(This is a guest article by Sharon Smith*)
Investing in stock… sounds scary? Many of us do not have much idea about stocks at all. Especially the youngsters who are just starting out, often inquire about how to start investing. Let’s start out with simple answers to the basic questions.
What is a stock?
A stock is, mostly simply termed, the partial ownership of a company. A lot of companies issue stocks when they plan growth. They sell stocks with the purpose of not falling into the clutches of debts. As stocks are equivalent to ownership of the company, the company is not liable to pay back the stock holders.
Why should you invest in stocks?
The simple reason is, once the company earnings increase, the value of stocks increase as well. Some of the companies pay dividends to their stock holders. Every quarter, companies calculate their profit percentage. Then, they reinvest certain profit amount into the business and pay out the rest of the amount as dividends to the stock holders. For example, if you buy $10,000 worth of stocks, each costing you $10, then you are buying 1000 shares of the company. Now, if the company earns a profit of 25% in that quarter of the year, it might reinvest 20% of the profit back into the business and decide to pay the rest 5% amount as dividends to its stock holders. Thus, you are earning $50. This is a legitimate income that you are earning and it is taxed.
There are usually two kinds of stocks – common stocks and preferred stocks.
Common stock is the ownership of the company in general. The companies offer common stocks through public offerings and tenders. The only obvious risk with common stock is that the price of the stocks fluctuates often. However, the investors can only lose their initial investment in case the stock prices fall.
The preferred stock is less risky than the common stock. Thus, the returns on the investment are also less. However, preferred stocks guarantee regular dividends for a fixed time period. Should the company default on dividend payments, and declare bankruptcy, the priority is given to the preferred stock holders regarding the assets entitlement. Preferred stock generates income for the investors, while raising the capitals for the company.
Start investing now
According to a mutual fund company, T. Rowe Price associates, if you wish to accumulate $1 million by the age of 65, you should begin investing at 25. Starting from this age, if you invest around $3900 annually, by the time you are 65 years old, you will be able to earn a return of 8% per year.
Here are four very important tips that you should keep in mind while considering investments.
- Investment is not a gamble. It is true that a lot of investors gain and lose huge money in pretty short time. However, you should understand that investing in small amount consistently will fetch you better result by ensuring financial security. Investing is a long term process and you need to leave your money for circulation in the financial market for at least 10 years.
- Do not consider investment, if you are in debt. Credit card debt is a big barrier towards financial stability. In case of debt, consolidate the outstanding amount and pay off. Do not incur any further debt on your card. It sounds difficult, but once you do that, it would be the best financial decisions that you would ever make.
- Get insurance first. Insurance is something that most young people do not give much thought to. However, that is a huge mistake. You must have proper insurance before investing your hard earned money. You may never need it, but in case you ever do, you will be glad to have it in place.
- Have an emergency fund. Emergencies can happen any time and under any circumstances. The biggest benefit of having an emergency fund is it prevents you to withdraw from your retirement accounts. In some types of emergencies like fire, illness etc, waiting periods for receiving insurance benefits might take more than two weeks. If you set yourself an emergency fund, that will keep you going during such crisis periods.
Once you have considered the above points, start investing. Just remember, investing in stocks would combat the risk of living beyond your means.
*About the author: Sharon Smith is a financial writer. She is associated with the Oak View Law Group. She offers advice on various debt management programs.