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Ways for Individuals to Invest in Stocks

By David Luhman on Mon, 05/11/2009 - 23:45

Ways for Individuals to Invest in Stocks

The best way for individuals to invest in stocks

One stock you shouldn't invest in

The best way to minimize your risk

Are variable annuities a good value?

DRIP investing

The best way for individuals to invest in stocks

Mutual funds are probably the best bet for most people because funds offer

  • Diversification
  • Low-cost, professional management
  • Low-cost transactions
  • Telephone transfer to a variety of other funds including money market funds

One stock you shouldn't invest in

Don't put too much money in your employer's stock

401(k) and Employee Stock Ownership Plan (ESOP) might give you a good deal on employer's stock

Consider placing some money in employer's stock, but don't invest more than 10 percent of your equity holdings in your company's stock

If your company hits hard times, you can get hit with a double whammy

  • The stock price falls
  • You lose your job

If your company offers you stock options as an incentive with little or no cost to you, take them

But invest the rest of your portfolio in other assets so that if your company went bankrupt, you'd still be OK

The best way to minimize your risk

Invest in a broadly diversified portfolio

Diversify across asset classes

  • stocks
  • bonds
  • real estate

Diversify within asset classes

  • large company stocks
  • small company stocks
  • foreign stocks

Diverisfy over time

  • dollar cost averaging
  • bond laddering

Example of how diversification reduces your risk without reducing your return

Studies show that typical returns for an individual stock ranges between -40 to +60 percent per year

So don't be impressed if a broker tells you about a stock that she picked went up 50 percent

It happens all the time

Returns for the market as a whole range between -7 to +27 percent per year

By investing in a broad-based mutual fund, you enjoy the same average gain, over time, as if you invested in a few individual stocks, but with less volatility

Are variable annuities a good value?

Annuities allow your earnings to grow on a tax-deferred basis

There are fixed annuities and variable annuities

Fixed annuities offer a promised return while variable annuities make no promises

Variable annuities

Are basically stock or balanced mutual funds with a veneer of insurance

You select where to invest your annuity

Securities are held in trust by a third party -- you are not a general creditor of the insurer

If the underlying securities do well, the value of your annuity increases

Variable annuities do offer a return of your original investment even if your investment loses value

But annuities have some drawbacks

The money generally can not be withdrawn without tax penalty before age 59.5

Sales commissions can be high

Surrender charges for exiting the annuity early can be high

Expenses for the insurance portion of the annuity can be high

The money you invest is after-tax money, unlike most money that you can put into a 401(k) or IRA account

401(k) and IRA accounts generally reduce your taxes immediately, and in the future

Annuities only save you taxes on your future earnings

DRIP investing

DRIP stands for Dividend Reinvestment Programs

DRIPs allow you to but stock from generally large companies without paying brokerage commissions

The company normally holds the purchased stock for you

When the company makes a dividend payment, your dividend payment is generally used to buy more shares of stock in the company

Large consumer-oriented companies often do this to promote customer loyalty to their products

The advantage is you can buy a small number of shares without paying a commission

But with deep discount brokers, you can purchase shares very cheaply

The main disadvantage is that quarterly purchases of shares will complicate the calculation of your cost basis for capital gains purposes

This disadvantage disappears if the stock is held inside a retirement account (if possible)

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