Stock Investing For Dummies, 5th Edition - Paul Mladjenovic (2016)

Part I. The Essentials of Stock Investing

Chapter 2. Taking Stock of Your Current Financial Situation and Goals

IN THIS CHAPTER

Preparing your personal balance sheet

Looking at your cash flow statement

Determining your financial goals

Yes, you want to make the big bucks. Or maybe you just want to get back the big bucks you lost in stocks during the bear market (a long period of falling prices) of 2000–2002 or perhaps in the infamous global financial crisis of 2008–09. (Investors who followed the guidelines from previous editions of this book did much better than the crowd!) Either way, you want your money to grow so that you can have a better life. But before you make reservations for that Caribbean cruise you’re dreaming about, you have to map out your action plan for getting there. Stocks can be a great component of most wealth-building programs, but you must first do some homework on a topic that you should be very familiar with — yourself. That’s right. Understanding your current financial situation and clearly defining your financial goals are the first steps in successful investing.

Let me give you an example. I met an investor at one of my seminars who had a million dollars’ worth of Procter & Gamble (PG) stock, and he was nearing retirement. He asked me whether he should sell his stock and become more growth-oriented by investing in a batch of small cap stocks (stocks of a company worth $250 million to $1 billion; see Chapter 1 for more information). Because he already had enough assets to retire on at that time, I said that he didn’t need to get more aggressive. In fact, I told him that he had too much tied to a single stock, even though it was a solid, large company. What would happen to his assets if problems arose at PG? Telling him to shrink his stock portfolio and put that money elsewhere — by paying off debt or adding investment-grade bonds for diversification, for example — seemed obvious.

This chapter is undoubtedly one of the most important chapters in this book. At first, you may think it’s a chapter more suitable for some general book on personal finance. Wrong! Unsuccessful investors’ greatest weakness is not understanding their financial situations and how stocks fit in. Often, I counsel people to stay out of the stock market if they aren’t prepared for the responsibilities of stock investing, such as regularly reviewing the financial statements and progress of the companies they invest in.

remember Investing in stocks requires balance. Investors sometimes tie up too much money in stocks, putting themselves at risk of losing a significant portion of their wealth if the market plunges. Then again, other investors place little or no money in stocks and therefore miss out on excellent opportunities to grow their wealth. Investors should make stocks a part of their portfolios, but the operative word is part. You should let stocks take up only a portion of your money. A disciplined investor also has money in bank accounts, investment-grade bonds, precious metals, and other assets that offer growth or income opportunities. Diversification is the key to minimizing risk. (For more on risk, see Chapter 4. I even touch on volatility there.)

Establishing a Starting Point by Preparing a Balance Sheet

Whether you already own stocks or are looking to get into the stock market, you need to find out about how much money you can afford to invest. No matter what you hope to accomplish with your stock investing plan, the first step you should take is to figure out how much you own and how much you owe. To do this, prepare and review your personal balance sheet. A balance sheet is simply a list of your assets, your liabilities, and what each item is currently worth so you can arrive at your net worth. Your net worth is total assets minus total liabilities. (I know these terms sound like accounting mumbo jumbo, but knowing your net worth is important to your future financial success, so just do it.)

Composing your balance sheet is simple. Pull out a pencil and a piece of paper. For the computer-savvy, a spreadsheet software program accomplishes the same task. Gather all your financial documents, such as bank and brokerage statements and other such paperwork; you need figures from these documents. Then follow the steps that I outline in the following sections. Update your balance sheet at least once a year to monitor your financial progress (is your net worth going up or down?).

Note: Your personal balance sheet is really no different from balance sheets that giant companies prepare. (The main difference is a few zeros, but you can use my advice in this book to work on changing that.) In fact, the more you find out about your own balance sheet, the easier it is to understand the balance sheet of companies in which you’re seeking to invest. See Chapter 11 for details on reviewing company balance sheets.

Step 1: Make sure you have an emergency fund

First, list cash on your balance sheet. Your goal is to have a reserve of at least three to six months’ worth of your gross living expenses in cash and cash equivalents. The cash is important because it gives you a cushion. Three to six months’ worth is usually enough to get you through the most common forms of financial disruption, such as losing your job.

remember If your monthly expenses (or outgo) are $2,000, for example, you should have at least $6,000, and probably closer to $12,000, in a secure, FDIC-insured, interest-bearing bank account (or another relatively safe, interest-bearing vehicle such as a money market fund). Consider this account an emergency fund, not an investment. Don’t use this money to buy stocks.

