long-term growth and earnings; its price-to-earnings (P/E) ratio; and any company news that can give you insight into debt level, acquisitions on the horizon, and competitive edge of products, services, and management. (The P/E ratio is derived by dividing a stock’s share price by its earnings-per-share price. The result shows how much investors are willing to pay for each $1 of earnings)
Annual reports, which you can request from a company’s own investor relations department, can give you some of these details; but for the rest, you have to sift through analysts’ reports and check the charts that are available from firms such as Morningstar (www.morningstar.com) and Standard & Poors (www.stockinfo.standardpoor.com). These services can show you a stock’s ups and downs over the years and even over the past month.
Analysts’ reports can project a company’s earnings, dividends, and price growth over the next few months and years. Don’t forget to check on competitors, too. Because all performance data is relative, a company that may seem like a great catch may actually be inferior to its peers, but you won’t know that if you don’t check. For example, if you’re thinking about investing in McDonald’s, make sure that you check out the stocks for Wendy’s, too.
Look for a stock with consistent performance that appears to sustain and even increase over time. The Dow Jones Industrial Average is the index of blue chips, listing the likes of IBM, Kodak, McDonald’s, and Sears. These stocks tend to hedge investors’ first exposure to equity investing by paying dividends that offset any lackluster performance. You may also want to seek out a value stock — a stock that has been underperforming its peers, but that seems poised to turn things around. An index called “Dogs of the Dow,” which is compiled by Dow Jones and printed in The Wall Street Journal, lists specifically those stocks that are on the outs. Of course, none is guaranteed to become the next best stock to own.
You have to judge for yourself by looking at a company’s long-term growth and earnings; its price-to-earnings (P/E) ratio; and any company news that can give you insight into debt level, acquisitions on the horizon, and competitive edge of products, services, and management. (The P/E ratio is derived by dividing a stock’s share price by its earnings-per-share price. The result shows how much investors are willing to pay for each $1 of earnings)
Annual reports, which you can request from a company’s own investor relations department, can give you some of these details; but for the rest, you have to sift through analysts’ reports and check the charts that are available from firms such as Morningstar (www.morningstar.com) and Standard & Poors (www.stockinfo.standardpoor.com). These services can show you a stock’s ups and downs over the years and even over the past month.
Analysts’ reports can project a company’s earnings, dividends, and price growth over the next few months and years. Don’t forget to check on competitors, too. Because all performance data is relative, a company that may seem like a great catch may actually be inferior to its peers, but you won’t know that if you don’t check. For example, if you’re thinking about investing in McDonald’s, make sure that you check out the stocks for Wendy’s, too.
Sunday, February 24, 2008
The minimum fund investment
Do you think that you need a fortune to get started? You’re wrong. Many fund companies have a $250 minimum investment requirement. Others with $2,500 or $10,000 minimum investments waive those requirements if you’re willing to invest $50 or $100 each month or even each quarter. Individual Retirement Accounts are another way to steer around high minimum investment requirements because many mutual fund companies allow you to start an IRA with $1,000.
(A few companies accept $250 as a minimum, but that is becoming more rare.) Almost all mutual funds offer this service to investors in an attempt to capture assets that the funds hope to hold on to for years — until the investors retire. Make sure, however, that you really can use an IRA and aren’t just looking for a way into a fund. You can’t tap the money until you reach age 59 1⁄2 without paying income taxes and a 10% penalty. If you’re investing for retirement, fine. If you’re investing to pay for your child’s college tuition or a beach house and expect to require the funds well before age 59 1⁄2, find a fund that fits your needs.
(A few companies accept $250 as a minimum, but that is becoming more rare.) Almost all mutual funds offer this service to investors in an attempt to capture assets that the funds hope to hold on to for years — until the investors retire. Make sure, however, that you really can use an IRA and aren’t just looking for a way into a fund. You can’t tap the money until you reach age 59 1⁄2 without paying income taxes and a 10% penalty. If you’re investing for retirement, fine. If you’re investing to pay for your child’s college tuition or a beach house and expect to require the funds well before age 59 1⁄2, find a fund that fits your needs.
A large-company growth index fund
A manager of an index fund invests in companies whose stocks are listed in an index such as the Standard & Poors 500. The fund tracks the performance of the index. The S&P has been the index with the best performance in the past decade. If you want even more diversification, try a fund that invests, for example, in the Wilshire 5000, which tracks all of the stocks listed in the American Stock Exchange, the New York Stock Exchange, and Nasdaq.
