May 6, 2008
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About the Author
Stress Free Traders helps day traders and investors choose hot stock trading opportunities in a practical way every day at http://www.StressFreeTraders.com
How to get started investing in stocks
By Charlie Davis
When people ask me how to get started investing in stocks, I usually give them the following game plan which is the same plan I use for every goal that I make for myself.
1. Write out your objective.
2. Develop a plan for achieving your objective (education)
3. Execute the plan.
Now let’s go through an example very similar to what I went through when I started investing. I warn you, this is a very detailed and, for some people, tedious process to go through. The more detailed the plan the better off you’ll be so if you’re serious about achieving goals make a very detailed plan!
1. Objective:
“To replace my job income in 10 years with income from stock investments. The gross amount I need to earn per year is $50,000. Assuming a return of 10% per year from stock investments means I would need to have $500,000 to invest.”
Assumptions:
1. That I can make a consistent 10% return on my portfolio each year.
2. That taxes will be similar or less than the employment taxes I pay each year on my gross salary of $50,000.
2. Develop a plan for achieving your objective (education)
My goal is to get to $500,000. I know that the journey of $500,000 begins with the first dollar. In building a plan I ask myself a lot of questions and try to come up with some reasonable answers.
Q: How much money can I afford to put away for this purpose?
A: I look at my budget and determine I can afford $200 per month for this goal but no more. I might as well save the money for investing starting now and be building up a balance. I don’t know how much I will need to open a brokerage account so the more I have when I’m ready to begin the better off I’ll be. I don’t have a brokerage account yet so I open a savings account specifically for this goal (and nothing else!) and I place an automatic transfer from my checking account into the savings account for $200 per month. I automate the transfer so I don’t have to think about it or remember to do it, it just happens.
Q: How much money will I need to open a brokerage account?
A: Time to do a little digging. I review some brokerage firms and decide to go with Ameritrade. I log on to Ameritrade.com and take a look at their funding requirements for new accounts. I see a link in the upper left corner of the main page that says Open An Account. I click it and discover it is a drop down menu with 5 options. The first option is Overview so I click that. That takes me to a page where I quickly see a link for FAQs or Frequently Asked Questions. I click that link and lo and behold the first question is What is the minimum amount required for opening an account? I get the following answer:
What is the minimum amount required for opening an account? Generally, $1,000 equity is required to open an IRA and $2,000 equity is required to open any non-IRA. Your minimum initial deposit is based on the account type you have selected and may be modified by special promotional offers. Regardless of any promotional offer, a $2,000 minimum deposit is required to be considered for margin and options privileges.
After thinking about it for a bit I decide that I want to go all the way with this and get an account with margin and options privileges (whatever those are - remember I’m a beginner) so I know I need to save $2000 to open the account I want. That will take me 10 months of saving.
Q: What do I do while I’m saving my initial account deposit?
A: Educate myself. I need to learn as much about stocks as possible in 10 months (or longer if that’s what it takes) so I comb Amazon.com for titles regarding stocks. After reading a ton of reviews I come up with about 15 titles that look promising. I already have an “education fund” budgeted so I use money from that to order the books. Then I turn my attention to the details of acquiring $500,000 until the books arrive.
Q: If I made 10% starting with my $2000 and kept adding $200 per month to my account, how long will it take to accumulate $500,000?
A: Being a savvy Microsoft Excel user, I punch in some numbers taking into account savings, interest and taxes and get the following answer (This answer is fairly accurate by the way): 490 months or 40.83 years!!! Wow, that’s not going to work! I need to make tweaks to my plan!
Q: What are some problems with my savings plan?
A: Well, I get a raise of roughly 3% every year at my job and I didn’t increase my $200 deposits at all. I could raise my deposit confidently by 25 dollars per month every year and see what that does. I make the changes and the answer is now 363 months or 30.25 years. Wow! Just by increasing the deposit per month by $25 after every year I take off over ten years from the required time. Still, 30.25 years is still a long time. I would like to accomplish this goal in 10 years.
Q: Instead of throwing any more money at the problem right now I decide to try a different approach. What percent per year would I have to earn in order to reach my goal in 10 years based on the deposits I have planned?
A: I create another worksheet in excel and start bumping up the the interest amount until I get my answer: 54.553%. But as you have probably noticed the goal has changed. Since I am no longer assuming 10% interest, the amount of money that I need at a higher interest rate has gone down. I now only need about $186,000. But this leads to the next question.
Q: Is there a way to make 54.533% per year consistently in the stock market?
A: I don’t know (Remember, I’m a beginner) but I got 10 months to find out!
My books come in and I start to read. This is serious stuff so I take notes on the important points. I read slowly but consistently. I make sure I read at least 5 % of the book per day. No less, no more. So, for a 300 page book, I read 15 pages per day. I don’t want to get burned out or miss important facts by reading too fast and too much and yet I want to keep a pretty aggressive reading schedule. At this rate I can finish about fifteen 300 page books in a 10 month period. I put into practice what I learn. I check websites for quotes, I learn about picking stocks, when to buy, when to sell, buying options etc…. And, I paper trade. That’s right, I pretend I have a brokerage account and that I’m buying and selling stocks and stock options. This is the time to make mistakes and learn from them not when you’re dealing with real money.
Meanwhile I am revisiting my plan a couple of times a week. I find ways to throw more money at the problem to reduce that huge goal of 54.533% per year. I also am realizing that large returns can be made with properly applied techniques of stock options, chart reading and a 7 or 8 percent loss sell rule to avoid really big losses! I learn that a year is a long time and if I’m careful and patient that a 55% return can be done. I also factor in some more detail like the payments I make during the year will be making interest.
3. Execute the plan
By the time the 10 months have passed, I am very excited to get started. I have a very detailed plan of exactly what I’m going to do. I’ve developed sound investing rules that absolutely will not be broken and I have gained 10 months of confidence from paper trading. I also have worked my goal down to needing a 35% or so gain each year on average. This is still a daunting goal but I’m feeling very confident from my paper trading that I can do it. The only thing to do now is to execute the plan.
In Summary:
Getting started in stock investing is not easy. It takes work and a detailed plan. The creation of the plan is the most labor intensive part of the process. Executing the plan should be the easiest part of the process - to the point of being boring. If it’s not, then you need to go back and work some more on your plan! I use checklists with mandatory questions on them like:
1. Is the overall market in an uptrend or a downtrend?
2. Did you put a 8% stop loss order on your stock after you bought it?
These questions (and dozens more!) help me think about what I’m doing, they enforce my rules. Key Point!: Whenever I do something stupid, I add an item to the checklist that forces me not to make that mistake again.
You also need to make sure that the objective is even necessary. This comes as part of the question and answer process. Do I really need to make $50,000 per year? Just because I make $50,000 now, does that mean I’ll really need that much in 10 years? I could refinance the house at that time to reduce my debt expense per month or I could investigate the tax consequences of making a living from paper assets vs. having job income. Surely employees get taxed more than capital gains income right? I don’t need to pay social security tax or FICA tax on capital gains do I? Find out. Leave no stone unturned. Good luck to you!
About the Author
Charlie Davis is a Systems Development Analyst by trade, a stock investor at heart, and a web author in the evenings.
Every weekend he combs the top 20% of all stocks based on earnings and uses formulas such as covered calls, 52 week highs on high volume, rolling stocks, etc…. to make money in the market. He provides this information for free at http://www.charlielovesstocks.com