Too many Americans don’t have an emergency fund, meaning that they put themselves at risk. Walking across a busy street while wearing a blindfold is a great example of putting yourself at risk, and in recent years, investors have done the financial equivalent. Investors piled on tremendous debt, put too much into investments (such as stocks) that they didn’t understand, and had little or no savings. One of the biggest problems during this past decade was that savings were sinking to record lows while debt levels were reaching new heights. People then sold many stocks because they needed funds for — you guessed it — paying bills and servicing debt.

warning Resist the urge to start thinking of your investment in stocks as a savings account generating more than 20 percent per year. This is dangerous thinking! If your investments tank or if you lose your job, you’ll have financial difficulty, and that will affect your stock portfolio (you may have to sell some stocks in your account just to get money to pay the bills). An emergency fund helps you through a temporary cash crunch.

Step 2: List your assets in decreasing order of liquidity

Liquid assets aren’t references to beer or cola (unless you’re Anheuser-Busch). Instead, liquidity refers to how quickly you can convert a particular asset (something you own that has value) into cash. If you know the liquidity of your assets, including investments, you have some options when you need cash to buy some stock (or pay some bills). All too often, people are short on cash and have too much wealth tied up in illiquid investments such as real estate. Illiquid is just a fancy way of saying that you don’t have the immediate cash to meet a pressing need. (Hey, we’ve all had those moments!) Review your assets and take measures to ensure that enough of them are liquid (along with your illiquid assets).

tip Listing your assets in order of liquidity on your balance sheet gives you an immediate picture of which assets you can quickly convert to cash and which ones you can’t. If you need money now, you can see that cash in hand, your checking account, and your savings account are at the top of the list. The items last in order of liquidity become obvious; they’re things like real estate and other assets that can take a long time to convert to cash.

warning Selling real estate, even in a seller’s market, can take months. Investors who don’t have adequate liquid assets run the risk of having to sell assets quickly and possibly at a loss as they scramble to accumulate the cash for their short-term financial obligations. For stock investors, this scramble may include prematurely selling stocks that they originally intended as long-term investments.

Table 2-1 shows a typical list of assets in order of liquidity. Use it as a guide for making your own asset list.

Table 2-1 Listing Personal Assets in Decreasing Order of Liquidity

Asset Item

Market Value

Annual Growth Rate %

Current assets

   

Cash on hand and in checking

$150

 

Bank savings accounts and certificates of deposit

$5,000

1%

Stocks

$2,000

11%

Mutual funds

$2,400

9%

Other assets (collectibles and so on)

$240

 

Total current assets

$9,790

 

Long-term assets

   

Auto

$1,800

–10%

Residence

$150,000

5%

Real estate investment

$125,000

6%

Personal stuff (such as jewelry)

$4,000

 

Total long-term assets

$280,800

 

Total assets

$290,590

 

Here’s how to break down the information in Table 2-1:

·        The first column describes the asset. You can quickly convert current assets to cash — they’re more liquid; long-term assets have value, but you can’t necessarily convert them to cash quickly — they aren’t very liquid.

Note: I have stocks listed as short-term in the table. The reason is that this balance sheet is meant to list items in order of liquidity. Liquidity is best embodied in the question, “How quickly can I turn this asset into cash?” Because a stock can be sold and converted to cash very quickly, it’s a good example of a liquid asset. (However, that’s not the main purpose for buying stocks.)

·        The second column gives the current market value for that item. Keep in mind that this value isn’t the purchase price or original value; it’s the amount you’d realistically get if you sold the asset in the current market at that moment.