Rather than trying to predict the direction of the market, the index funds are designed to match the performance of the index. These funds are considered to be unmanaged because they invest and hold the same stocks as in the index. Unfortunately, the fact that index funds match the performance of the index is the worst part, too, because in a bear market (when stock prices drop significantly), index funds have no place else to turn for investments but to the index. Remember, however, that index funds can offer the investor long-term, steady growth.
You can pick a small-company mutual fund, a medium-company mutual fund, a bond mutual fund, and an international mutual fund as you continue building your portfolio, but it’s a good idea to start with a fund that invests in large company stocks. Because, since the late 1920s, these types of stock have historical average annual returns of more than 11%, this type of fund can anchor the rest of your portfolio.
Rather than trying to predict the direction of the market, the index funds are designed to match the performance of the index. These funds are considered to be unmanaged because they invest and hold the same stocks as in the index. Unfortunately, the fact that index funds match the performance of the index is the worst part, too, because in a bear market (when stock prices drop significantly), index funds have no place else to turn for investments but to the index. Remember, however, that index funds can offer the investor long-term, steady growth.
You can pick a small-company mutual fund, a medium-company mutual fund, a bond mutual fund, and an international mutual fund as you continue building your portfolio, but it’s a good idea to start with a fund that invests in large company stocks. Because, since the late 1920s, these types of stock have historical average annual returns of more than 11%, this type of fund can anchor the rest of your portfolio.
Large U.S. growth funds
Large U.S. growth fund managers look for large and mid-size U.S. companies that are fairly stable performers, but have the potential to continue growing. Changes in society, such as the aging of the Baby Boom generation, may be one reason that some companies have good growth potential. For example, some managers like companies in health care, entertainment, travel, and financial services because they have the potential to benefit from the dollars of older, richer Boomers.
Thursday, February 21, 2008
Balanced funds
Although managers of balanced funds invest to earn respectable returns, they manage first and foremost to avoid sizeable losses. To do this, many invest in bonds. In some fund portfolios, bonds account for as much as 30% or more of the balanced fund’s holdings.
First Steps in Mutual Fund Investing
Mutual funds can be a great fit for a first-time investor. Because they’re managed by a professional, you don’t have to wrack your brain about what individual stock or bond to buy or when to buy it or sell it. At the same time, you get a fairly diversified portfolio in one fell swoop, which involves much less risk than if you invest in only one stock. If you’re uncomfortable with the kind of risk that stocks present, find a good mutual fund for your launch into investing.
Starting out with a mutual fund doesn’t represent the end of your quest; it’s the beginning. You can always select a handful of decent stocks down the road to add to your portfolio. With more than 8,000 mutual funds to choose from, the world may be your oyster, but you eventually have to make selections that suit you best. In the next three sections, I talk about three types of mutual funds that can be good first investments.
Make sure that you check out a Morningstar or Value Line report on each fund you’re considering; one-, three-, five- and ten-year performance track records can yield valuable information.
You want to see consistent returns over time and relatively low expenses (ideally 1% or less). If you read the report carefully, you can also get a sense of how a manager approaches his or her investments, and whether the style is more aggressive than you’re comfortable dealing with.
Also review the fund’s prospectus, which outlines the fund’s investment objectives and policies, expenses, and risks. Some better mutual fund companies are starting to graphically depict the worst quarter and year they’ve experienced, along with the best, so that you can quickly get an idea of how low and high the fund may go with your money.
Starting out with a mutual fund doesn’t represent the end of your quest; it’s the beginning. You can always select a handful of decent stocks down the road to add to your portfolio. With more than 8,000 mutual funds to choose from, the world may be your oyster, but you eventually have to make selections that suit you best. In the next three sections, I talk about three types of mutual funds that can be good first investments.
Make sure that you check out a Morningstar or Value Line report on each fund you’re considering; one-, three-, five- and ten-year performance track records can yield valuable information.
You want to see consistent returns over time and relatively low expenses (ideally 1% or less). If you read the report carefully, you can also get a sense of how a manager approaches his or her investments, and whether the style is more aggressive than you’re comfortable dealing with.
Also review the fund’s prospectus, which outlines the fund’s investment objectives and policies, expenses, and risks. Some better mutual fund companies are starting to graphically depict the worst quarter and year they’ve experienced, along with the best, so that you can quickly get an idea of how low and high the fund may go with your money.
