Getting started in paper assets is very easy. Anyone today can go online and buy or sell a share of stock. Deciding what and when to buy and sell is where it gets tricky.
Stocks are only one form of hundreds of the paper assets available today. There is a term you may have heard of: derivatives. It’s a fancy word that is used often. What does it mean?
The root word of derivative is derive, which means, “to come from something.” Think of orange juice:
- You slice an orange.
- You squeeze the juice out of the orange into a glass.
- The juice is a derivative of the orange.
A share of stock is a derivative of the company that issues it. A stock option, such as a put or a call, is a derivative of a stock.
A quick word on brokers
It’s obvious that I am a huge proponent of women getting financially educated, myself included. When I first delved into paper assets years ago, I knew nothing about the stock market.
So, I did what, at the time, seemed like the smart thing to do. I found a stockbroker. His name was Mark. I told Mark, “I have a little money to invest in stocks. What do you recommend?”
He said, “You can’t go wrong with Coca-Cola. It’s been on the upswing for the past three months.”
Not knowing anything about Coca-Cola, other than I loved it as a kid, I said, “Okay, I’ll buy $400 worth.” Almost a year went by, and I was hearing some rumblings about the stock. Since I had bought it, the price had gone up modestly, and I was happy with my profit. I called up Mark and said, “I want to sell my shares of Coca-Cola.”
“This is not the time to sell. You’re getting out too early. Stay in it,” he advised.
“No, I’m happy with the money I’ve made. I want to sell.”
He continued his argument, growing more convincing as he made his case. Long story short, I did not sell. Weeks later, the stock price fell below where I bought it.
I was angry. I was angry with Mark for talking me out of it, but even more angry with myself for not trusting my instinct. I called up Mark and said, with an attitude, “Sell!”
I sold out of emotion and took a loss. What else could be the reason I sold? I didn’t know anything to start with, and now I knew he didn’t know either.
My experience with Mark illustrates the old joke, “There’s a reason the word ‘broke’ is in broker.” But the reality is that my losses were my fault as much as my brokers. I didn’t know anything about paper assets let alone how to choose a good advisor for them…and there are good advisers.
What a good broker looks like
My stockbroker, Tom, has also become a dear friend. Why is he my stockbroker? For three reasons:
- He never comes to me with a hot tip.
- He thoroughly researches every recommendation he gives me.
- Tom has already invested in every single investment he suggests to me. He practices what he preaches.
Tom’s two rules for investing in stocks are:
- If you don’t understand how the company makes money, then don’t invest in that company.
- If it looks too good to be true, then it probably is.
Tom is an educator, although he may not realize it, and my knowledge grows whenever I work with him.
The Pros of Paper Assets
- Very liquid
Paper assets are quick to get into, and quick to get out of.
- Easy entry
It does not take a lot of time or effort to begin investing in stocks, bonds, etc. (However, you still have to do your homework.)
- Cash flow
Stocks that pay dividends can provide long-term cash flow. There are other paper vehicles that will deliver cash flow if you learn the strategy.
- Tax advantages
The gains, or profits, for paper assets held longer than a year are taxed at the lower long-term capital-gains rates. Dividends are taxed at the lower long-term capital-gains rates as well.
- Home-based business
Include your children in what you are investing in. They can learn along with you!
The Cons of Paper Assets
- No control
You have no control over how the company makes money, spends money, or manages its debts and liabilities. (Unless, of course, it’s your company that is offering shares to the public.)
Stock prices can rise and fall dramatically, especially in uncertain economic times.
- No leverage
For the average investor, they must pay 100% to own the asset. They cannot borrow money to purchase a mutual fund or shares of stock.
- High fees and commissions
High fees and commissions are charged on the majority of trades, whether you are buying or selling.
Paper investing isn’t for everyone. The best way to decide if it’s for you is to do some homework and study.