·        The third column tells you how well that investment is doing compared to one year ago. If the percentage rate is 5 percent, that item is worth 5 percent more today than it was a year ago. You need to know how well all your assets are doing. Why? So you can adjust your assets for maximum growth or get rid of assets that are losing money. You should keep assets that are doing well (and you should consider increasing your holdings in these assets) and scrutinize assets that are down in value to see whether they’re candidates for removal. Perhaps you can sell them and reinvest the money elsewhere. In addition, the realized loss has tax benefits (see Chapter 21).

tip Figuring the annual growth rate (in the third column) as a percentage isn’t difficult. Say that you buy 100 shares of the stock Gro-A-Lot Corp. (GAL), and its market value on December 31, 2014, is $50 per share for a total market value of $5,000 (100 shares multiplied by $50 per share). When you check its value on December 31, 2015, you find out that the stock is at $60 per share for a total market value of $6,000 (100 shares multiplied by $60). The annual growth rate is 20 percent. You calculate this percentage by taking the amount of the gain ($60 per share less $50 per share = $10 gain per share), which is $1,000 (100 shares times the $10 gain), and dividing it by the value at the beginning of the time period ($5,000). In this case, you get 20 percent ($1,000 divided by $5,000).

tip What if GAL also generates a dividend of $2 per share during that period — now what? In that case, GAL generates a total return of 24 percent. To calculate the total return, add the appreciation ($10 per share multiplied by 100 shares = $1,000) and the dividend income ($2 per share multiplied by 100 shares = $200) and divide that sum ($1,000 plus $200, or $1,200) by the value at the beginning of the year ($50 per share multiplied by 100 shares, or $5,000). The total return is $1,200 on the $5,000 market value, or 24 percent.

·        The last line lists the total for all the assets and their current market value.

Step 3: List your liabilities

Liabilities are simply the bills that you’re obligated to pay. Whether it’s a credit card bill or a mortgage payment, a liability is an amount of money you have to pay back eventually (usually with interest). If you don’t keep track of your liabilities, you may end up thinking that you have more money than you really do.

Table 2-2 lists some common liabilities. Use it as a model when you list your own. You should list the liabilities according to how soon you need to pay them. Credit card balances tend to be short-term obligations, whereas mortgages are long-term.

Table 2-2 Listing Personal Liabilities

Liabilities

Amount

Paying Rate %

Credit cards

$4,000

18%

Personal loans

$13,000

10%

Mortgage

$100,000

4%

Total liabilities

$117,000

 

Here’s a summary of the information in Table 2-2:

·        The first column names the type of debt. Don’t forget to include student loans and auto loans if you have them.

remember Never avoid listing a liability because you’re embarrassed to see how much you really owe. Be honest with yourself — doing so helps you improve your financial health.

·        The second column shows the current value (or current balance) of your liabilities. List the most current balance to see where you stand with your creditors.

·        The third column reflects how much interest you’re paying for carrying that debt. This information is an important reminder about how debt can be a wealth zapper. Credit card debt can have an interest rate of 18 percent or more, and to add insult to injury, it isn’t even tax-deductible. Using a credit card to make even a small purchase costs you if you don’t pay off the balance each month. Within a year, a $50 sweater at 18 percent costs $59 when you add in the annual potential interest on the $50 you paid.

tip If you compare your liabilities in Table 2-2 and your personal assets in Table 2-1, you may find opportunities to reduce the amount you pay for interest. Say, for example, that you pay 18 percent on a credit card balance of $4,000 but also have a personal asset of $5,000 in a bank savings account that’s earning 2 percent in interest. In that case, you may want to consider taking $4,000 out of the savings account to pay off the credit card balance. Doing so saves you $640; the $4,000 in the bank was earning only $80 (2 percent of $4,000), while you were paying $720 on the credit card balance (18 percent of $4,000).

If you can’t pay off high-interest debt, at least look for ways to minimize the cost of carrying the debt. The most obvious ways include the following:

·        Replace high-interest cards with low-interest cards. Many companies offer incentives to consumers, including signing up for cards with favorable rates (recently under 10 percent) that can be used to pay off high-interest cards (typically 12 to 18 percent or higher).

·        Replace unsecured debt with secured debt. Credit cards and personal loans are unsecured (you haven’t put up any collateral or other asset to secure the debt); therefore, they have higher interest rates because this type of debt is considered riskier for the creditor. Sources of secured debt (such as home equity line accounts and brokerage accounts) provide you with a means to replace your high-interest debt with lower-interest debt. You get lower interest rates with secured debt because it’s less risky for the creditor — the debt is backed up by collateral (your home or your stocks).

