The following is a guest post from Tony at Trading Slugger about how to get started in investing. If you would like to guest post on Disease Called Debt, please get in touch for my guidelines! Take it away Tony…
Doing something the first time can be hard. Investing may seem like a foreign world at first with all the P/E ratios, earnings-per-share and other terminology that investors need to understand. But the basics behind long term investing are actually really simple – you just need to know where you can place your hard earned money. In this post, I’m going to go over a couple of simple ways that you can invest for your first time.
Invest in Dividend Stocks
Dividend investing is really popular among people who have 9 to 5 jobs and don’t have a lot of time on their hands to focus on selecting stocks. In the world of investing there are two kinds of investment profits:
- Dividend gains. Dividends are a distribution of a portion of a company’s earnings to shareholders. For example, let’s say Company X made $3 billion last year. Company X declares a dividend worth $500 million, allocating that $500 million among its shareholders (investors who own Company X stock).
- Stock price appreciation. This is the route that most traders like myself and some investors prefer. We make money off the changes in an asset’s price. If Stock X goes from $40 to $50 and I happened to own Stock X, then I just made $10 on each share I own of Stock X.
Stock price appreciation is what active investors and traders focus on. As a trader, I don’t really care about dividends. A company that pays “large dividends” may only pay 5% a year. So if a stock is worth $100, a shareholder will at most receive $5 as dividends from that stock. In comparison, a 10% fluctuation in a stock’s price is just a month’s work. Last year the S&P gained 29%, so stock price appreciation gains dwarfed any gains that dividend investors received. For experienced traders, it’s much more profitable to focus on stock picking than buying and holding stocks that pay “large” dividends.
Dividend investing is used by investors who want a consistent cashflow. That is why many mom and pop investors prefer dividend investing. They don’t need to worry about timing the market: all they have to do is buy the stock and collect annual or quarterly dividends. This is known as passive investing.
I have one piece of advice if you do intend on investing in dividend stocks. Make sure that your dividend stock’s price does not fluctuate a lot. Buy stable, well established companies such as AT&T and Wal-Mart. Do not invest in fast growing high tech stocks just for their dividends. Why? Because if you time the market wrong (i.e. the market price goes down), the loss on your stock price will vastly exceed any profits you make from dividends. The stock price for well established companies tends to fluctuate less than the stock price for fast growing companies. Some moon-shot stocks shoot from $30 to $60 and then back down to $10. In addition, be aware that companies sometimes skip a dividend (don’t pay their dividends) during economic crises, which was common in 2008 and 2009.
AT&T is a favorite among dividend investors. (Disclaimer: I’m in no way affiliated with AT&T). It pays 5% worth of dividends each year and has never missed a dividend payment in 28 years. I don’t own any AT&T as a trader, but I know that a lot of investors buy AT&T for the dividends.
Buying the Index
Stock picking for the sake of stock price appreciation is hard. There are a lot of things that you and I (as business outsiders) don’t know about the company, such as what products it has in the works, how strong the management team is, and what real future growth prospects are (not just the overly optimistic numbers that executives tout in their quarterly earnings reports).
As such, a lot of investors prefer to invest in the “index”. The index, for those of you who don’t know, is a weighted average of many, many stocks. In essence, the index seeks to represent the entire U.S. stock market (or Canadian stock market, or British stock market, etc). Investing in indexes is a lot easier than stock picking because all you have to do is predict the future direction of the overall U.S. stock market. There are many different U.S. stock market indexes, and the two most widely quoted ones are the Dow Jones Industrial Average (30 largest U.S. stocks) and the S&P 500 (500 largest U.S. stocks).
At the moment, I do not recommend you invest in a U.S. stock market index. Regardless of how you look at things, the U.S. stock market is insanely overvalued right now. For example, the S&P 500 is 35% above its 2007 high. Is the U.S. economy better today than it was during the go-go years of 2005 to 2007? Of course not! There is a huge disconnect between fundamentals (how the U.S. economy is really doing) and the U.S. stock market right now. As a result, stocks are simple too overvalued as a whole.
Invest in Commodities
Let me ask you a question. Is your grocery bill going up? Do you feel like the prices of fruits and meats are much higher than they were 2 years ago? Well you’re not alone. Although the “official” government inflation numbers do not show it, raw material (agricultural, oil, etc) prices are on the rise.
You do not have to be on the brunt end of this rise in commodity prices. You don’t have to buy stocks. You can actually invest in commodities! You can invest in agricultural goods, oil, natural gas, gold, silver, etc. How?
You can buy commodities ETF’s. An ETF company buys the commodity for you and stores it. That way you don’t physically need to buy barrels of oil and store them in your garage if you want to invest in oil. The ETF company then sells “stocks” in itself, so basically you own a piece of all the commodities that the ETF company owns. If an ETF company owns 1 million barrels of oil, distributes 100,000 shares in itself and you bought 10 shares, you basically just bought 100 barrels of oil. You will profit when the price of oil rises and lose money when the price of oil falls.
Invest in Bonds
Investors who can’t stomach risk tend to buy bonds, which are relatively risk-free. Bonds are known as “fixed income” assets. In other words, your investment return is guaranteed (as long as the bond issuer does not default on the bond). Bond investors profit via the bond’s interest rate.
Investing in bonds is not attractive at all right now. U.S. interest rates are approaching 2 year lows and European interest rates are approaching historic lows, which means that over the long term, interest rates can only go up around the world. Just look at this chart for the 10 year U.S. government bond interest rate.
With bond interest rates so low, interest rates have only one way to go over the next few years: up.
Author Bio: Thank you for reading! I’m Tony and I blog at Trading Slugger. Feel free to check out my blog at Trading Slugger.
*Image courtesy of Flickr