3 Things to Do Before Investing in the Stock Market

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By John Schmoll

Investing in the stock market is often viewed as one of the best ways to grow wealth and reach long-term financial goals. Unfortunately no handbook is given out when you start to invest, which leads to mistakes, discouragement and a decision by some to give up on investing altogether.

If you find yourself in need of guidance as you start investing in the stock market, below are some tips to help get you started.

1. Review your finances.

The first thing you should do is determine how much money you have to invest. Take a look through a wide-angle lens to view your entire financial life. Ask yourself:
  • Am I currently carrying any consumer debt?
  • Do I have an emergency fund to cover my needs in the event of a job loss?
Depending on the answer to those two questions, you should be better able to determine how much you have to invest in the stock market. Do not worry about how much or how little you have to invest, as the key is to start investing. This is where the idea behind compound interest comes into play. The sooner you begin, the more time your money has to grow. With wise investments, a little can turn into a lot over a long period of time, so don't let a small starting amount scare you away from investing.

2. Educate yourself.

Education might be the most important factor in early investing success. This is especially the case if you haven't had much experience with investing prior to now. %VIRTUAL-article-sponsoredlinks%If you are like many beginning investors, you may not know where to look for quality, unbiased investing guidance. While there are many resources online, the best resources can be found through your 401(k) provider or online brokerage. In most cases, this education is free and can be a great boost to your investment knowledge.

Not only will educating yourself help you feel less overwhelmed when it comes to investing, it should also help your bottom line because you'll learn how to recognize high-fee investments, avoid them and move toward a purposeful investment strategy.

3. Invest with a plan.

It may sound obvious, but one of the first things you should do when you start investing is come up with an investment plan. This investment plan can be as simple or as detailed as you want. Think of it like using a map or GPS when traveling on vacation. You likely will get nowhere near your chosen destination without a form of navigation, and investing is no different.

The investment plan stage is where you need to determine your investing goals. For example:
  • Are you investing for retirement?
  • Are you investing for a child's college education?
  • Are you investing to provide income now that you're retired?
These are just some of the questions you can ask yourself. The key to is to make your plan personal. Tailor it to the amount of time you have to reach your goals and your risk tolerance. Your answers to questions like the ones above will help you form a framework for your investment plan that can ultimately help you reach your investing goals.

The bottom line: Investing in the stock market can be overwhelming, but by following a few simple steps, you can start down the road of investing for your future needs.

John Schmoll is the founder of personal finance website frugalrules.com, an online community centered on increasing financial literacy, budgeting, investing and finding freedom through frugality.

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3 Things to Do Before Investing in the Stock Market

Warren Buffett is a great investor, but what makes him rich is that he's been a great investor for two thirds of a century. Of his current $60 billion net worth, $59.7 billion was added after his 50th birthday, and $57 billion came after his 60th. If Buffett started saving in his 30s and retired in his 60s, you would have never heard of him. His secret is time.

Most people don't start saving in meaningful amounts until a decade or two before retirement, which severely limits the power of compounding. That's unfortunate, and there's no way to fix it retroactively. It's a good reminder of how important it is to teach young people to start saving as soon as possible.

Future market returns will equal the dividend yield + earnings growth +/- change in the earnings multiple (valuations). That's really all there is to it.

The dividend yield we know: It's currently 2%. A reasonable guess of future earnings growth is 5% a year. What about the change in earnings multiples? That's totally unknowable.

Earnings multiples reflect people's feelings about the future. And there's just no way to know what people are going to think about the future in the future. How could you?

If someone said, "I think most people will be in a 10% better mood in the year 2023," we'd call them delusional. When someone does the same thing by projecting 10-year market returns, we call them analysts.

Someone who bought a low-cost S&P 500 index fund in 2003 earned a 97% return by the end of 2012. That's great! And they didn't need to know a thing about portfolio management, technical analysis, or suffer through a single segment of "The Lighting Round."

Meanwhile, the average equity market neutral fancy-pants hedge fund lost 4.7% of its value over the same period, according to data from Dow Jones Credit Suisse Hedge Fund Indices. The average long-short equity hedge fund produced a 96% total return -- still short of an index fund.

Investing is not like a computer: Simple and basic can be more powerful than complex and cutting-edge. And it's not like golf: The spectators have a pretty good chance of humbling the pros.

Most investors understand that stocks produce superior long-term returns, but at the cost of higher volatility. Yet every time -- every single time -- there's even a hint of volatility, the same cry is heard from the investing public: "What is going on?!"

Nine times out of ten, the correct answer is the same: Nothing is going on. This is just what stocks do.

Since 1900 the S&P 500 (^GSPC) has returned about 6% per year, but the average difference between any year's highest close and lowest close is 23%. Remember this the next time someone tries to explain why the market is up or down by a few percentage points. They are basically trying to explain why summer came after spring.

Someone once asked J.P. Morgan what the market will do. "It will fluctuate," he allegedly said. Truer words have never been spoken.

The vast majority of financial products are sold by people whose only interest in your wealth is the amount of fees they can sucker you out of.

You need no experience, credentials, or even common sense to be a financial pundit. Sadly, the louder and more bombastic a pundit is, the more attention he'll receive, even though it makes him more likely to be wrong.

This is perhaps the most important theory in finance. Until it is understood you stand a high chance of being bamboozled and misled at every corner.

"Everything else is cream cheese."
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