Investing in a real estate investment trust (REIT)
If you don’t want to be a landlord, you might consider option number three: investing in real estate through a REIT (real estate investment trust). REITs are diversified real estate investment companies that purchase and manage rental real estate for investors. A typical REIT invests in different types of property, such as shopping centers, apartments, and other rental buildings. You can invest in REITs either through purchasing them directly on the major stock exchanges or through a real estate mutual fund that invests in numerous REITs.
Sunday, February 17, 2008
Buying an investment property
A second way to invest in real estate is to buy residential housing such as single family homes or multi-unit buildings, and rent them. In many ways, buying real estate in this way isn’t an investment, it’s a business.
Maintaining a property can easily turn into a part-time job. If you’re a person who dreams of putting heart and soul into a property, however, it may be worth investigating. If you do decide to take this route, first, be sure that you have sufficient time to devote to the project. Second, be careful not to sacrifice contributions to tax-deductible retirement accounts such as 401(k)s or IRAs in order to own investment real estate.
Deciding to become a real estate investor depends mostly on you and your situation. Is real estate something that you have an affinity for? Do you know a lot about houses, or have a knack for spotting up-and-coming areas? Are you cut out to handle the responsibilities that come with being a landlord? Do you have the time to manage your property? Another drawback to real estate investment is that you earn no tax benefits while you’re accumulating your down payment.
Retirement accounts such as 401(k)s and IRAs may give you an immediate tax deduction as you contribute money to them. If you haven’t exhausted your contributions to these accounts, consider doing so before taking a look at investment real estate.
Maintaining a property can easily turn into a part-time job. If you’re a person who dreams of putting heart and soul into a property, however, it may be worth investigating. If you do decide to take this route, first, be sure that you have sufficient time to devote to the project. Second, be careful not to sacrifice contributions to tax-deductible retirement accounts such as 401(k)s or IRAs in order to own investment real estate.
Deciding to become a real estate investor depends mostly on you and your situation. Is real estate something that you have an affinity for? Do you know a lot about houses, or have a knack for spotting up-and-coming areas? Are you cut out to handle the responsibilities that come with being a landlord? Do you have the time to manage your property? Another drawback to real estate investment is that you earn no tax benefits while you’re accumulating your down payment.
Retirement accounts such as 401(k)s and IRAs may give you an immediate tax deduction as you contribute money to them. If you haven’t exhausted your contributions to these accounts, consider doing so before taking a look at investment real estate.
Buying your own home
Most people invest in real estate by becoming homeowners. Part of the American dream is that the equity, which is the difference between the market value of your home and the loan owed on it, increases over time to produce a significant part of your net worth.
Unless you have the good fortune to live in a rent-controlled apartment, owning a home should be less expensive than renting a comparable home throughout your adult life. Why? As a renter, your housing costs will follow the level of inflation, while as a homeowner, the bulk of your housing costs are not exposed to inflation if you have a fixed-rate mortgage.
Owning your home can add to your sense of financial security as the economy fluctuates. In addition to the financial benefits, home ownership gives you more control over your own living space; for example, it allows you more freedom to decorate your home’s exterior and interior according to your own tastes.
Uncle Sam gives homeowners another major financial boost by making your mortgage interest and property tax costs deductible. Although you don’t get any tax benefit if you have to sell your home at a loss, any profit made when you sell your primary residence is tax-free up to $250,000 ($500,000 for a married couple) as long as you lived there for at least two of the five years prior to the sale.
Unless you have the good fortune to live in a rent-controlled apartment, owning a home should be less expensive than renting a comparable home throughout your adult life. Why? As a renter, your housing costs will follow the level of inflation, while as a homeowner, the bulk of your housing costs are not exposed to inflation if you have a fixed-rate mortgage.
Owning your home can add to your sense of financial security as the economy fluctuates. In addition to the financial benefits, home ownership gives you more control over your own living space; for example, it allows you more freedom to decorate your home’s exterior and interior according to your own tastes.
Uncle Sam gives homeowners another major financial boost by making your mortgage interest and property tax costs deductible. Although you don’t get any tax benefit if you have to sell your home at a loss, any profit made when you sell your primary residence is tax-free up to $250,000 ($500,000 for a married couple) as long as you lived there for at least two of the five years prior to the sale.
Tuesday, February 12, 2008
Investing in Real Estate
There are three ways that you can become a real estate investor: first, by buying your own home; second, by buying an investment property; and third, by investing in a real estate investment trust (REIT).
