What to know before investing in the stock market, the basics that are important.
https://www.nerdwallet.com/article/investing/diversification By Tiffany Lam-Balfour, James Royal, Ph.D., Elizabeth Ayoola
Hello, I'm your host, Mr. Chuck, I retired accountant turn truck driver, I reduce my debt in a relatively short period of time, debt reduction to achieve financial freedom takes commitment, confidence determination. investing in the stock market, what do you need to know before you start investing in the stock market? I've classified two areas you should know a little bit about, and that's asset classes and diversification. Those are the two important things you should understand before you start investing in the stock market, but even before that, do you have an emergency fund set up that's well funded, well funded, meaning more than $500, may be more than $1,500, you need to have an emergency fund to cover all your emergencies, before you start investing in the stock market. Also, you should have a savings account, a high yield s avings account with significant amount of money, maybe $15,000 to$ 20,000, 6 months to a year's worth of your income or expenses, whichever would be greater. Once you have achieved those goals, then you can consider investing in the stock market. But let me back up here a little bit. If you have more than $250,000, in one bank, you're in trouble, you haven't diversified. Why $250,000 if you have more than $250,000 in one bank, or you're approaching $250,000, you need to spread that money into another bank. Why? Because the Federal Insurance depository corporation or whatever it's called, only ensures the first $250,000 if that bank would fail. So by diversify into more than one bank, you are less likely to lose any money. Now you may not get your money instantly, but you'll eventually get that $250,000. So if you have let's say an example $500,000 in one bank, and that bank fails, not likely, but it's also possible, you'll get your $250,000, maybe in six months to a year, but that remaining amount that you have in there, you may never see or you may only get $10,000 of it, depending on what happened to that bank. So by diversifying into more than one bank, and I'm assuming these are all in some type of high yield account, or maybe a certificate of deposit of five years or three years. So you can get a higher rate of interest. That's you know, the goal and your investment is to try to get the largest return possible with the least amount of risk. So if you got money in your emergency fund, say buy a new car, if you have to, you got money in a savings account, at least $100,000 or $50,000 r whatever, then you may be rea y to start investing in the sto k market. If you have a 401k or n a retirement account throu h work, you already are investi g in the stock market. We' e talking about additional mon y that you have saved over tim , that's getting a lower ra e yield, say like 1% interest. A d you can take that money and p t it in the stock market a d invest it and have a yield f say 6%. This varies year o year. There's no guarantee n future return based on pa t results. Also, if you're putti g in more than $25,000 you shou d be talking to a financi l advisor. Somebody who knows wh t they are doing and can set up a plan for you to make investmen s based on your risk and ri k tolerances for the future. f you don't want to take ris , then you need to leave it in t e local bank, maybe yo r certificate of deposit. But wi h higher risk comes larg r returns. So what do you need o know? Before you start putti g money into the market, I'm ju t gonna use market because it c n be bought anything. Well, the e are different asset classes. A d what is an asset class is a group of similar investme t vehicles, different classes r types of investment assets, su h as fixed, fixed inco e investments are grouped togeth r based on having a simil r financial structure. They a e typically traded in the sa e financial markets, and subje t to the same rules a d regulations. There are fi e major classes, there's on y three of them that you would e investing in, you already ha e one, if you have money in t e bank, that's cash or ca h equivalents. Now that can al o include money market fund , Certificate of deposits, ca h deposits, and your savin s account. That's cash or ca h equivalents. The prima y advantage of that is they a e liquid, you can get to yo r money easily and at a y particular time. There's o restrictions, before you ev n put money in the stock marke , you should already be in tha . The another asset class is re l estate or tangible assets. f you own your own home, y u already have an investment n real estate. Don't forget th t your home that you're living i , is also in investment. That s why you need to maintain th t home to keep the value of it u . So if you ever want to sell th t home, you can get the mo t highest market value from th t asset and get a relatively go d return, you should have tho e two things in place before y u are in the market. Unless y u graduate from college, you ha e student loan debt, you're buyi g things, and maybe you're renti g an apartment because you don t have the money yet, or you li e in the area where housing s really expensive. So it may e cheaper to rent, that's oka . And your employer may e offering a 401k. So maybe y u are in the market. And you' e putting 3% or 5% of your inco e in there every pay period, a d your employer is matchin he should only be put in the maximum amount that the employer is matching. For now, we're talking about additional investments that you're going to be making down, you know, in the future, or maybe you're already there, which are not in your retirement account. These are investments you're holding out that are gonna be taxable every year, based on the dividends they paid you or if you sell them the gain or loss that happened. So we're talking about stocks or equities, stocks are investments in one company. Stocks are also most likely referred to as equities. Because when you invest in that company by buying or stocks, your are a it's an equity portion of that corporation or that company, your own part ownership of that company. So that's why they were included as equities, their shares of ownership in a