·        Replace variable-interest debt with fixed-interest debt. Think about how homeowners got blindsided when their monthly payments on adjustable-rate mortgages went up drastically in the wake of the housing bubble that popped during 2005–2008. If you can’t lower your debt, at least make it fixed and predictable.

warning In 2015, auto loans surpassed $1 trillion, consumer loans exceeded $942 billion, and college debt topped $1.2 trillion (corporate debt was also near record highs). The biggest weakness in the U.S. economy for 2016–2017 is excessive debt at many levels (government, corporate, consumer, and so on). The cracks started to show up as high-yield (“junk” or very low quality) bonds started to crash in December 2015 as debt became less attractive to investors.

Make a diligent effort to control and reduce your debt; otherwise, the debt can become too burdensome. If you don’t control it, you may have to sell your stocks just to stay liquid. Remember, Murphy’s Law states that you will sell your stock at the worst possible moment! Don’t go there.

I OWE, I OWE, SO OFF TO WORK I GO

One reason you continue to work is probably so that you can pay off your bills. But many people today are losing their jobs because their company owes, too!

Debt is one of the biggest financial problems in the United States today. Companies and individuals holding excessive debt contributed to the stock market’s painful plunge in 2008 and 2009. The general economy and financial markets are still a major danger zone for 2016–2017. If individuals and companies managed their liabilities more responsibly, the general economy would be much better off.

At of the end of 2015, worldwide debt exceeded a mind-boggling $230 trillion. For comparison’s sake, the world’s GDP during that same time was only about $60 trillion (give or take a billion). The greatest portion of that debt comes from the public sector. In the United States, federal, state, and municipal debt are at all-time highs. This is debt that everyone has to deal with indirectly because it’s incurred by politicians and government bureaucrats but must be addressed by us. The pressure is on for higher income taxes, real estate taxes, and other taxes. Yikes! (Now I know why some people become cave-dwelling hermits.) And yes … the stock market (and the stocks in your portfolio) will be affected!

Step 4: Calculate your net worth

Your net worth is an indication of your total wealth. You can calculate your net worth with this basic equation: total assets (Table 2-1) less total liabilities (Table 2-2) equal net worth (net assets or net equity).

Table 2-3 shows this equation in action with a net worth of $173,590 — a very respectable number. For many investors, just being in a position where assets exceed liabilities (a positive net worth) is great news. Use Table 2-3 as a model to analyze your own financial situation. Your mission (if you choose to accept it — and you should) is to ensure that your net worth increases from year to year as you progress toward your financial goals (I discuss financial goals later in this chapter).

Table 2-3 Figuring Your Personal Net Worth

Totals

Amounts ($)

Increase from Year Before

Total assets (from Table 2-1)

$290,590

+5%

Total liabilities (from Table 2-2)

($117,000)

–2%

Net worth (total assets less total liabilities)

$173,590

+3%

Step 5: Analyze your balance sheet

After you create a balance sheet (based on the steps in the preceding sections) to illustrate your current finances, take a close look at it and try to identify any changes you can make to increase your wealth. Sometimes, reaching your financial goals can be as simple as refocusing the items on your balance sheet (use Table 2-3 as a general guideline). Here are some brief points to consider:

·        Is the money in your emergency (or rainy day) fund sitting in an ultrasafe account and earning the highest interest available? Bank money market accounts or money market funds are recommended. The safest type of account is a U.S. Treasury money market fund. Banks are backed by the Federal Deposit Insurance Corporation (FDIC), while U.S. treasury securities are backed by the “full faith and credit” of the federal government. Shop around for the best rates at sites such as www.bankrate.comwww.lendingtree.com, and www.lowermybills.com.

·        Can you replace depreciating assets with appreciating assets? Say that you have two stereo systems. Why not sell one and invest the proceeds? You may say, “But I bought that unit two years ago for $500, and if I sell it now, I’ll get only $300.” That’s your choice. You need to decide what helps your financial situation more — a $500 item that keeps shrinking in value (a depreciating asset) or $300 that can grow in value when invested (an appreciating asset).

·        Can you replace low-yield investments with high-yield investments? Maybe you have $5,000 in a bank certificate of deposit (CD) earning 3 percent. You can certainly shop around for a better rate at another bank, but you can also seek alternatives that can offer a higher yield, such as U.S. savings bonds or short-term bond funds. Just keep in mind that if you already have a CD and you withdraw the funds before it matures, you may face a penalty (such as losing some interest).