Although it’s true that over time, real estate owners and investors have enjoyed rates of return comparable to the stock market, real estate is not a simple way to get wealthy. Nor is it for the faint of heart or the passive investor. Real estate goes through good and bad performance periods, and most people who make money in real estate do so because they invest over many years.
Although it’s true that over time, real estate owners and investors have enjoyed rates of return comparable to the stock market, real estate is not a simple way to get wealthy. Nor is it for the faint of heart or the passive investor. Real estate goes through good and bad performance periods, and most people who make money in real estate do so because they invest over many years.
Identifying potential bond investments
Here’s a look at some items you need to evaluate before investing in a fund:
- Issuer stability: This is also known as credit quality, which assesses an issuer’s ability to pay back its debts, including the interest and principal it owes its bond holders, in full and on time. Although many corporations, the United States government, and a multitude of municipalities have never defaulted on a bond, you can expect that some issuers can and will be unable to repay.
- Maturity: A bond’s maturity refers to the specific future date when you can expect your principal to be repaid. Bond maturities can range from as short as one day all the up to 30 years. Make sure that the bond you select has a maturity date that works with your needs. T-Bills and zero coupon bonds pay interest at maturity. All other bonds pay interest every six months. Most investors buy bonds in order to have a steady flow of income (from interest).
The longer the maturity in a bond, the more risk associated with it — that is, the greater the fluctuation in bond value based upon changes in interest rates.
- Interest rate: Bonds pay interest that can be fixed-rate, floating, or payable at maturity. Most bond rates are fixed until maturity, and the amount is based on a percentage of the face or principal amount.
- Face value: This is the stated value of a bond. The bond is selling at a premium when the price is above its face value; pricing below its face value means that it’s selling at a discount.
- Price: The price you pay for a bond is based on an array of different factors, including current interest rates, supply and demand, and maturity.
- Current yield: This is the annual percentage rate of return earned on a bond. You can find a bond’s current yield by dividing the bond’s interest payment by its purchase price. For example, if you bought a bond at $900 and its interest rate is 8% (0.08), the current yield is 8.89% — 8% or 0.08 ÷ $900 = 8.89.
- Yield to maturity (YTM): This tells you the total return you can expect to receive if you hold a bond until it matures. Its calculation takes into account the bond’s face value, its current price, and the years left until the bond matures. The calculation is an elaborate one, but the broker you’re buying a bond from should be able to give you its YTM. The YTM also enables you to compare bonds with different maturities and yields. Don’t buy a bond on current yield alone. Ask the bank or brokerage firm from whom you’re buying the bond to provide a YTM figure so that you can have a clear idea about the bond’s real value to your portfolio.
- Tax status: The interest you earn on U.S. Treasury bills, notes, and bonds is exempt from local and state tax. Interest paid on municipal bonds is usually exempt from local (if you live in the municipality issuing the bond), state (if the municipality issuing the bond is in your state of residence), and federal tax, although you pay capital gains tax on any increase in the price of the bond. On corporate bonds, you pay both state and federal taxes, where applicable, for interest paid and capital gains taxes on any increase in price.
If you sell a corporate, treasury, or municipal bond for more than you paid for it, you’ll pay capital gains tax on the difference.
Recognizing different types of bonds
Bonds come in all shapes and sizes, and they enable you to choose one that meet your needs in terms of your investment time horizon, risk profile, and income needs. First, here is a look at the different types of U.S. government securities that are available:
- Treasury bills: T-Bills: T-Bills have a minimum purchase price of $10,000 and are offered in 3-month, 6-month, and 12-month maturities. T-Bills do not pay current interest, but instead are always sold at a discount price, which is lower than par value. The difference between the discount price and the par value received is considered interest. For example, if you pay the discount price of $9,500 for a $10,000 T-Bill, you pay 5% less than you actually get back when the bill matures. Par is considered to be $10,000.
- Treasury notes: Treasury notes have maturities of 2 to 10 years. The minimum investment is $1,000, but they are also issued in $5,000 and $10,000 amounts. Treasury notes have coupons that pay interest every six months.
- Treasury bonds:With maturities of up to 30 years, these are the long-term offerings from the Treasury Department; as such, these bonds typically pay the highest interest. The minimum investment is $1,000, but they are also issued in $5,000 and $10,000 amounts. Treasury bonds have coupons that pay interest every six months.
