The following is a guest post from Barbara Friedberg, the editor-in-chief of BarbaraFriedbergPersonalFinance, as well as a portfolio manager, and MBA professor. She has an MBA in finance, a BS in economics, and a MS in Counseling. Visit the website to download her newly released free eBook, 20 Minute Guide to Investing.
Last month I wrote a guest post entitled, I’ve got the Time, How do I Get the Money, here at BFS. That article broadly covered investing and underscored why you should start to invest NOW! Following with the educational mission of BarbaraFriedbergPersonalFinance, this article continues the investing theme and breaks down one of the most basic pieces of the investing puzzle: Stocks.
Flash back a million years (okay, a couple of decades)……When I first started investing, all I knew was that in the late 1920’s and early 30’s the stock market crashed, people lost all their money, and went jumping off of buildings. Armed with that one-sided information, at the beginning of my investing life, I WAS TERRIFIED OF THE STOCK MARKET. I thought it was a place where you put your money and it all went away!
Over time, education, and lots of experience I came to understand that investing in stocks is more than a one way ticket to the poor house. In fact, it might even be a way to build wealth. So………
WHAT IS A STOCK?
A stock is part ownership in a corporation. When you buy a share of stock, you are buying a small fraction of the entire company. Some stocks pay dividends and others do not. A dividend is a small cash payment expressed as a percent of the purchase price. These payments are paid from 1 to 4 times/year and range from 0.5% on up to 8% or more. The 49 year average for dividend payments from 1960-2009 was 3.17%. 3% looks pretty good today considering my savings account interest rate does not even approach 1%!
Historically, stocks had higher returns than bonds and cash assets; although during the first decade of 2000 something very unusual happened; bonds returned more than stocks. Does that mean that I should give up the idea of investing in stocks?
I don’t think so. As a matter of fact, contrarian investors might suggest that the best time to invest in an asset class (i.e. stocks) is after a period of poor performance. Have you ever heard of the statement, “Buy low sell high?” Typically, after a period of underperformance, it is a good time to invest.
What does this Mean to ME?
- Like any other investment, investing in stocks offers the opportunity for increases and decreases in your personal wealth.
- In the short term, the stock market is very volatile and goes up and down a lot. So, NEVER invest in the stock market any money that you need in the next 5+ years.
- In the long term, it is likely that a diversified portfolio which includes some stock investments will offer a return greater than bonds, cash, and the rate of inflation! In fact, over the last century, including dividends the S & P 500 (a proxy for the US stock market) returned approximately 9%/year*.
- If you are saving for retirement, a down payment for a house (greater than 5+ years away), or college expenses for your kid, you might want to put some of your cash in the stock market.
WHAT SHOULD I DO?
- Make sure you have some savings, term life insurance (if you have dependents), and NO credit card debt.
- Read and educate yourself about investing.
- A work retirement account (401K) is a great place to start investing.
In sum, don’t be afraid of investing in the stock market. Stock mutual funds are a great place to begin investing. But, before you begin, get educated!
*Caveat: This article is for information purposes only and may not be appropriate for your individual situation.
Crystal’s Question: Since stocks could be one of the best investments for 2011, do you have any stock questions for Barbara? Come on, this is your chance here at BFS since I know nothing, lol. 
I am so glad I didn’t bail on my stocks when the market tanked a couple years ago. I pretty much buy and hold and cross my fingers. I have been burned a couple times, but I have also seen some pretty great gains. It is a roller coaster for sure, and you have to have the stomach for the ride.
@Everyday Tips, we are finally up 2-3% overall in our Scottrade account…we held all the stock we bought while it crashed and 11 out of 12 of the current stocks we own are back to normal and the dividends have turned us a profit. We’re crossing our fingers too. We sell to reap the profits and rebuy other high dividend stocks occasionally, but overall we are buy and hold investors…
I have a diversified stock portfolio, along with other types of investments. One thing I have yet to figure out though, is how do you know when it’s time to sell in general. I don’t mean selling individual stocks, instead I’m talking about stocks you’ve held for the long term.
@Everyday tips-ANyone who says trading in and out of stocks is not a long term investor. Over time the research is very clear, those who attempt to time the market, come out behind! Just don’t focus in the day to day values (or you will go insane)
@ Crystal- Keep it up, time is your friend.
@ Jackie – When to sell? How much time do you have for that one. Because it is such a difficult question, I recommend choosing an asset allocation in line with your risk tolerance and invest in low cost index funds or etfs. Then rebalance every year or so. Then you take the emotion out of it. (Check out my FREE eBook on Investing for more detail and cute cartoons)
Like Everyday Tips, I just rode out the market downturn too. I had friends at work that were pulling money out and getting ready to head to the hills. I’m sure they are regretting their decision.
My balances have come back and I’m starting to gain again.
During the “Great Recession” one thing that I did change though was to buy some dividend stocks while they were on the low side! Now that prices are returning to normal levels I’ll go back to a mixed approach again.
Oh, at least 80% of the value of my financial investment are in my 401K in a diversified portfolio.
Nice intro Barb
Hi Money, Sounds like you are patient and making wise financial decisions. Investing, like life, is a marathon, not a sprint. There’s no room for impulsive decisions.
Good article from Barbara for newer investors.
There are currently plenty of values to be found on the market. Some great blue-chip dividend-paying companies are trading for fairly attractive valuations.
@ Dividend, If one has the time to do some research, there certainly are some values. When there is fear and uncertainty, there are opportunities to invest! Always appreciate your input, Dividend.
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