In investing starting small makes sense, especially when you are trying to learn to invest on your own.
In order to start investing you need to understand what bonds and stocks are. You can refer to this post to get an overview: http://tinyurl.com/j768zcv
Couple of questions to start with:
What am I going to invest in?
- I am going to invest in stocks. Why? I am relatively young, the $ 5 000 I have allocated is to learn investing, and I believe I can make a higher return compared to bonds or other type of investments. The type of financial product you will choose to put your money in will depend on your risk tolerance (how soundly can you sleep with your money in this product), the purpose for investing, and how much time you have before you need to withdraw your investment.
Where am I going to invest?
- The where can be the geography of your investment, or the trading exchange of your investment which depends on the type of financial product. For example, I am Canadian. Currently $1 Canadian dollar buys me 75 cents in US currency. As a small investor exchange rate conversions are extremely important if you choose to trade outside your current country. In addition to managing and understanding my investment, I need to understand currency movements in order calculate my after tax after currency conversion profits. There is also the cost of converting back and forth to a different currency. This is too much to handle and understand for most first time investors. As such I recommend starting with a product that trades within your own country so you do not need to worry about the exchange rate.
- Part two of where, is the trading exchange in which you are going to choose a financial product from. In my case since I have already chosen stocks as the type of product I have a few exchanges available to me in Canada. The exchanges differ by countries. Most of the countries in the world has one or more stock exchanges. Some examples of the different exchanges: http://www.world-stock-exchanges.net/top10.html.
- Canada has at least six exchanges: http://www.world-stock-exchanges.net/canada.html. Exchanges are usually categorized by products with specific characteristics or by region.
- I am going to pick a product that trade on the TSX. This is because TSX is Canada’s largest equity exchange, and all the large companies’ trade within TSX. When you pick an exchange you want to ensure it is a large one with many people using it. What this ensures is a concept called liquidity. You want to make sure when you are ready to buy there is a seller for that product, and when you are ready to sell there is a buyer for this product. Large exchanges usually means you have many buyers and sellers, so you do not need to worry about having someone on the other side. On specialized exchanges, there may not be as many people and it may suffer from lack of liquidity. This also applies to the type of product you choose to invest in. If you were to buy Apple stocks, it is very liquid, it is traded often and by many people. The same cannot be said for a small oil company stock.
For how long am I going to invest?
- This is another question that will determine the type of products you will invest in. It is usually not recommended to invest in stocks if you need your money in less than 3 years. This is because stock markets can move down or up quite rapidly and it takes time to recover when it does drop. So you don’t want to be in a situation where your stocks have dropped in value, and you don’t have the flexibility to hold. You can invest, and cash out in less than 3 years if it makes sense from the gains you have and the direction of the stock, however you want to ensure you do have the flexibility if needed.
For any first time investor I would recommend going through a simulation program for at least a month. I will write another post recommending a trading simulation program so that you can learn to trade, and understand how you react to market movements as a person. This is also very important if you want to manage your own investments.