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I sat down with a close friend of mine who’s a finance professional, and who has worked in the industry for the last four years. I often go to her for advice if I’m making a big financial decision, or If I need help understanding an aspect of the financial system/stock market I can’t wrap my head around. I’ll even text or email her if I hear a bit of financial jargon I don’t quite understand.
This week, she answered eight of my very basic investing questions so that I can get a better handle on not only the stock market, but how to manage my money more smartly, and how to make it work hardest for me. You see, I don’t yet invest at all in the stock market, but it’s a goal of mine. I want to ensure that I have as comprehensive an understanding as possible so that I can do right by me and my money. Check it out, and take a look at our interview below!
1. Wait for it….What is investing in a nutshell?
Hah! That’s actually a very good question. A lot of people assume they know the answer to that question because they should because they hear it so often. So, in very basic layman’s terms, investing simply means that you are putting money or capital into something with the expectation that that asset will increase in value or provide you with additional income. It means that you are deciding that this money you set aside is going to “work” for you, for lack of a better word. It’s not any more complicated than that!
2. How far out do I need to plan my financial goals in order to invest? Does it matter?
This is another question I get all the time, and it’s really got to be determined on a case-by-case basis, factoring in each person’s goals and financial situation. Here’s a great short list of some of the questions you should have answers to before you invest significantly:
What are my investing goals, and what do I want out of this? Am I saving for a large purchase like a car or an apartment/house, or long-term for retirement?
Do I have the flexibility to afford this investment once all my essentials are paid off, and I’ve put money into my emergency fund?
Am I comfortable with the level of risk involved with this investment?
How much can I afford to lose?
How long do I plan to keep this money invested?
What other things have I invested in? Are my targeted investment diversified?
3. Can I invest if I have debt?
Of course, you can! However, you need to make the decision for yourself based on your very specific situation. If you have student loans or consumer debt, you need to make the decision on where your money would be best utilized. This article is a great read on how you can help make that decision for yourself. It says, “If you pay off debt first, you will lose the power of compound interest on the investments you could have made with that money. But if you invest first, you will be stuck with managing the debt, paying high-interest rates, and other unintended consequences.” There is a lot to think about when it comes to tradeoffs vs. gains, and it’s helpful to assess which of the two would be the most financially attractive. This is another great in-depth read on learning how to invest when you are (potentially) deep in debt. Finally, TFD posted an article about investing with student loans here.
4. What’s the difference between a stock and a share?
This is an incredibly common question I get asked by people who have a hard time understanding these smaller details that add up to massive confusion when we start to get into larger and more complicated discussions. The answer is quite simple. A “stock” is a general term that describes the ownership of certificates of any company. A “share” is a general term that describes ownership of a particular company. That’s all that means. Share is a more granular term since it applies to something specific.
5. What is a dividend?
Gotta love a sweet little video explaining what a dividend is! A dividend, again, in basic terms here, is a payment a corporation makes to its shareholders. This payment, or distribution, can be used to reinvest in more shares of the same company, buy shares in another company, or transferred out of your brokerage account to be used for whatever you want, really. (Side note: shareholders/stockholder is a basic term used to refer to anyone, a person, institution, or even a corporation, who legally owns a share of stock in a public or private corporation.)
6. What the heck is an ETF? Should I care/know what it is?
An ETF is an exchange-traded fund, an investment fund that typically tracks a stock or bond index, or the value of a commodity. What is a bond index you may ask? It’s simply a compilation of pricing data for a number of investments to track the performance of a segment of the stock or bond market. Now, back to ETFs! Investors can buy and sell ETFs like they would common stocks. These ETFs have become incredibly popular due to low costs and high daily liquidity (i.e. there are many buyers and sellers transacting frequently). This is because ETFs typically have low expense due to their passive investment strategy and low turnover of securities in the fund. It’s a less active approach to investing, but there is a lot of evidence that shows passive investing strategies beat more active ones in the long run. TFD mentioned ETFs in their Investing Terms YouTube video awhile back! Be sure to watch that!
7. Am I taxed on the money I make in the stock market?
Yes. You’re totally taxed on the money you make in the stock market. This way, financial advisors advocate for you to put money in tax-sheltered account like a 401(k) and/or IRA (which grow tax-free until you retire. Cha chiiiiiing). Depending on your specific situation, you can be taxed different percentages — typically ranging from 15% up to your highest income tax bracket percentage. You’re taxed on both dividends or capital gains, but again, that depends on what type of stock you had. You can read up on it in more detail in the articles linked here and here.
8. Do I physically go somewhere to invest, or is it all done online?
You never need to get up off your couch! There are a number of online brokerage accounts you can choose from, each with different fees per trade, minimum balances, and other features. You can link up your bank account to make an initial transfer to get started and decide how you would like to fund the account going forward, maybe setting aside a small amount of each paycheck or waiting to accumulate a bit of savings and sweeping the excess into your brokerage account every few months. Most of these brokerage accounts are pretty self-service, which also makes them lower-fee than using an investment advisor or financial planner. Here’s a helpful article that weighs the pros and cons of using an investment advisor to help you decide whether using one is right for you.