·        Can you pay off any high-interest debt with funds from low-interest assets? If, for example, you have $5,000 earning 2 percent in a taxable bank account and you have $2,500 on a credit card charging 18 percent (which is not tax-deductible), you may as well pay off the credit card balance and save on the interest.

·        If you’re carrying debt, are you using that money for an investment return that’s greater than the interest you’re paying? Carrying a loan with an interest rate of 8 percent is acceptable if that borrowed money is yielding more than 8 percent elsewhere. Suppose that you have $6,000 in cash in a brokerage account. If you qualify, you can actually make a stock purchase greater than $6,000 by using margin (essentially a loan from the broker). You can buy $12,000 of stock using your $6,000 in cash, with the remainder financed by the broker. Of course, you pay interest on that margin loan. But what if the interest rate is 6 percent and the stock you’re about to invest in has a dividend that yields 9 percent? In that case, the dividend can help you pay off the margin loan, and you keep the additional income. (For more on buying on margin, see Chapter 17.)

·        Can you sell any personal stuff for cash? You can replace unproductive assets with cash from garage sales and auction websites.

·        Can you use your home equity to pay off consumer debt? Borrowing against your home has more favorable interest rates, and this interest is still tax-deductible.

warning Paying off consumer debt by using funds borrowed against your home is a great way to wipe the slate clean. What a relief to get rid of your credit card balances! Just don’t turn around and run up the consumer debt again. You can get overburdened and experience financial ruin (not to mention homelessness). Not a pretty picture.

The important point to remember is that you can take control of your finances with discipline (and with the advice I offer in this book).

Funding Your Stock Program

If you’re going to invest money in stocks, the first thing you need is … money! Where can you get that money? If you’re waiting for an inheritance to come through, you may have to wait a long time, considering all the advances being made in healthcare lately. (What’s that? You were going to invest in healthcare stocks? How ironic.) Yet, the challenge still comes down to how to fund your stock program.

Many investors can reallocate their investments and assets to do the trick. Reallocating simply means selling some investments or other assets and reinvesting that money into something else (such as stocks). It boils down to deciding what investment or asset you can sell or liquidate. Generally, you want to consider those investments and assets that give you a low return on your money (or no return at all). If you have a complicated mix of investments and assets, you may want to consider reviewing your options with a financial planner. Reallocation is just part of the answer; your cash flow is the other part.

Ever wonder why there’s so much month left at the end of the money? Consider your cash flow. Your cash flow refers to what money is coming in (income) and what money is being spent (outgo). The net result is either a positive cash flow or a negative cash flow, depending on your cash management skills. Maintaining a positive cash flow (more money coming in than going out) helps you increase your net worth. A negative cash flow ultimately depletes your wealth and wipes out your net worth if you don’t turn it around immediately.

The following sections show you how to calculate and analyze your cash flow. The first step is to do a cash flow statement. With a cash flow statement, you ask yourself three questions:

·        What money is coming in? In your cash flow statement, jot down all sources of income. Calculate income for the month and then for the year. Include everything: salary, wages, interest, dividends, and so on. Add them all up and get your grand total for income.

·        What is your outgo? Write down all the things that you spend money on. List all your expenses. If possible, categorize them as essential and nonessential. You can get an idea of all the expenses that you can reduce without affecting your lifestyle. But before you do that, make as complete a list as possible of what you spend your money on.

·        What’s left? If your income is greater than your outgo, you have money ready and available for stock investing. No matter how small the amount seems, it definitely helps. I’ve seen fortunes built when people started to diligently invest as little as $25 to $50 per week or per month. If your outgo is greater than your income, you better sharpen your pencil. Cut down on nonessential spending and/or increase your income. If your budget is a little tight, hold off on your stock investing until your cash flow improves.

remember Don’t confuse a cash flow statement with an income statement (also called a profit and loss statement or an income and expense statement). A cash flow statement is simple to calculate because you can easily track what goes in and what goes out. Income statements are a little different (especially for businesses) because they take into account things that aren’t technically cash flow (such as depreciation or amortization). Find out more about income statements in Chapter 11.