- Zero-coupon bonds: Zero-coupon bonds do not pay current interest. You buy the bond at a steep discount, and interest accrues (builds up) during the life of the bond. At maturity, the investor receives all the accrued interest plus his/her original investment. Zero-coupon bonds are taxed each year on the interest earned (even though it’s not actually paid out), unless it is a zero-coupon municipal bond (which would be free of federal and possibly state taxes.) Zero-coupon bonds are usually used in IRA accounts.
- Savings bonds: These have been the apple pie of American investing for years. They act like zero coupon bonds, but you can purchase them in small denominations from banks or the Treasury Department. For more zest, the agency began offering inflation-indexed bonds in 1998, which guarantee that your return will outpace inflation. The bond’s yield is actually based on the inflation rate plus a fixed rate of return, such as 3%. Interest on savings bonds is not taxed until the bond is cashed in. Financial experts generally see United States government bonds as the safest investment bet around. But remember that risk and reward are tradeoffs that you need to look at in tandem. As with all investments, the safer the investment, the less you’re likely to earn or lose!
The following are other types of available bonds:
- Municipal bonds: These are loans you make to a local government, whether it’s in your city, town, or state. Because most are free from local (if you live in the municipality issuing the bond), state (if the municipality issuing the bond is in your state of residence), and federal taxes, they can be valuable to those who seek tax relief —often folks in higher income tax brackets. Generally, these bonds have proven their worth as safe investments over the years (although there have been a few instances when municipalities proved unreliable); they pay a stated interest rate over the life of the bond. Some municipal bonds are insured, making them safe from default. Municipal bonds are generally available at minimums of $5,000.
- Corporate bonds: These are issued by companies that need to raise money, including public utilities and transportation companies, industrial corporations and manufacturers, and financial service companies. Minimum investment in corporate bonds is $1,000. Corporate bonds can be riskier than either U.S. government bonds or municipal bonds because companies can go bankrupt. So a company’s credit risk is an important tool for evaluating the safety of a corporate bond. Even if an organization doesn’t throw in the towel, its risk factor can be enough to cause agency analysts, such as Standard & Poors or Moody’s, to downgrade the company’s overall rating. If that happens, you may find it more difficult to sell the bond early.
- Junk bonds: Junk bonds pay high yields because the issuer may be in financial trouble, have a poor credit rating, and are likely to have a difficult time finding buyers for their issues. Although you may decide that junk bonds or junk bond mutual funds have a place in your portfolio, make sure that spot is small because these bonds carry high risk.
Although junk bonds may look particularly attractive at times, think twice before you buy. They don’t call them junk for nothing. You could potentially suffer a total loss if the issuer declares bankruptcy. As one wag suggested, if you really believe in the company so much, invest in its stock, which has unlimited upside potential.
Friday, February 8, 2008
Understanding how bonds work
You have a number of important variables to consider when you invest in bonds, including the stability of the issuer, the bond’s maturity or due date, interest rate, price, yield, tax status, and risk. As with any investment, ensuring that all these variables match up with your own investment goals is key to making the right choice for your money. Be sure to buy a bond with a maturity date that tracks with your financial plans. For instance, if you have a child’s college education to fund 15 years from now and you want to invest part of his or her college fund in bonds, you need to select vehicles that have maturities that match that need. If you have to sell a bond before its due date, you receive the prevailing market price, which may be more or less than the price you paid.
In general, because they often specify the yield you’ll be paid, bonds can’t make you a millionaire overnight like a stock can. What can you expect to earn? Long-term corporate bonds, for example, have paid anywhere from an average of 1% in the 1950s to 13% in the 1980s, when in general all bonds did well. What can you expect to lose?
In general, because they often specify the yield you’ll be paid, bonds can’t make you a millionaire overnight like a stock can. What can you expect to earn? Long-term corporate bonds, for example, have paid anywhere from an average of 1% in the 1950s to 13% in the 1980s, when in general all bonds did well. What can you expect to lose?
Learning about Bond Basics
A bond is basically an IOU. When you purchase a bond, you are lending money to a government, municipality, corporation, federal agency, or other entity. In return for the loan, the entity promises to pay you a specified rate of interest during the life of the bond and to repay the face value of the bond (the principal you invested) when it matures or comes due. The entity to whom you’re lending money when you buy a bond is called the issuer.
Bonds aren’t like stocks. You are not buying part ownership in a company or government when you purchase a bond. Instead, what you’re actually buying —or betting on —is the issuer’s ability to pay you back with interest.
