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Investing: What you need
to know BEFORE investing
Here are five important things you need to do
BEFORE investing your money. Make sure that you've completed your financial
arrangements before investing (especially in the stock market). The money for
stock investment should be what's left after you've made these arrangements.
Before investing, make sure you buy life and other insurance policies for
yourself and your family as no other forms of investment can provide security
for the most important things in your life-your own life, family, property.
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Have an
Emergency Fund
- Life happens. Your car breaks down. The roof leaks. Your kids get sick.
Someone gets divorced. Someone loses a job. Someone dies. When things happen,
you need to be prepared. How much do you need? Everyone should have about 3 to
6 months worth of living expenses in a savings account or money market
account. If you want higher return, you might want to put it in shorter-term
bonds or bond mutual funds. But DO NOT use this money to buy stocks or stock
mutual funds. Stock market is no place to invest your short term emergency
cash.
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Pay off
consumer debts - If you are paying 10, 15, or 20 percent interest on
an outstanding credit card or personal loan, pay it off BEFORE investing.
It's very difficult for you to get the same kind of return on your investment
after taxes. Let's say you're paying 12 percent interest on a consumer loan.
You would need to earn 18 percent on your investment pre-tax yearly to justify
not paying off the debt. This is assuming you are in a 32 percent tax
bracket. You can't get that kind of return every year anywhere else WITHOUT
taking a huge amount of risk.
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Max out tax-sheltered
investments FIRST - When you invest inside tax-sheltered retirement
accounts such as IRAs, 401(k)s, SEP-IRAs, and Keoghs, part or all of your
money may be tax deductible. This means that your contributions are not
considered taxable income; therefore you are not required to pay income tax on
that money until you receive payment of your accounts. This will normally be
after your retirement, when your taxable income may be lower. By saving on
current income taxes, you make the plan more affordable for yourself and you
have more take-home pay to use for other needs than with a taxable savings
program.
Another big advantage when you’re investing in a
retirement account is all taxes on your investment earnings will be deferred
until you begin to make withdrawals. That means you will not pay tax on
investment earnings until you receive payment from your account. This enables
your money to grow faster and build to a greater amount than if it were placed
in an investment where taxes were due each year, because 100% of your earnings
are also earning interest. And sometimes in the case of Roth IRAs, earnings
are tax-free.
Before opening an investment account with a bank, stock broker or a mutual
fund company, ask yourself the question: "Do I want to open a regular account
(taxed) or retirement account (tax sheltered), such as a Roth IRA?" Even
if you are not an investment genius, you're smart enough to know that the more
money you pay in taxes, the less you will have. There is another reason
why you shouldn't day trade securities; capital gains tax on short term
trading is higher than long term capital gains. Putting money into
retirement accounts allows your money to grow without taxation, and in the
case of Roth IRAs, earnings are tax free when it's time to take it out.
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DON'T Gamble with your money! -
While investing may have some amount of risk, the outcome of your
investment choices really depend on your willingness to learn and
understand the keys to successful investing. Gambling in the investment
world is called speculation - such as trading in futures, options, and
commodities. Prices on these instruments depend on
short-term, highly volatile price movements. As with gambling in a
casino, you can occasionally win when the market moves the right way at
the right time. But in the long run, you will lose. In most cases,
all of it. Think about this: if majority of people are losing
money in the casinos, who is making all that money? The company that
runs the casinos. So the question is: would you rather be a gambler or
an investor by buying shares (stocks) in the company that runs the
casino?
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Understand what you are
investing in -
Don't invest in instruments that you don't fully understand. Despite
popularity of stocks, for example, most people don't fully understand
stocks. Much is learned from conversations around the water cooler with
others who also don't know what they're talking about. Chances are you've
already heard people say things like, "My cousin made a killing in XYZ
stock, and now he's got another hot tip..." or "Watch out with stocks--you
can lose your shirt in a matter of days!" So much of this misinformation
is based on a get-rich-quick mentality, which was especially prevalent
during the amazing dotcom market in the late 90s. People thought that
stocks were the magic answer to instant wealth with no risk which isn't
true. Stocks can (and do) create massive amounts of wealth, but they
aren't without risks. The only solution to this is education. The key to
protecting yourself in the stock market is to understand where you are
putting your money. Understand the advantages and disadvantages of a
particular investment before putting your hard earned money in to it.
If you would like to learn more before you
invest, there is a very good book by Rod Davis called
What You Need to Know Before You Invest: An Introduction to the Stock
Market and Other Investments
Related Article:
Five costly financial mistakes
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