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Last month I wrote a guest post entitled, I’ve got the Time, How do I Get the Money, here at BFS. That article broadly covered investing and underscored why you should start to invest NOW! Following with the educational mission of BarbaraFriedbergPersonalFinance, this article continues the investing theme and breaks down one of the most basic pieces of the investing puzzle: Stocks.

Flash back a million years (okay, a couple of decades)……When I first started investing, all I knew was that in the late 1920’s and early 30’s the stock market crashed, people lost all their money, and went jumping off of buildings. Armed with that one-sided information, at the beginning of my investing life, I WAS TERRIFIED OF THE STOCK MARKET. I thought it was a place where you put your money and it all went away!

Over time, education, and lots of experience I came to understand that investing in stocks is more than a one way ticket to the poor house. In fact, it might even be a way to build wealth. So………

WHAT IS A STOCK?

A stock is part ownership in a corporation. When you buy a share of stock, you are buying a small fraction of the entire company. Some stocks pay dividends and others do not. A dividend is a small cash payment expressed as a percent of the purchase price. These payments are paid from 1 to 4 times/year and range from 0.5% on up to 8% or more. The 49 year average for dividend payments from 1960-2009 was 3.17%. 3% looks pretty good today considering my savings account interest rate does not even approach 1%!

Historically, stocks had higher returns than bonds and cash assets; although during the first decade of 2000 something very unusual happened; bonds returned more than stocks. Does that mean that I should give up the idea of investing in stocks?

I don’t think so. As a matter of fact, contrarian investors might suggest that the best time to invest in an asset class (i.e. stocks) is after a period of poor performance. Have you ever heard of the statement, “Buy low sell high?” Typically, after a period of underperformance, it is a good time to invest.

What does this Mean to ME?

  • Like any other investment, investing in stocks offers the opportunity for increases and decreases in your personal wealth.
  • In the short term, the stock market is very volatile and goes up and down a lot. So, NEVER invest in the stock market any money that you need in the next 5+ years.
  • In the long term, it is likely that a diversified portfolio which includes some stock investments will offer a return greater than bonds, cash, and the rate of inflation! In fact, over the last century, including dividends the S & P 500 (a proxy for the US stock market) returned approximately 9%/year*.
  • If you are saving for retirement, a down payment for a house (greater than 5+ years away), or college expenses for your kid, you might want to put some of your cash in the stock market.

WHAT SHOULD I DO?

  • Make sure you have some savings, term life insurance (if you have dependents), and NO credit card debt.
  • Read and educate yourself about investing.
  • A work retirement account (401K) is a great place to start investing.

In sum, don’t be afraid of investing in the stock market. Stock mutual funds are a great place to begin investing. But, before you begin, get educated!

*Caveat: This article is for information purposes only and may not be appropriate for your individual situation.

Crystal’s Question:  Since stocks could be one of the best investments for 2011, do you have any stock questions for Barbara?  Come on, this is your chance here at BFS since I know nothing, lol.  🙂