10 Steps to make your First Investments in Financial Markets
People who are guaranteeing you astronomical return are only crooks. Bernard Madoff one of the biggest Ponzi scheme was successful over the years because he was supposed to provide investors with more than 10% performance each year during 20 years and without risk!
1) Evaluate your profile
First of all you should determine your own investor profile. This is generally the first step when you meet your investment advisor for the first time.
Are you a young student with a promising career or are you retired with a small pension benefit?
Are you willing to bet all your savings?
Three factors are important in determining your risk profile:
The longer the time horizon, better are the chance you will be able to recover from potential losses.
»Aversion to risk
Some people can stand the risk of losing maybe 50% of their savings, if you cannot bear it, choose safe investments.
If you are anticipating a grow in future earning, you can risk more money now.
2) Choose a broker
The second step is to choose a broker. The best way is to choose an online broker. Why? Because they are cheaper and you will avoid listening to your banker telling you to invest in a particular product just because he wants you to buy specific banking products.
When electing a broker online, you should check the following points:
» Efficiency of execution.
» Cost: transaction fees (fees taken for every transaction) custody fees (fees to be paid each year even if you are not trading).
» Other: functionality, does it provide free research, education. Are you going to trade frequently or not?
3) What kind of investments?
Let’s face it, unless you have at least 20,000 USD to invest in financial market, you should only invest with Mutual funds and/or ETF.
Let’s review the major investment vehicles
» Mutual Funds
In a mutual fund, investors are pooling money. The fund is a legal entity guaranteeing the proper management to investors. The management of the money is delegated to a fund manager.
» Where to find mutual funds?
You can find mutual fund classification on Morningstar website.
» How to select your mutual funds?
A) Cost control
Avoid funds with front load and back load. A front load is a fee you pay with your initial investment. A back load happens when you are redeeming your shares. Check the expense ratio. Usually domestic equity funds are around 1.4 %, fixed income fund, 1.1% and international funds are more expensive with an expense ratio at 1.9%
You should look at the size of the fund, avoid funds under 20 millions USD. Have also a look of the past performance. Even if past performance doesn’t guarantee any future performance, it will help you to select a well-managed fund.
» Exchange Traded Funds
An ETF is an index fund that trade like stocks. Generally an ETF is less expensive and more tax efficient than a mutual fund.
» Where to find ETF (exchange traded fund)?
The major companies proposing ETF are Ishares and Proshares.
» How to select your mutual funds?
A) Cost control
-You should look at the expense ratio; usually it is around 0.5% per year. So if you invest 1,000 USD you will have to pay 5 USD. Like for every traded investment, you should look at the Bid/ask spread. The spread should be small. -Check also the commission taken by your broker each time you are selling or buying ETFs.
Have a look at this historic of the ETF. The fund should be at least 20 millions. The historical performance of the EF and the index it is aiming to track should be close. A very important thing is that the trading price should be very close to the NAV (Net asset Value), NAV is the real value of the portfolio.
A stock is an ownership in a corporation and represents a claim on the assets of the company.
» Where to find information on stock equities?
The best free resources available for this matter is Yahoo finance and Google finance.
» How to select stock equities?
A) Price earning ratio.
The price-earning ratio is very simple it is the Market value per share/ earning per share. If the PE is 10, this mean the investor is ready to pay 10 times the current earnings. Each industry has its level of PE but as a yardstick, PE under 10 is considered cheap and PE over 20 is considered expensive.
B) Price to book value.
The price to book value ratio is the market value per share/total tangible assets- total liabilities. Again each industry has its own level of PB. But as a general thing a PB less than 1 means the total market value is less than the book value (which is good). The company could be cheap or meeting some difficulties.
C) Price to cash flow.
The price to cash flow is bit more advanced. IT is calculated the following way: Market value per share/cash flow per share. The interesting point is that it removes the effect of depreciation and other non-cash factors.
A bond is a debt investment in which technically the investor is lending money to an entity (the entity could be a corporation or a government).
» Where to find bonds?
Finding information on bonds is more difficult, because bonds investment are usually reserved for institutional investors. The minimum amount could be 50,000 and even 100,000. But you can still find lower minimum investment (like 1,000). You can find information of bonds on the Yahoo website (http://finance.yahoo.com/bonds)
» How to select bonds?
First of all you should have a look at the rating of the bond. Ratings are issued by company like Standard and Poor’s, Moody’s or Fitch. You should at least buy a BBB (minimum investment grade). The best notation is AAA. For more information on ratings you can refer to this website.
The most important concept in bond investing is the yield. The yield is the interest rate / price of the bond. Let’s take an example: Let say you buy a bond at the price of 90 USD with an interest rate of 5 %, if you hold the bond until maturity you will get 10 USD (assuming the bond par is 100) on capital gain plus 5 % interest a year. At the time of your investment the yield was 5.56 %
Why an increase in interest rate is not good for bonds investments?
When interest rate are increasing the price of the bond will go down and the yield will increase.
4) Buying securities
Now you are ready to invest. If you are new in the market, you should start investing only in what you can understand, starting only in equities and bonds is a good beginning. When buying a security you have several choices how to enter your order:
Market Orders: Market orders are orders to buy or sell a contract at the current best price, whatever that price may be.
Limit Orders Limit orders are orders to buy or sell a contract at a specific or better price.
Stop Orders: Stop orders are similar to market orders, in that they are orders to buy or sell a contract at the best available price, but they are only processed if the market reaches a specific price.
Diversification is one of the most important steps; you should reach the maximum efficiency (risk/reward) between 20 and 30 stocks spread across various industries. If the amount you think to invest is less than 10,000 USD, it will be better to invest in a mutual fund or/and ETF.
Allocation is a major step regarding the construction of your own portfolio a typical allocation could be 60% bonds, 40% equities, 5% commodities and 5% real estate for example. But it all depends on your tolerance against risk, your age, your goal and your net worth.If you are young, you can afford to invest more heavily in stocks. Why? Because you will have time recoup any potential loss and you are suppose to be able to save more money during your career. The principal rule is to decrease the percentage of stocks if you are approaching retirement.
Research should not be neglected in order to avoid the next company going bankrupt. Even if it takes time, try not to rely on third party research, big company are only promoting the stocks in which they have a financial interest. Analysts do not follow a lot of medium, small companies. Try to give a look at the financial statements. If you are not comfortable with it, start learning the basics. The SEC (Securities and exchange commission) is proposing the basic rules in how to interpret the financial statement. Still on the SEC’s site, you will find the latest official statement for a company listed in the USA.
8) Watch your portfolio
Have a look at your portfolio and try to anticipate any economic change; changing regulation can impact your portfolio heavily for example. You don’t need to look everyday at your portfolio. Just try to read the newspaper or the news through Internet.
9) Continuing education
The great thing about investing in financial market is that you will continually learn. You can read the financial news; follow financial blogs, taking finance exams. You will find useful links on our webpage.
10) You still don’t feel ready to invest by yourself?
Of course you cannot ask your broker or your banker to provide you with an independent advise. It’s their job to sell you products. But don’t be upset if you don’t feel confortable investing by yourself. You can still register yourself to the next close investment club. For a minimum investment, you will be able to invest your money (pooled with other members) while you will interact with more senior investors. You will find everything you need to know about investing on the National Association of Investor Corporation website.