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Learning How to Invest (Part 2)

Planning and setting objectives

Investing is a long-term process, like planning a long vacation. Ask yourself these questions before you embark on this endeavor:

  • What is your destination? (What financial goals do you have?)

  • How long is your vacation? (What is your time frame in investing?)

  • What should you bring along? (What investments forms will you choose?)

  • How much gas do you need to use? (How much will you invest to achieve your goals? How much can you invest a regular plan?)

  • Do you have stopovers on the way? (What short-term financial expenses do you have?)

  • How long is your vacation? (Will you have to retire using your investment?)

  • If you run out of gas because you frequently stop to rest and drive through the night, you are bound to spoil your vacation. So it is if you do not save enough money, if you invest haphazardly or fail to invest at all.


Answer these questions judiciously and honestly. Muddling through this process of self-examination and preparation will cause you to see the finer points of investing which requires a lot of number-crunching. Calculate accurately how much a college education will cost and how much you will need during your retirement years. It will not only be satisfying to know that you can actually attain your destination, you will also remain aware of what you must do along the way in order to fulfill your future goals.

In case you are panicking because you consider numbers to be a great challenge, do not be alarmed. There are user-friendly online interactive calculators which can assist you estimate your financial goals. As we said, the more realistic and detailed your figures are, the greater the chances of setting and realizing viable goals.

How stock trading works

Now that you have set your finances in order and you have also established definite financial objectives, you are now ready to learn how to begin investing. With mutual funds, the procedure is quite easy: Call the fund company and request them to open an account for you. Dealing with stocks can be a more challenging endeavor.

Stocks are traded at various stock exchanges. The major US exchanges are the New York Stock Exchange (NYSE), the American Stock Exchange (AMEX), and the Nasdaq Stock Market. Although there are differences in the manner these exchanges perform their trading, the process itself of buying and selling shares requires a similar process in all of them.

Stock exchanges are where buyers and sellers connect. The buyers make a "bid", which is the price at which they are willing to buy a share, while sellers “ask” the price at which they are willing to sell their shares. The “spread” is the difference of the two prices, which often goes to the professionals who manage trades in exchanges.

Depending on the amount of shares traded on a certain day or period, the value of the spread will vary. For traded stocks which are making brisk sales, the spreads will tend to be very small because of competition. Conversely, the spread will tend to be large for stocks being traded thinly, to cover the risk that exchange professionals have to take.

Any investor can establish a bid or ask price by placing orders to buy or sell at a certain price. Such orders are referred to as “limit” orders. Exchange professionals monitor these "open" orders, executing them when conditions are satisfied and utilizing these orders to determine preference for the stock.

Buying stocks is primarily done through brokerage accounts. You may choose between two options: the overly high-priced full-service brokers, or the discount broker. To know more about picking brokers, visit our Broker Center, comparing brokers and choosing the best one who can open an account for you.

The dangers of margin

Through a brokerage account, you can choose between a cash account or a margin account. A cash account allows you trade using available money you are willing to invest. A margin account allows you to buy stocks using other people’s money – which you borrow. Margin accounts can be attractive for obvious reasons; however, the risks can be significant.

Some brokers will advise you to opt for margin as they have hidden interest in doing so, using greater "buying power" as a lure. Remember that what you increase is not only your "borrowing power" but also the risks you take.

Moreover, brokers get some of their killing through collecting interest on margin loans – a sort of commission. The two words (broker and commission) were born twins! As investors borrow more money to buy more stocks, the brokers (who promote margin accounts) collect more commission fees. The broker possesses complete control over the loan collateral, while having the power to interfere and compel you to sell stock in case you are defaulting on your loan. Warning: Margin will milk you dry while the broker gets all the milk and honey.

Direct investment plans (DIPs) and Dividend reinvestment plans (DRPs)

If you think you are not up to opening a brokerage account yet, other plans can provide a different but sure way to buy stock. Nicknamed by investors as Drips, these plans let shareholders buy stock from a company, directly and at low costs or fees. Only a few firms offer these plans, although they are best for investors who only have limited amounts of money to spend at regular periods.

Summary

Now that you have gained enough background information on how to start investing in stocks, as well as what your financial goals are, how much money you will need to invest, how long it will take to recover your investment, the next move is to begin considering where to invest and the kind of potential gain you hope to make.

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