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Using Common Stocks for Investment

In a recent article, "Using Stocks for Speculation," I wrote about a number of ways a person could try and increase capital by speculating on stock price movement. I don't advocate that the average small investor, which includes most of us, use them because those methods are highly risky, very time consuming, and are more akin to gambling than investing. This article will begin a series of pieces about using stocks for investment purposes.

It seems to me that making an investment is different than simply betting that the price of a stock you hold will rise, (or fall in the case of short selling), during a specific and normally short time frame. When you invest in stocks you're buying shares of a successful business, and you expect to profit from that success over a longer time period. You're interested in growing your money and you'd like that to happen at a low level of risk compared to speculative methods of using stocks. You're in it for "the long haul."

Investment Plan:

To succeed at growing your assets using common stocks, or any other investment for that matter, you need to be systematic about approaching the project, and that means developing a plan to follow. We won't discuss the development of a really detailed financial plan here, but you'd be wise to do one at some point. For now let's talk about some necessary elements of a simple plan for the road trip to your financial future.

Write Your Plan:

You'll want to document your plan for the trip so you can refer to it modify, and elaborate the plan from time to time. So find a binder, or note book in which to record your plan as you develop it.

Find Your Starting Place:

It's always a good idea to know where you're starting point is for any trip you might plan to take. Otherwise how can you know which turns to take to reach your destination? This also applies to the financial road trip you'll plan, and doing a net worth calculation will tell you where you are today-your starting place. It isn't difficult to do just:

• Total the value of what you own
• Total the value of what you owe.
• Subtract what you owe from what you own, and there you have your net worth.

You'll want to do a net worth calculation a couple of times a years so you can track your progress over time.

Control Where Your Money Goes:

Now that you know your starting point, take a hard look at your debt level and your spending patterns because you'll want to control both in order to find money to invest for your future. If you have a negative net worth, meaning you owe more than you own, you'll want to work especially hard in terms of planning since debt-especially credit card debt-and uncontrolled spending will make your trip difficult if not exactly impossible. It's sort of like starting a cross country drive in a car that only goes forty miles per hour and has mechanical problems every few miles that you've got to stop and fix-makes for a slow, unpleasant trip.

Set Goals:

As with any trip, you also need to know where you're going, so think about your goals and add them to your plan. These don't need to be written in enormous detail, but develop a couple of short term, medium term, and long term goals. Things like:

• Eliminate credit card debit in six months
• Build emergency savings to equal three months of my salary
• Save enough for a house down payment in two years
• Retire by age 65 with enough money to maintain my current lifestyle.

Goal setting will help you discover the steps you'll need to take to reach them, serving the same function that a road map would for a driving trip.

Budget for Investment:

Develop a budget so as to free money for investment. In a detailed financial plan we would want a detailed budget too, but for now let's consider something simple. There's a phrase most people have heard at one time or another, and it goes like this. PAY YOURSELF FIRST

• The idea is for you to put money into your savings and investment plan before you pay anything else.
• In effect, paying yourself first serves as a rudimentary budget because it forces you to live on what's left.
• So decide on a "pay yourself first" percentage you can manage and add that to the plan in your notebook.

Here's a quick personal story about this notion. When my wife and I were finally both out of graduated school, we began paying ourselves first, initially with a measly five percent of our collective income, and we found we didn't miss the money. Over the following years most increases in salary, (minus the "cost of living raises" we gave ourselves occasionally), were put toward investment. Eventually we reached a point where-for many years-the portion going into savings and investment was just under twenty percent of our income.

Follow Through:

Next, commit yourself to following your plan systematically-like clockwork-with each and every paycheck.

Stock Investment, Some Considerations:

1. Investment in common stocks is the best way grow your money beyond the rate of inflation, but there is some risk involved. You will see the price of stocks you hold vary over time on the down side as well as the up side. However, studies show that in every ten year period of time-no matter which starting year you choose-common stock prices are always higher at the end of the time frame than they were at the beginning. By choosing stocks or stock mutual funds carefully and allowing enough time for your investments to work for you, the longer term risks can be managed.
2. A second consideration relates to how much of your own time you will devote to your investment program, and that is dependent on how you'd like to approach investing. You can invest in stocks in a number of ways, the two main ones being to buy mutual funds or buy stocks individually outside of mutual funds. If you want to buy individual stocks, be prepared to spend a fair amount of time on a regular basis studying, evaluating, and monitoring you investments. If you plan to use mutual funds rather than buy individual stocks, your time commitment will be less, but to be successful you'll still need to pay close attention, make decisions, and monitor your portfolio.
3. You need to understand the tax consequences of investing in stocks. By placing your money in Traditional IRAs (Individual Retirement Accounts), Roth IRAs, or 401-K, or 403-B programs through your employer, you will gain tax advantages.

• Traditional IRA contributions are made with pre-tax dollars, so the IRS takes taxes when you draw money from the account, as one would do in retirement.
• Roth IRA contributions must be with after tax dollars, but then can grow with no further income tax liability—ever.
• In employer sponsored 401K (for profit organizations) and 403B (non profit organizations) plans, contributions are made with pre-tax dollars and taxed when the money is distributed to you after age fifty nine and a half.
• When you buy stocks individually, there are also tax advantages, but they are different.
  • Dividends you receive are taxed as regular income.
  • When you sell stock shares, the profit is taxed as capital gains rather than as regular income, provided you've held the stock for at least one

4. Whichever approach you decide to use, you'll need to have your goals and your methods of reaching them clearly in mind. There are lots of people out there who are very willing to tell you how to invest your money, not all of them having your best interest in mind. Your best protection against stock market risk is knowledge and clarity about the road you will travel to reach your objectives. This involves reading, studying, planning, commitment, and follow through.

In the next article for the ITS: FYI page we'll discuss some consideration in buying individual stocks, so stay tuned.

arley