Bonds aren’t like stocks. You are not buying part ownership in a company or government when you purchase a bond. Instead, what you’re actually buying —or betting on —is the issuer’s ability to pay you back with interest.
Identifying potential stock investments
What do you need to know to determine which stocks are potential investments? To get started, stick with stocks relating to your own interests or knowledge. If you frequent particular stores or restaurants and you use and like their products, find out if they are publicly held companies. Start identifying and watching these stocks. That advice doesn’t mean that you should buy their stock right away. You still have some homework to do.
The following list tells you what to look for when investigating potential stock investments. S&P’s Personal Wealth newsletter, which is available at most libraries (and online at www.personalwealth.com), along with the ValueLine newsletter (www.valueline.com) and any brokerage firm analyst report can provide you with much or all of the following pertinent facts and measures
The following list tells you what to look for when investigating potential stock investments. S&P’s Personal Wealth newsletter, which is available at most libraries (and online at www.personalwealth.com), along with the ValueLine newsletter (www.valueline.com) and any brokerage firm analyst report can provide you with much or all of the following pertinent facts and measures
- Find out if the industry is growing. Some industries aren’t. News stories on the industry in question can tell you the state of the industry and so can the company’s annual report. Company shareholder departments and the Securities and Exchange Commission (SEC), the Washington, D.C.-based regulator that oversees public companies, can provide you with copies of annual reports and the quarterly reports (called 10Qs) that companies must file. You can also find them on the Internet at www.freeedgar.com.
- Find primary competitors. Don’t look at a stock in isolation. A company that looks enticing by itself may look like a 100-pound weakling when you evaluate its strengths and weaknesses next to the leading competitors in the industry. Check out at least two competitors of any stock you’re evaluating.
- Check out annual earnings and sales. This is key in deciphering how quickly a company is growing over oneyear, three-year, and five-year time periods, and whether its earnings are keeping pace with sales. Look for growth rates of at least 10%.
- Look at the stock’s price-to-earnings (P/E) ratios. This is the primary means of evaluating a stock. The P/E ratio is derived by dividing a stock’s share price by its earningsper-share. The result tells you how much investors are willing to pay for each $1 of earnings. Those stocks that have faster earnings growth rates also tend to carry higher P/Es, which means that investors are willing to pay through the nose to own shares. The value of a P/E ratio, however, can be subjective. One investor may think that a particular company’s P/E ratio of 20 is high, while another may consider it low to moderate.
- Find out the price-to-book value (P/B) ratio. The P/B ratio is the stock’s share price divided by book value, or a firm’s assets minus its liabilities. This ratio is a good comparison tool and can tell you which companies are assetrich and which are carrying more debt. A low P/B ratio can be an indicator that a stock may be a good value investment.
- Check out the stock’s price-to-growth flow ratio. This ratio is the share price divided by growth flow (annual earnings plus research-and-development costs) per share. This is a useful measure for assessing fast-moving companies, especially in the technology sector, where management often puts profits back into product development.
- Look at the stock’s PEG ratio. The PEG ratio is a company’s P/E ratio divided by its expected earnings’ growth rate and is an indicator of well-priced stock. In a soaring stock market, like the one that dominated the 1990s, a PEG ratio below 1.5 suggests that a stock may be a good value. A PEG ratio above 2 can indicate that a stock may be overheated.
- Look ahead. Projections of five-year annual growth rates and five-year P/E ratios can tell you whether analysts believe that the companies you’re evaluating can continue to grow at their current rate, can beat it, or will start to fall behind. Make a list of the stocks you are interested in and watch their performance over time. Doing so gives you a feel for how the stocks respond to different types of economic and market news. You can also see which stocks’ prices move around and are more volatile.
Sunday, February 3, 2008
Recognizing different types of stock
Companies issue two basic kinds of stock, common and preferred, and each provides shareholders with different opportunities and rights:
- Common stock: Represents ownership in a company. Companies can pay what are called dividends to their shareholders. Dividends are paid out from a company’s earnings and can fluctuate with the company’s performance. Note: Not all companies pay dividends. Common stock offers no performance guarantees, and although this kind of stock has historically outperformed other types of investments, you can lose your entire investment if a company does poorly enough to wipe out its earnings and reputation into the foreseeable future. Common stock dividends are paid only after the preferred stock dividends are paid.
