I was pretty sure that, in order to be financially on top of things, I'd need to be a stock investor. I believed that I would need to take what money I had in savings and invest in stocks like AAPL (Apple), GOOG (Google), and NAT (Nordic American Tanker). Doing the "investor thing" always seemed like some distant goal to me though and each time I thought about doing it, I decided that I just couldn't make up even the cost to do a single trade ($7).
I was talking to my friends Tim and Sam today over lunch about investing. We started by talking about index funds and ETFs, which are solid investments that automatically result in diversification as well as get you the lowest maintenance fees available for your broker-managed accounts, i.e. retirement accounts. Tim was diving into an argument that was centered around smart investing and how choosing the right buys and sells has put him at 50% gains for the year. He told me that index funds and ETFs could never come close with their puny 11-12% annual gains.
I had to admit that his reasoning and results seemed compelling, but the conversation morphed because I was trying to identify how I could make similar gains by investing. The light went on for me in the conversation: if a trade is $7, a $700 trade would automatically put me down 2%. This means that, since I'd have to pay $7 to buy and then $7 to sell, that I'd have to make a minimum of $14.01 to make a profit. I've already lost significantly by the time I've bought those stocks.
See, I have just a little money that I'm investing. To become diversified, I need tens of thousands of dollars. If I make an investment in one stock at $10,000, a $14 trading fee doesn't amount to as much, but then all my eggs are in one basket. Diversifying by investing in ten different stocks puts me at $140 for trading. I've already lost about 1.4%, so I'm hoping to make up the difference across my portfolio. Now, imagine that I buy and sell pretty frequently. Each time I do this, I'm chipping away at my percentage gain and each percentage point that I steal is one that I have to make up. If I buy and sell 20 times with my $10,000 and my gains are 15% (just barely above the passive index funds), that means that I've spent $280 and I've actually had to make closer to 18% to cover those fees. I'm cutting myself down with fees. My best bet is to be a passive investor with such a little sum of money.
So, this led me to the understanding that, when you have less than $10,000 to invest you ought to just put your money into a savings account that bears a tidy little bit of interest. That interest is guaranteed and it keeps your money liquid. The worst thing about stock investing is having to sell because you need your money.
Save up that money and pay down high interest debt. The math shows that, to be an active trader, the fees add up to several percentage points and, therefore, even medium interest debt becomes a more viable target for your financial attention.
Contribute to your 401k, to your IRA, and to your Roth IRA while you build your wealth for the eventual investing endeavor. Those accounts are not a waste (unless your 401k does not have matching by your employer in which case contributing to a 401k is not better than paying off debt many times).
You can contribute up to $5,000 a year to your IRA. Depending on your income, 100% of that $5,000 is a tax write off. Some employers will allow pre-tax dollars to go to an IRA, but if that's not an option, you can write it off when you pay your taxes. Check out what the IRS has to say about IRAs.
All this to say that I've decided against investing actively until I've maxed my retirement contributions, paid off all the higher interest debt I owe (no credit cards for me--just a car loan and some student loans), and have a solid safety net of funds that are liquid. Active investing, while a fun topic of study, is not yet obtainable for me.
Are you an investor? Do you disagree with my conclusions? Provide me with some feedback in the comments section!
Images provided by Idea go / FreeDigitalPhotos.net
No comments:
Post a Comment