Great Savings 14: Save On Investing

 

Figuring out the world of investing can look complicated. Take these simple steps.

Investing is tricky business. Some would tell you successful investing is as much about luck and gambling as it is about finding value in a product or company. Others would say stock and bond prices are as much a reflection of a government’s fiscal priorities, some news event or fickle investor sentiment as any underlying worth. So how can you be money smart when it comes to investing? Think long-term.

 

It’s important to understand there are different kinds of investors. Some people trade stocks and other investments daily, weekly or monthly. These folks believe they have a handle on a market or market segment’s direction and can therefore make more money buying or selling frequently. In essence, they are trying to “time” the market to make the most money. Guess what? Brokerages love traders like these because they earn far more commissions from them. In fact, if you read financial pages these days, you’ll find more and more talk about long-term trading being dead. Think about that carefully. The more you trade the more the brokerages make money so of course they’d want you to believe long-term trading is fiscally unsound.

 

Great Savings Tip #14 From Javabird.com: Save on investing.Long term traders buy and hold onto investments believing there is real value to be had by taking a long view. Think of a company like Apple or Microsoft. If you bought the stock of either in their early days and hung onto it over the years you’d have made a fortune from the stock appreciation in spite of big gyrations in the stock market. Does this prove long-term trading is always superior to short-term trading? Unfortunately, it’s more complicated than that. What’s often just as important is when you buy into an investment and when you sell it.

 

For example, if you buy into a stock when the price is low, you could do very well when it comes time to sell it. On the other hand, if you buy into it when the price is high you could easily lose a substantial portion of your investment if the price has gone down. This presents a couple problems for an investor: (1) How do you know when to buy and sell? (2) What’s the best way to buy in?

 

 

Unless you’re a whiz at math and have invented a bulletproof secret investment formula, or unless you happen to luck onto the hottest market advisory service of the month, deciding when and how to buy or sell a stock or fund can feel extremely difficult. Most of us just aren’t equipped to make the best investment decisions because there’s a lot to learn and know. And unless you want to take the time to dive into the world of investing trying to pick the right stocks or bonds is next to impossible. So what should you do? Think long-term and consider these steps:

 

(1) Develop nerves of steel. Though we wish it weren’t true, most investors are driven by fear. If they see the market taking a nose dive it’s only naturally to want to pull out of an investment. Unfortunately, markets rarely go straight up or down and neither do investments. That means the minute you sell your stock as the market falls don’t be surprised to discover it rising to a new higher price the next day. Hanging in there can seem counter-intuitive, so be prepared to steel your nerves as you go to invest. Meanwhile, you can protect yourself from large losses by placing a “stop order” on an investment. A stop order is a predetermined price level which will trigger a sale. Automatic online stops are easy to set for stocks and exchange traded funds (ETF) but you’ll need your broker’s assistance if you want to set a stop on a mutual fund. One warning: Don’t set a stop price too close to market price or you’ll find you’ll “stop out” of your investment prematurely.

 

(2) Avoid excess trading. As mentioned above, brokers love it when you trade in and out of stocks. To see why this is true consider an example: Suppose you make 100 trades over the course of a year at $7 a pop (the price your broker charges). That’s $700 a year. Now, multiple that by 30 years of active investing and you get 30 x $700 = $21,000. If your broker has 100,000 traders just like you he made $2,100,000,000 over the same time—that’s 2.1 billion in case you missed it! Plus, chances are many of the trades you made were poorly timed so not only do you lose on all the extra commission, but you lose on every trade that went the wrong way.

 

(3) Only invest money you can afford to lose. Investment implies risk and generally the higher the return you expect the more risk it entails. For this reason, if you only have a few dollars in an emergency savings fund beef that up to at least 6 months of your salary before putting money aside for investing. Or if you have no savings and are heavily in debt, by all means pay off the debt first and then build up your savings. All those interest charges you’re paying on debt take a huge toll and are detrimental to building long-term wealth. Put your finances in order before investing. Then start investing by seeking “conservative” funds that have a proven long-term track record of consistent returns.

 

(4) If you’re just getting started investing, stick to well-diversified “indexed” mutual or exchange-traded funds. These funds are comprised of groups of stocks, bonds or other investments and follow a market index like the S&P 500, the Dow or some special segment of the market like real estate or energy, etc. Diversification in funds like these works in the favor of long-term investors as there’s less guessing whether a particular stock or other investment is at a low or high point as you go to buy or sell it. By owning more stocks or other investments in a fund like this you spread your risk around.

 

(5) Buy into your funds by dollar cost averaging. What do we mean? Say you have $5000 to invest. Instead of plopping the whole amount down on day one and buying x shares of SPY (an exchange traded fund that follows the S&P 500 index), average into the shares by splitting your investment into equal chunks and buying a chunk each month. Thus, if I split the $5000 investment into 5 equal parts I could buy $1000 worth of shares on say the 15th of the month over the next 5 quarters. This strategy usually works to even out temporary price fluctuations in an investment, but it is meant to be used when investing over the long term. (For more on this topic see: InvestorGuide.com )

 

Compare 3, 5 and 10 year returns.

Make sure you spend the time to compare investments. You can save big by picking the right funds.

 

(6) Pay attention to the management fees. Go to a site like Yahoo or Google finance and look up the fund you plan to invest in. You’ll find a tab or column on the page which shows the management and other fees for the fund. Typically, indexed funds like those described above have much cheaper fees than those where the manager picks and chooses the investments. This makes sense if you stop to think about it. Also, ETF’s generally seem to have lower management fees than mutual funds. You’ll want to check into specific funds to see the differences. Note: Just because one fund charges a little more doesn’t make it a bad fund if the fund has a long-term record of success. However, consistent 3, 5 and 10 year returns for funds are rarer than you might imagine. Bottom line: Do your research and a little math. If you end up paying .75% for an index fund versus 1.50% for an actively managed, the actively managed fund should be generating at least (1.50% – .75% =) .75% more profit each year to come out even. Even a small difference like this can really add up over time.

 

(7) Stick to no-load mutual funds. If you buy mutual funds, stick to funds that don’t charge an upfront “load” to get in. A fee like this which can range up to 5% or more puts your investment in the hole as you’re starting out. It’s rare that strategy pays. When searching for funds available at your broker find the option which limits the search to no-load funds. That should weed the others out.

 

(8) Find a good discount brokerage—one that offers window trades. These days there are lots of choices for online brokers, but do a little comparison shopping before locking in. Some charge more than others for trading and some offer special “window” trades one or two times a day. Window trades are great as they cut the normal trade fee to fractions of a penny by combining your purchases with the purchases of other traders using the brokers services. Buying in a window trade can therefore turn that $4 to $8 dollar or more per trade commission into a freebie. It’s hard to beat that. One example of a brokerage that does window trading is Folio Investments.

 

Think First

 

Investing is risky business. Never invest without doing your homework first. If you’re unsure what to do, find people who understand the markets and can offer their assistance. Remember, when they say past performance is not an indicator for future results they mean it! For more on the topic of investing try reading our posts: “The Lazy Investor” and “12 Strategies For Successful Investing” or check out our “Investing Ideas” page.

 

Action Item: Find a well-diversified index exchange traded fund and a similar mutual fund. Now, compare them for the top ten holdings, the 3, 5 and 10 year return and the management fees. Also compare the management style and other important differences as laid out in the fund’s overview. Which one is better? Do you have enough information to make a decision? Keep digging until you do.

 

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