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The Investment Questions You’re Too Afraid to Ask

I’m devoting today’s newsletter to answering this email from a loyal reader Down Under:

“I am just starting out with buying stocks and want to try to set myself up better financially. I work as a nurse in Australia and have saved every cent I can to start buying stocks.

I really am grateful for any advice and recommendations on which stocks to look at to buy. I don’t mind if it is something I need to hold onto for a while to make profits or if it’s something I can sell within a few weeks.

Which stocks or other investments do you recommend buying for someone who only has a few thousand dollars to invest?” — Rowena R.

Rowena’s question reminds me of the famous title of a book that was a cultural phenomenon during America’s sexual revolution: Everything You Always Wanted to Know About Sex* (*But were afraid to ask), by Dr. David Reuben. The 1969 sex manual was a massive bestseller and even spawned a 1972 film parody by Woody Allen.

Below, to assist Rowena in her task, I review everything you always wanted to know about investing… but were afraid to ask.

More importantly, the following guidelines encompass essential concepts that even many sophisticated, experienced stock investors have either forgotten, thought they knew, or never knew to begin with.

Although hardly a comprehensive summary, I chose crucial areas that, according to my experience, are neglected or misunderstood, but nonetheless form the basis of sound investing knowledge.

The First Step: Choose a Broker

Rowena, I know your task seems daunting, but remember this Chinese proverb: “A journey of a thousand miles begins with a single step.”

Before you sign up with any online broker and deposit your money, think about the sort of investor you are and what you really need from a brokerage. Novice investors should start with the basic buy-and-hold approach.

For most individual investors, cost and fees are the key determinants in choosing an online broker. The largest brokers charge between $6.99 and $9.99 per trade, but some of the smaller services charge as low as $2.50 per trade. These commissions apply to both selling and buying.

However, rates for different types of trades vary among e-brokers, so it’s good to know what you plan to do with your account.

For beginners, customer service is important if you need to talk to a live human being to get urgent questions answered. Some e-brokers provide 24/7 support and a dedicated customer service line. But many discount brokers offer less customer service to reduce overhead costs and keep service fees low.

Reduce Risk with Diversification

Don’t pull all of your eggs in one basket.

If you invest everything in only one or two investments, you could get ruined if they crash. Spread your money among several sectors and asset classes.

But here’s the catch for investors such as Rowena: with a modest deposit, it’s nearly impossible to create a well-diversified portfolio. You may need to buy the shares of only one or two companies to begin with and then diversify as your portfolio grows in value.

The Personal Finance Growth and Income portfolios are good places to find rock-solid stocks, with accompanying advice from our team of experts.

But for instant diversification, read on…

Mutual Funds, Index Funds and ETFs

With limited capital to invest, the major benefits of mutual funds, index funds and exchange-traded funds (ETFs) come into play. Individual investors who want to profit from the markets but don’t envision themselves as stock-picking wizards can opt instead for these types of funds.

I often get this question from readers: What’s the difference between a mutual fund, an index fund and an ETF? Even experienced investors get confused about the distinctions.

A mutual fund is a basket of stocks, bonds, or other asset classes. This basket is professionally managed by an investment company on behalf of investors. In exchange for this service, the fund charges investors a fee, which hovers around 1% of assets annually or more.

With a mutual fund or index fund, you can typically buy and sell shares directly through the fund company (as well as through a brokerage account). The fund company will let you trade those shares once a day, based on that day’s closing price.

ETFs aren’t sold directly by fund companies; they’re listed on an exchange and you need a brokerage account to buy and sell those shares.

Keep an eye on mutual fund fees. To grasp the devastating effects high fund fees can have on a portfolio over the long haul, imagine investing $100,000 in a mutual fund that charges 0.3% in annual fees, and in which your money grows an average of 9% annually.

Compare that to another fund that also returns 9% a year, but with an annual fee that’s one percentage point more, or 1.3%. Over 25 years, that first fund will grow to $800,000, but the second fund will reach only $621,000, a difference of $179,000. Whether you’re a novice or not, that’s a lot of money!

Unlike a mutual fund, whereby the portfolio manager picks investments that he believes will outperform, an index fund buys all the shares that make up a certain index, such as the Standard & Poor’s 500 index of blue chip stocks, which is considered a bellwether for the entire economy. The goal is to mimic the performance of that entire market. Index funds operate in the way all mutual funds do, in that they are priced at the close of the trading day based on the net asset value (NAV) of the underlying securities.

ETFs passively reflect broader indices or their smaller sector subsets. An ETF is an investment fund that’s traded on stock exchanges, akin to actual stocks. An ETF can hold basic investment assets such as stocks, commodities or bonds, and it trades over the course of the trading day at the same price as the NAV of its underlying assets. ETFs can be traded more easily than index funds and mutual funds, similar to how common stocks are traded on a stock exchange.

Chances are you won’t be able to cost-effectively buy individual stocks and still be diversified with a small amount of money. Given these restrictions, it’s probably worth starting out on your investment journey with a mutual fund, index fund or ETF. How do you choose the fund that’s right for you?

A central place to find the best funds for your particular needs is the Personal Finance Fund Portfolio, which pinpoints best-of-breed funds accompanied by our investment team’s advice.

Questions about investing? Send me an email: mailbag@investingdaily.com John Persinos

Are you getting a fair deal?

How can you be sure of getting a fair deal in your investments? As our Deon Vernooy, chief investment strategist of Canadian Edge, explains:

“Most investors in risky assets expect a positive return on their investments. Aggressive traders want a high return in a short time while conservative, long-term investors look for a return higher than a bank deposit or government bond.

A reasonable return depends on the risk that an investor assumes by investing in a particular stock.

The starting point is always the return on a risk-free asset (say, long-term government bonds) before adding a risk premium linked to the risk profile of the particular investment. No investor should buy a stock if there isn’t a realistic chance of getting this return.”

I’m Giving Away All Our Research

There’s no substitute for doing research, especially for novice investors such as Rowena.

We’re now offering you something that no other publisher could dream of doing… the opportunity to get all of the research and recommendations that we publish free for the rest of your life.

It’s a lifetime membership in our private investing group called the Wealth Society.

When you join, you’ll get access to the caliber of investments once reserved for high net worth investors… plus unlimited access to everything we publish… for the rest of your life!

Discover everything this program offers here.

 

 


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