- Preferred stock: Constitutes ownership shares as well, but this stock differs from common stock in ways that reduce risk to investors, but also limit upside potential, or upward trends in stock pricing. Dividends on preferred stock are paid before common stock, so preferred stock may be a better bet for investors who rely on the income from these payments. But the dividend, which is set, is not increased when the company profits, and the price of preferred stock increases more slowly than that of common stock. Also, preferred stock investors stand a better chance of getting their money back if the company declares bankruptcy.
A company’s stock is also categorized depending on its perceived expected performance. Basically, a company’s stock falls into one of two categories: growth or value Over time, you’re likely to buy a mix of both types of stocks for your portfolio, so knowing the different characteristics of each is important. Understanding growth and value stocks can help you evaluate your options more carefully.
Growth companies are typically organizations with a positive outlook for expansion and, ultimately, stock prices that move upward. Investors looking for growth companies usually are willing to pay a higher price for stocks that have consistently produced higher profits because they’re betting the companies will continue to perform well in the future.
Because they use their money to invest in future growth, growth companies are less likely to pay dividends than other, more conservative companies; when they do pay dividends, the amounts tend to be lower. An investor who buys a growth stock believes that, according to analysis of the company’s history and statistics, the company is likely to continue to produce strong earnings and is therefore worth its higher price.
The stock of a growth company is, however, somewhat riskier because the price tends to react to negative company news and short-term changes in the market. Also, the company may not continue to produce earnings that are worth its higher price.
In contrast, value stocks are out of favor, left on the shelf by investors who are busy reaching for more expensive and trendier items. For that reason, you spend fewer dollars to buy a dollar of their profits than if you invest in a growth stock. When investors buy value stocks, they’re betting that they’re actually buying a turn-around-story — with a happy ending down the road.
Value companies carry risk, too, because they may never reach what investors believe is their true potential. Optimism doesn’t always pay off in profits.
Growth companies are typically organizations with a positive outlook for expansion and, ultimately, stock prices that move upward. Investors looking for growth companies usually are willing to pay a higher price for stocks that have consistently produced higher profits because they’re betting the companies will continue to perform well in the future.
Because they use their money to invest in future growth, growth companies are less likely to pay dividends than other, more conservative companies; when they do pay dividends, the amounts tend to be lower. An investor who buys a growth stock believes that, according to analysis of the company’s history and statistics, the company is likely to continue to produce strong earnings and is therefore worth its higher price.
The stock of a growth company is, however, somewhat riskier because the price tends to react to negative company news and short-term changes in the market. Also, the company may not continue to produce earnings that are worth its higher price.
In contrast, value stocks are out of favor, left on the shelf by investors who are busy reaching for more expensive and trendier items. For that reason, you spend fewer dollars to buy a dollar of their profits than if you invest in a growth stock. When investors buy value stocks, they’re betting that they’re actually buying a turn-around-story — with a happy ending down the road.
Value companies carry risk, too, because they may never reach what investors believe is their true potential. Optimism doesn’t always pay off in profits.
Understanding how stocks work
Companies issue stock to raise money to fund a variety of initiatives, including expansion, the development of new products, the acquisition of other companies, or to pay off debt. In an action called an initial public offering (IPO), a company opens sale of its stock to investors. An investment banker helps underwrite the public stock offering. By underwrite, I mean that the investment banker helps the company determine when to go public and what price the stock should be at that time.
When the stock begins selling, the price can rise or fall from its set price depending on whether investors believe that the stock was fairly and accurately priced. Often, the price of an IPO soars during the first few days of trading, but then can later fall back to earth.
After the IPO, stock prices will continue to fluctuate, based on what investors are willing to accept when they buy or sell the stock. In simple terms, stock prices are a matter of supply and demand. If everyone wants a stock, its price rises, sometimes sharply. If, on the other hand, investors are fearful that, for example, the company’s management is faltering and has taken on too much debt to sustain strong growth, they may begin selling in noticeable volume. Mass sales can drive the price down. In addition to specific company issues, the price can drop for other reasons, including bad news for the entire industry or a general downturn in the overall economy.
Stocks are bought and sold on stock exchanges, such as the New York Stock Exchange, Nasdaq, and the American Stock Exchange. Companies that don’t have the cash reserves necessary to be listed on one of the exchanges are traded overthe-counter, which means that they receive less scrutiny from analysts and large investors such as mutual fund managers.
In addition, professional analysts who are paid to watch companies and their stocks can give a thumbs-up or a thumbsdown to a stock, which in turn can send stock prices soaring or plummeting. These stock analysts sit in brokerage firms on New York’s fabled Wall Street and various cities’ Main Streets. The analyst’s job is to watch closely the actions of public companies and their managers and the results those actions produce.
