Expert: Paul Henneman - 7/9/2006

Question
I'm interested in knowing how does the stock market works. If i have large amount of money how do i know which stocks will do good in the markets?

Also if you do good in the stock market how do you get your money? Is it through your investor writing you a check or give you a ticket? How much does the investor get out of your percentage?

Answer
Andrew,
  Thank you for your question!
  Unfortunately this is a huge topic, far to large for me to adequately address here. I have included some information below on how I think people should get started in the stock market, and how to think about future finances in general. The stock market is a difficult place, it is almost as easy to lose money as it is to make it. Professionals spend their entire lives studying the stock market and how to make money in it, and it is a very complex issue that does not have any one single clear answer. I hope that the below information is helpful:

The earlier you begin to plan, the easier it will be. Investments take time to grow.
I believe that you should think of things in terms of three different categories, and I will offer further specifics on each:  1. Debt reduction to lead to debt elimination 2. Education 3. Action

1. Debt Reduction and elimination of debt:
Start immediately with this. It is key to the financial well being of everyone in the future. People in this country has a very bad habit of running high debt in the form of credit cards, car loans, and all sorts of credit for just about anything.  Credit is so easy to get, it is difficult for many young people to resist. By the time most of us are adults, the terrible cycle of high debt is already established. The first key to a wonderful lifestyle in the second half of life is to resist this.
Most credit cards charge 15% or more in interest. It does not make sense to invest when folks are paying so much extra for each purchase! If you have credit cards and/or car loans, pay them off. This usually frees up hundreds and hundreds of extra dollars each month that normally goes to these bills. This can be used to both invest and improve your lifestyle. If you can't pay cash, you can't afford it! The exception is real estate, as that is 'appreciating asset' that increases in value.  It is a good move to purchase and own a home if it is feasible.
There is nothing worse than paying high interest on a car, then having that car decline so rapidly in value as you use it, possibly the worst of ‘depreciating assets’ that exists. Of course we all need cars, but if the money is not there, don't buy an Acura when a Honda will do so to speak. Put as much down as possible, and see about a 3 year or less loan. The goal is to pay it off as quickly as possible, then drive it 'free and clear' for as long as possible. Cars are perhaps the largest things standing in the way of most people having a truly wonderful second half of life.  We are conditioned to buy the most expensive car possible and this is a huge drain on our finances.
Good investors can double their money every five years. Take the $25,000 price tag of an average car these days, go out 40 years, and see how much that car actually costs!

2. Education
Successful investing takes discipline, education, and patience. A plan should be established and strictly followed for decades. My suggestion is to spend the next six months researching. Start with "Investing for Dummies", available at amazon.com and most major bookstores. This will give you the basics on most major forms of investment, and you can do further research on what appeals to you. In general, the higher the possible return of an investment, the more risky it is. As an example, a money market account will earn you about 2% a year; this is a very low gain. But it is perfectly safe and you would get that 2% every year without fail. A portfolio of stocks can earn you on average 20% or more each year. But some years will be good, and others bad. Many investors lost half or more of their worth during the bad markets of 2001 and 2002. However, over a long period of time, the risk evens out and the returns are much more substantial. An average of 20% return each year would double your investment every four years. (Not every five, as you have to account for the growth in the portfolio for the next year returns).  Another good resource here is any of the books written by William O’Neil, founder of Investment Business Daily. Keep in mind this is one approach, but he goes into depth on how he successfully selects stocks and builds a stock portfolio. Always read with a critical mind, no one has the holy grail when it comes to investing. If they claim that they do, it is a scam. There will always be failures, but the idea is find more successes than failures. This is very possible over time.
I believe that the ultimate solution is two fold. First, move slowly. While stocks and other investments can treat you well, they can also treat you very poorly if the wrong decisions are made. Start with a money market, this is a great place to 'park' your savings while you learn more. The one I like best, with the highest returns I have seen and FDIC insured (very important) is www.NetBank.com. Then I suggest mutual funds. Do your research. The book I mentioned above will help, and www.morningstar.com is perhaps the best-known source of mutual fund information available. Lipper is another. When you have more than $5,000 invested, branch out to several mutual funds that specialize in different areas such as real estate, technology, health care, utilities, or others. That way if a specific industry does poorly, you will not feel it too badly.
Only after a few years or whenever you feel confident should you venture into stocks. But start practicing right away. Begin researching possible stocks you would want to invest in (again the book I mentioned will help you learn what to look for).  Track your ideas on a free service such as yahoo.finance.com and see what your stock picks do.

3. Action
When you are finally ready, my suggestion would be to have 20% of your portfolio in safe investments such as bonds and money market accounts, 30% in stocks and 50% in mutual funds.  You will likely not have a large amount to start with, so begin with a mutual fund. Continue to contribute every month, and it should grow further in addition to the returns you get. When you have enough, buy into a second, then a third mutual fund. When you have at least 10 to 15 thousand in mutual funds, begin to think about a stock portfolio. Always hold a basket of stocks, not a single stock, as it is too risky if you are wrong in your decision. For trading services I like www.FOLIOfn.com the best, www.ScotTrade.com is also good.  These are discount brokerage firms that can make trades for you online for very low fees. You could establish an account with a major brokerage firm. I do not recommend this. They charge very high fees that come out of your returns. And their so-called ‘experts’ do not have your concerns as their number one priority. Instead they are looking for the fees, and often push stocks or investments according to their organizations best interests, not yours. You will be much better served if you do the research yourself. Of course if you are not interested finance as a topic and the time needed (a few hours a week should do it), working with a full service brokerage may be more attractive.

The most important thing is to STICK WITH IT! Even with a minimal income everyone in this country would retire wealthy if they avoided debt and planned for the future with at least a small contribution to their investments each month. I congratulate you on your interest and sincerely wish you the best. It takes work, but your finances should become a hobby, learn every chance you get. If I can be of any further service, please do not hesitate to follow up with me!

Sincerely,
Paul Henneman
President
ValuEngine, Inc.
www.ValuEngine.com
www.VEInstitutional.com
www.VEReports.com