publicly traded company. They're traded on the stock exchange says the New York Stock Exchange or NASDAQ, you can potentially profit from equities, either through the rise in the share price or by receiving dividends. The asset class of ecorise is often sub divided by market capitalization. What is market capitalism? capitalization. What that is, is the share price of the stock times the number of stocks outstanding. So it's a cap, it's a computation, he take the price of the stock times the number of outstanding shares, and you come up with a number, if it's 300 million to $2 billion, that's consider small cap. If it's over 2 billion to 10 billion, that's consider mid cap. Any company that's worth that that computation comes up more than 10 billion, then it's consider large cap. That is the classification. Within the equity sector. There's other classification within the equity sector that we're going to talk about in a little bit. The other class is bonds or other fixed income investments. Fixed Income investments are investments and debt securities that pay a rate of return in the form of interest. Such investments are generally considered less risky than investing in equities or other asset classes. So they would be bonds, a corporation would sell bonds, you buy a $5,000 bonds at 3% interest. If you buy that, if you pay less than $5,000, for it, you're buyi g it at a discount. So if you b y if you pay $4000, for it, y ur rate of return is going to be higher than if you pay $5,00 . If you pay $6,000, for it, you're paying a premium. So yo r rate of return is gonna be le s than the stated rate of m ntors, whatever it was, I said, think 3%. So it's less risky, ecause these bonds are grad d by a third junk bond or pre ium or whatever. They're graded by the company that are is ued on issuing these bonds o fixed income investments. So that's for the other one, or fut res or other derivatives. Its utures contract spot and orward foreign exchange opti ns and expanding array of fi ancial derivatives, derivat ves or financial instruments ar based on or derived from an und rlying asset. For example stock options are a deriva ive of stocks. I don't recomme d that you diversify nd buy derivatives or futures. Unless you really are, know what you'r is the most riskiest thing you can do. You can make a lot of money and you can lose a lot of money. If you don't know what you're doing, stay away and don't buy anything you don't understand. When I mean that, if you don't understand how it works, or how you're going to make money, or how you're going to get rid of it. It's a good thing not to buy. And this, I'm not telling you anything about what type of stock to buy or which company to invest in. So now we're going to break down the stock and equities. He can either buy the stock in a single company or you can buy mutual funds. Or why would you want to buy a mutual fund and electronically Traded Funds are another type of mutual funds. Let's start with mutual funds. a mutual fund and its description will tell you where they're investing the money. It may be a mutual fund that's investing only in large cap stock. That means we're only gonna buy stock of companies that have more than $10 million valuation for the market capitalization. Another mutual fund may only buy company stock that are mid cap. Between 10 million and 300 million. Nope. Sorry. Between more than 10 billion to 300 billion, I forgot the break off would be mid caps, and they're only gonna buy stock in companies in that range. And so why is it good the buy a mutual fund, because instead of buying stock in one company, which poses the greatest risk, they're buying stock in multiple companies, and spreading the risk out in that asset class that they're investing in. So there may be 40, or 50 different companies within that asset class, and they're spent spreading the money out, one company could fail, but they might only own 1% of it, another company could do really good, but maybe they only own one version of it. So the highs and lows, or the lows are offset by the highs. So you're generally in a better position for not losing a whole lot of money. I would have said not losing any money. But that would be a myth. And you always gotta be aware, there's risk when you're investing in the stock market. Some people equate investing in the stock market the same as going to a casino. The biggest difference is, you put your money in the stock market, it can go up or down, but he can take your money back whenever you want. When you go to the casino, you put your money on the table. And then unless you pick it up before the game starts, you can't get it back. You they're gonna win or lose. And it's quick. And there's no decision making. I don't know. But it's not like corn to the casino. bonds, you do the same thing. electronic transfer funds are a mutual fund, that's only you can only buy it or sell it through electronic means means you had to buy it through the computer. We're a regular mutual fund, you can buy it through a stockbroker, or your financial advisor, or yourself. And you can call them up and say I want to buy X number of shares of this mutual fund and transfer the money to them. And four or five days later you get it. We're electronic Traded Funds are only done electronically. So you put your order in to buy through the computer, which is probably what everybody's doing anyway, there's generally less people involved in electronic trading funds, so their fees are a lot less. So your return potentially could be greater. So let's move on now that we talked about classes, the next topic is gonna be diversification. Okay, diversification, we're only going to talk about within the stock market within stocks, bonds, or cash is your already be diversified in your cash. So we're only going to look at stocks and bonds. So for stocks, I already talked about investing in mutual funds, because if you buy a mutual fund, you're buying stocks and various different companies. And you can do it by class, or the type of class it is, or sector would be another word. Some sectors if the economic cycle is going good, and it's strong, there's low unemployment, and there's lots of people buying stuff, then they do really good such as automobiles housing, says