By carefully monitoring news about a company’s earnings, corporate strategies, new products and services, and legal and regulatory problems and victories, analysts give stocks a buy, sell, or hold rating. Such opinions can have a wide-sweeping impact on the price of a stock, at least in the short-term. Rumblings, real or imagined, can send the price of a stock, or the stock market overall, tumbling downward or soaring skyward.
The price of stock goes up and down — a phenomenon known as volatility — but if the news creating the stir is short-term, panic is an overreaction. You don’t want to sell a stock when its price is down, only to see it make a miraculous recovery a few days, weeks, or even months down the road. Smart investors who have done their research and are invested for the longer-term won’t be impacted by short-term price dips or panics. Unless of course, you use the opportunity to buy a stock you’ve already researched and were going to buy anyway. The old adage — buy low, sell high — holds as true today as it did 75 years ago.
How low can stock prices go? In October 1987, stock prices tumbled by 22.6%. This decline meant that the value of a $10,000 investment dropped to $7,740. Many stocks recovered, but some did not.
You can lose all your money with a stock investment, and that risk is why you need to analyze your choices carefully.
The three most basic types of risks associated with stock investments are
When the stock begins selling, the price can rise or fall from its set price depending on whether investors believe that the stock was fairly and accurately priced. Often, the price of an IPO soars during the first few days of trading, but then can later fall back to earth.
After the IPO, stock prices will continue to fluctuate, based on what investors are willing to accept when they buy or sell the stock. In simple terms, stock prices are a matter of supply and demand. If everyone wants a stock, its price rises, sometimes sharply. If, on the other hand, investors are fearful that, for example, the company’s management is faltering and has taken on too much debt to sustain strong growth, they may begin selling in noticeable volume. Mass sales can drive the price down. In addition to specific company issues, the price can drop for other reasons, including bad news for the entire industry or a general downturn in the overall economy.
Stocks are bought and sold on stock exchanges, such as the New York Stock Exchange, Nasdaq, and the American Stock Exchange. Companies that don’t have the cash reserves necessary to be listed on one of the exchanges are traded overthe-counter, which means that they receive less scrutiny from analysts and large investors such as mutual fund managers.
In addition, professional analysts who are paid to watch companies and their stocks can give a thumbs-up or a thumbsdown to a stock, which in turn can send stock prices soaring or plummeting. These stock analysts sit in brokerage firms on New York’s fabled Wall Street and various cities’ Main Streets. The analyst’s job is to watch closely the actions of public companies and their managers and the results those actions produce.
By carefully monitoring news about a company’s earnings, corporate strategies, new products and services, and legal and regulatory problems and victories, analysts give stocks a buy, sell, or hold rating. Such opinions can have a wide-sweeping impact on the price of a stock, at least in the short-term. Rumblings, real or imagined, can send the price of a stock, or the stock market overall, tumbling downward or soaring skyward.
The price of stock goes up and down — a phenomenon known as volatility — but if the news creating the stir is short-term, panic is an overreaction. You don’t want to sell a stock when its price is down, only to see it make a miraculous recovery a few days, weeks, or even months down the road. Smart investors who have done their research and are invested for the longer-term won’t be impacted by short-term price dips or panics. Unless of course, you use the opportunity to buy a stock you’ve already researched and were going to buy anyway. The old adage — buy low, sell high — holds as true today as it did 75 years ago.
How low can stock prices go? In October 1987, stock prices tumbled by 22.6%. This decline meant that the value of a $10,000 investment dropped to $7,740. Many stocks recovered, but some did not.
You can lose all your money with a stock investment, and that risk is why you need to analyze your choices carefully.
The three most basic types of risks associated with stock investments are
- You may lose money.
- Your stocks may not perform as well as other, similar stocks.
- A loss may threaten your financial goals.
Stock investing carries certain risks, but they can be minimized by careful investment selection and by diversification, a technique for building a balanced portfolio.
Sizing Up Stocks
A stock is a piece of paper that signifies that you own part of a company. The market price of a stock is directly related to the profits and the losses of the company. In other words, when the company profits, the worth of your stock increases. When the company falters and its profits decline, so does the worth of your stock.
Investors who buy stock own shares of the company. That’s why they’re called shareholders.
Investors who buy stock own shares of the company. That’s why they’re called shareholders.
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