DOT-COM-AND-GO

If you were publishing a book about negative cash flow, you could look for the employees of any one of 100 dot-com companies to write it. Their qualifications include working for a company that flew sky-high in 1999 and crashed in 2000 and 2001. Companies such as eToys.com, Pets.com, and DrKoop.com were given millions, yet they couldn’t turn a profit and eventually closed for business. You may as well call them “dot-com-and-go.” You can learn from their mistakes. (Actually, they could have learned from you.) In the same way that profit is the most essential single element in a business, a positive cash flow is important for your finances in general and for funding your stock investment program in particular.

Step 1: Tally up your income

Using Table 2-4 as a worksheet, list and calculate the money you have coming in. The first column describes the source of the money, the second column indicates the monthly amount from each respective source, and the last column indicates the amount projected for a full year. Include all income, such as wages, business income, dividends, interest income, and so on. Then project these amounts for a year (multiply by 12) and enter those amounts in the third column.

Table 2-4 Listing Your Income

Item

Monthly $ Amount

Yearly $ Amount

Salary and wages

   

Interest income and dividends

   

Business net (after taxes) income

   

Other income

   

Total income

   

remember Your total income is the amount of money you have to work with. To ensure your financial health, don’t spend more than this amount. Always be aware of and carefully manage your income.

Step 2: Add up your outgo

Using Table 2-5 as a worksheet, list and calculate the money that’s going out. How much are you spending and on what? The first column describes the source of the expense, the second column indicates the monthly amount, and the third column shows the amount projected for a full year. Include all the money you spend: credit card and other debt payments; household expenses, such as food, utility bills, and medical expenses; and nonessential expenses such as video games and elephant-foot umbrella stands.

Table 2-5 Listing Your Expenses (Outgo)

Item

Monthly $ Amount

Yearly $ Amount

Payroll taxes

   

Rent or mortgage

   

Utilities

   

Food

   

Clothing

   

Insurance (medical, auto, homeowners, and so on)

   

Telephone/Internet

   

Real estate taxes

   

Auto expenses

   

Charity

   

Recreation

   

Credit card payments

   

Loan payments

   

Other

   

Total outgo

   

tip Payroll taxes is just a category in which to lump all the various taxes that the government takes out of your paycheck. Feel free to put each individual tax on its own line if you prefer. The important thing is creating a comprehensive list that’s meaningful to you.

remember You may notice that the outgo doesn’t include items such as payments to a 401(k) plan and other savings vehicles. Yes, these items do impact your cash flow, but they’re not expenses; the amounts that you invest (or your employer invests for you) are essentially assets that benefit your financial situation versus expenses that don’t help you build wealth. To account for the 401(k), simply deduct it from the gross pay before you calculate the preceding worksheet (Table 2-5). If, for example, your gross pay is $2,000 and your 401(k) contribution is $300, then use $1,700 as your income figure.

Step 3: Create a cash flow statement

Okay, you’re almost to the end. The next step is creating a cash flow statement so that you can see (all in one place) how your money moves — how much comes in and how much goes out and where it goes.

Plug the amount of your total income (from Table 2-4) and the amount of your total expenses (from Table 2-5) into the Table 2-6 worksheet to see your cash flow. Do you have positive cash flow — more coming in than going out — so that you can start investing in stocks (or other investments), or are expenses overpowering your income? Doing a cash flow statement isn’t just about finding money in your financial situation to fund your stock program. First and foremost, it’s about your financial well-being. Are you managing your finances well or not?

Table 2-6 Looking at Your Cash Flow

Item

Monthly $ Amount

Yearly $ Amount

Total income (from Table 2-4)

   

Total outgo (from Table 2-5)

   

Net inflow/outflow

   

remember At the time of this writing, 2015 was shaping up to be yet another record year for personal, government, and business debt. Personal debt and expenses far exceeded whatever income they generated. That announcement is another reminder to watch your cash flow; keep your income growing and your expenses and debt as low as possible.

Step 4: Analyze your cash flow

Use your cash flow statement in Table 2-6 to identify sources of funds for your investment program. The more you can increase your income and decrease your outgo, the better. Scrutinize your data. Where can you improve the results? Here are some questions to ask yourself:

·        How can you increase your income? Do you have hobbies, interests, or skills that can generate extra cash for you?

·        Can you get more paid overtime at work? How about a promotion or a job change?