clothing, but I don't agree with that. I think people buy clothes no matter what. But you know, your larger ticket items genuinely sell more when the economy is doing better, because there's more people making more money. When the economy goes down, and there's higher rates of unemployment. Maybe you're not getting pay raises, then consumer goods or staples are going to do good, which would be grocery utilities, health care, necessities that you have to buy, no matter what economy is doing. So that's a diversified keishon within stocks. Another thing is size or market capitalization which we already talked about. small cap, mid cap, large cap, large cap companies tend to be more stable and can weather economic downturns more easily. But they also have a tendency to less growth potential than their smaller counterparts. By because they're already pretty large. A small counterpart is is maybe getting started maybe only been in business 10 years. Maybe they just found their product where they can make a lot of profit, maybe they're developing new products. So there's more potential for growth, we're also more potential for risk. For bonds, it depends on who's issuing the bond, integrated bonds from various ethnic issues such as Treasury, US government bonds, mutual bonds, corporate and more. So who is issuing the bond is what you should consider for your diversification with bonds, you should have some initial bonds, you should have some treasury bonds, you should have some corporate bonds, you need to mix it up credit quality combined bonds with various credit risk bonds that offer levels of credit worthiness or safety with corresponds with the bonds level of return. For instance, treasuries are considered potentially risk free, since it's unlikely the federal government will go bankrupt, which explains to a relatively lower rate of return, we're a struggling Corporation may be having a higher rate of return on their bonds, but there's a higher rate of risk. And then you have maturity, you need the blend short, intermediate and long term bonds, long term bonds receive higher returns because they're subject to more interest rate risk. Let's think about that for a moment. Right now, the interest rates are so low, that they most likely are not going to go much lower if all but we're gonna go up, he don't want to be buying a 30 year bond now, because you'd be tying their money up. And if you tried to sell that bond, five years, 10 years from now, a 2% rate of interest is not going to sell for much when the current rate is 8%. That's this an example I'm not making any predictions, right now, you probably should stick with a short and intermediate rate. Bonds short may mean two years or less, intermediate seven years or less. Why? Because most likely, the rate of interest is gonna go up as only way it's got the only place it can go. If it goes down and goes negative. That means that you wouldn't have to pay the issue money. So if it's a negative 1%, and you own that bond, why would you buy it? Because you'd have to pay a 1% interest to the issuer? Why would you do that? I wouldn't ever who would buy them, I don't know who knows this an example. And then diversification for stocks and bonds, geographically incorporate stocks and bonds from around the world countries have very economic cycles. So that makes sense to expose to both domestic and international bonds. International or foreign markets are further classify as developed markets in emerging markets, developed markets, European nation, Australia, Japan, Singapore, etc. tend to be more stable, whereas emerging markets Brazil, Russia, India and China tend to be more volatile, with higher growth potentials. And my question is why Russia and China are consider emerging markets, especially China. I don't know what makes that up. That's another form of diversification by geographic perhaps using one buying US stocks. Let's find them buy companies are located around the country. Say some on the east coast. I'm on the west coast, some in the middle, some in the north, some in the south, I'm talking about is their headquarters. active versus passive allocate both actively and passively managed accounts managed securities can be purchased through mutual funds, and funds or exchange traded, which we talked about and active funds a portfolio manager picks which stocks to include in the fund. This differs from passive index funds or ETF ETFs which mimic an underlying index and cost less. Passive funds often can outperform active funds. During market up swings, but active funds can be better downside, protected during market downturns. So what that saying is you should put some of your money in some index funds, and you should put some in your money and actively managed funds. We're talking about mutual funds, index funds or exchange traded. I'm not a big fan of index funds. And I'm not going to go into why. I'll be back in one moment was my final thoughts. If you listen to this podcast reduce that increased wealth on an Apple device. Scroll through all the episodes towards the bottom. And you can select write a review, and leave your comments. And you can rate this podcast. I appreciate all feedback. And I thank you for your time and doing so. If you're new to investing, before putting money in the stock market, you need to do your homework. Do some research and learn on the basics of the stock market. Before you get started. it's advisable you do the same. Even if you're going to use a financial planner, you need to know if the financial planner is working to your best interest. a financial planner you should be using is a fiduciary. He's always investing your money in your risk tolerance. For your best entrance. Don't rely on stockbrokers because they're only out to make a commission. I have nothing against stockbrokers. But you need to know the basics. What are asset classes? What is diversification? What are you willing to risk? What extreme risk are you willing to take? Or how conservative investments? Is your portfolio gonna be 90% stocks and percent bonds? Or would it be 60% stocks and 40% bonds, whatever the makeup is, it's got to be diversified and you should understand what your stockbroker or financial planner is doing before they do it.