1
Pay off high interest debt. If you have a loan or credit card debt with a high interest rate (over 10%) there’s no point in investing your hard-earned cash. Whatever interest you earn through investing (usually less than 10%) won’t make much of a difference because you’ll be spending a greater amount paying interest on your debt. For example, let’s say Sam has saved $4,000 for investing, but he also has $4,000 in credit card debt at a 14% interest rate. He could invest the $4,000 and if he gets a 12% ROI (return on investment–and this is being very optimistic) in a year he’ll have made $480 in interest. But the credit card company will have charged him $560 in interest. He’s $80 in the hole, and he still has that $4,000 principal to pay off. Why bother? Pay off the high interest debt first so that you can actually keep any money you make by investing. Otherwise, the only investors making money are the ones who loaned it to you at a high interest rate.
2
Build your emergency fund. If you don’t have one already, it’s a good idea to focus your efforts on setting aside 3-6 months of living expenses just in case. This is not money that should be invested; it should be kept readily accessible and safe from swings in the market. You can split your extra money every month, sending part of it to your emergency fund and part of it to your investing fund. Whatever you do, don’t tie up all of your extra money in investments unless you have a financial safety net in place; anything can go wrong (a job loss, an injury, an illness) and failing to prepare for that possibility is irresponsible.
3
Write down your investment goals. While you’re paying down high interest debt and building your emergency fund, you should think about why you’re investing. How much money do you want to have, and in what period of time? Different investors have different goals, such as:
Holding onto money so that it’s just above inflation
Having a specific amount of money for a down payment in 10 years
Building a nest egg for retirement in 20 years
Building a college fund for a child or grandchild in 5 years
4
Choose your investments. The bigger the chunk of money you have available for investing, the more choices you have. Most people diversify by investing in more than one place, but the way they split their investments depends on their goals and the amount of risk they’re willing to accept.
Savings accounts – low minimum balance, liquid but with limitations on how often the account is accessed, low interest rate (usually much lower than inflation), predictable
Money market accounts (MMAs) – higher minimum balance than savings, liquid but with limitations on how often the account is accessed, earns about twice the interest rates of savings accounts,[2] high-yield MMAs offer higher interest rates but higher risks
Certificates of deposit (CDs) – similar to savings account but with higher interest rates and restrictions on early withdrawal, offered by banks, brokerage firms and independent salespeople, low-risk but reduced liquidity, may require high minimum balance for desired interest rates
Bonds – a loan taken out by a government or company to be paid back with interest; considered “fixed income” securities because the same income will be generated regardless of market conditions,[3] you’ll need to know the par value (amount loaned), coupon rate (interest rate), and maturity rate (when the principal and interest must be paid back)
Stocks – usually purchased through brokers; you buy pieces (shares) of a corporation which entitles you to decision-making power (usually by voting to elect a board of directors). You may also receive a fraction of the profits (dividends). Dividend reinvestment plans (DRPs) and direct stock purchase plans (DSPs) – bypass brokers (and their commissions) by buying directly from companies or their agents, offered by more than 1,000 major corporations,[4] can invest as little as $20-30 per month and can buy fractional shares of stocks, but can also be high-risk (you cannot decide the price at which to buy when you invest via such plans).
Real estate property – ties up money (not easy to liquidate investment), capital intensive (usually leveraged through mortgage loans)
Mutual funds – not insured by any government agency, built-in diversification, some funds have low initial purchase amounts, and you’ll have to pay annual management fees
Real Estate Investment Trusts (REITs) – similar to mutual funds, but instead of investing in stocks, they invest in real estate
Gold and silver – these are great ways to store your money and keep up with inflation. They are not subject to tax, and they are easy to store and very liquid (can buy and sell easily).
5
Save money to invest. If you don’t already have money set aside for investing, you’ll need to build up your investment fund. By now, you should know how much money you’ll need to reach your goals, given the risks you’ve chosen to undertake.
6
Buy low. Whatever you choose to invest in, try to buy it when it’s “on sale” — that is, buy when no one else is buying. For example, in real estate, you’ll want to purchase property when it’s a buyer’s market, which is when there is a large number of houses for sale in relation to the number of potential buyers. When people are desperate to sell, you have greater room for negotiation, especially if you can see how the investment will pay off when others don’t (or perhaps they do, but can’t afford to act on it at the time).
An alternative to buying low (since you never know for sure when it is low enough) is to to buy at a reasonable price and sell higher. When a stock is “cheap”, such as 80% or more below its 52 week high, there is a reason. Stocks don’t drop in price like houses. Stocks typically drop in price because there is a problem with the company, whereas houses drop in price not because there is a problem with the house, but because there is a lack of overall demand for houses. When the entire market drops, however, it is possible to find certain stocks that fell simply because of an overall “sell-off.” To find these good deals, one must do extensive valuations. Try to buy at a discount price when the valuation of the company shows its stock price should cost more.
7
Hold on tight. With more volatile investment vehicles, you may be tempted to bail. It’s easy to get spooked when you see the value of your investments plummet. If you did your research, however, you probably knew what you were getting into, and you decided early on how you were going to approach the swings in the market place. When the stocks you hold plummet in price, update your research to find out what is happening to the fundamentals. If you have confidence in the stock, hold, or, better yet, buy more at the better price. But if you no longer have the confidence in the stock and the fundamentals have changed permanently, sell. Keep in mind, however, that when you’re selling your investments out of fear, so is everyone else, and your exit is someone else’s opportunity to buy low.
8
Sell high. If and when the market bounces back, sell your investments, especially the cyclical stocks. Roll the profits over into another investment with better valuations (buying low, of course) and try to do so under a tax shelter that allows you to re-invest the full amount of your profits (rather than having it taxed first). In the U.S., examples would be 1031 exchanges (in real estate) and Roth IRAs.