·        Where can you cut expenses?

·        Have you categorized your expenses as either “necessary” or “nonessential”?

·        Can you lower your debt payments by refinancing or consolidating loans and credit card balances?

·        Have you shopped around for lower insurance or telephone rates?

·        Have you analyzed your tax withholdings in your paycheck to make sure that you’re not overpaying your taxes (just to get your overpayment back next year as a refund)?

Another option: Finding investment money in tax savings

According to the Tax Foundation (www.taxfoundation.org), the average U.S. citizen pays more in taxes than for food, clothing, and shelter combined. Sit down with your tax advisor and try to find ways to reduce your taxes. A home-based business, for example, is a great way to gain new income and increase your tax deductions, resulting in a lower tax burden. Your tax advisor can make recommendations that work for you.

tip One tax strategy to consider is doing your stock investing in a tax-sheltered account such as a traditional Individual Retirement Account (IRA) or a Roth Individual Retirement Account (Roth IRA). Again, check with your tax advisor for deductions and strategies available to you. For more on the tax implications of stock investing, see Chapter 21.

Setting Your Sights on Your Financial Goals

Consider stocks as tools for living, just like any other investment — no more, no less. Stocks are among the many tools you use to accomplish something — to achieve a goal. Yes, successfully investing in stocks is the goal that you’re probably shooting for if you’re reading this book. However, you must complete the following sentence: “I want to be successful in my stock investing program to accomplish _____.” You must consider stock investing as a means to an end. When people buy a computer, they don’t (or shouldn’t) think of buying a computer just to have a computer. People buy a computer because doing so helps them achieve a particular result, such as being more efficient in business, playing fun games, or having a nifty paperweight (tsk, tsk).

remember Know the difference between long-term, intermediate-term, and short-term goals, and then set some of each (see Chapter 3 for more information).

·        Long-term goals refer to projects or financial goals that need funding five or more years from now.

·        Intermediate-term goals refer to financial goals that need funding two to five years from now.

·        Short-term goals need funding less than two years from now.

remember Stocks, in general, are best suited for long-term goals such as these:

·        Achieving financial independence (think retirement funding)

·        Paying for future college costs

·        Paying for any long-term expenditure or project

Some categories of stock (such as conservative or large cap) may be suitable for intermediate-term financial goals. If, for example, you’ll retire four years from now, conservative stocks can be appropriate. If you’re optimistic (or bullish) about the stock market and confident that stock prices will rise, go ahead and invest. However, if you’re negative about the market (you’re bearish, or you believe that stock prices will decline), you may want to wait until the economy starts to forge a clear path.

warning Stocks generally aren’t suitable for short-term investing goals because stock prices can behave irrationally in a short period of time. Stocks fluctuate from day to day, so you don’t know what the stock will be worth in the near future. You may end up with less money than you expected. For investors seeking to reliably accrue money for short-term needs, short-term bank certificates of deposit or money market funds are more appropriate.

remember In recent years, investors have sought quick, short-term profits by trading and speculating in stocks. Lured by the fantastic returns generated by the stock market during 2009–2015, investors saw stocks as a get-rich-quick scheme. It’s very important for you to understand the differences among investing, saving, and speculating. Which one do you want to do? Knowing the answer to this question is crucial to your goals and aspirations. Investors who don’t know the difference tend to get burned. Here’s some information to help you distinguish among these three actions:

·        Investing is the act of putting your current funds into securities or tangible assets for the purpose of gaining future appreciation, income, or both. You need time, knowledge, and discipline to invest. The investment can fluctuate in price, but you’ve chosen it for long-term potential.

·        Saving is the safe accumulation of funds for a future use. Savings don’t fluctuate and are generally free of financial risk. The emphasis is on safety and liquidity.

·        Speculating is the financial world’s equivalent of gambling. An investor who speculates is seeking quick profits gained from short-term price movements in a particular asset or investment. (In recent years, many folks have been trading stocks [buying and selling in the short term with frequency], which is in the realm of short-term speculating.)

These distinctly different concepts are often confused, even among so-called financial experts. I know of one financial advisor who actually put a child’s college fund money into an Internet stock fund, only to lose more than $17,000 in less than ten months! For more on the topic of risk, go to Chapter 4.