• Investing Basics
  • Investing Basics FAQs

    The world of investing and personal finance can occasionally be perplexing. Often when a specific investment question comes to mind, no obvious source for an answer is apparent.

    Here is a list of practical answers to frequently asked investing and personal finance questions. This quick reference guide is designed to be a "go to source" for answers to your investing needs.
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    Investing Basics: Start-Up Tips

    How do I get started in investing?

    A detailed discussion of the process is presented in the Investor Classroom area of our Web site in the section called Investing Basics. However, here are some successful investing tips to use when first building a portfolio.

    • Successful Investing Tip #1: First build up and maintain a cash reserve to meet short-term emergencies and other liquidity needs.
    • Successful Investing Tip #2: Try to develop an overall investment strategy that you are aiming for, even if you can't implement the strategy immediately.
    • Successful Investing Tip #3: Select mutual funds that meet your investment strategy first; use the minimum initial investment as a secondary consideration.
    • Successful Investing Tip #4: Select a balanced fund (for less aggressive investors) or a broad-based index fund (for more aggressive investors) for your initial investment, and build from there.
    • Successful Investing Tip #5: The minimum initial investment of the funds that you have selected will set the investment savings goal that you are trying to achieve.
    • Successful Investing Tip #6: The percentage commitment to each stock market segment will determine when you should start adding funds to your initial investments.
    • Successful Investing Tip #7: Don't agonize over small deviations from your overall allocation plan. For instance, if a minimum investment in a small stock fund results in a 12% or 13% commitment to small stocks, rather than your target 10%, go ahead and make the commitment. Your overall allocation goal is only a rough guide.

    For further guidance, AAII also offers an on-line booklet, Lifetime Investment Strategy, that can help you get started.

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    Investing Basics: Researching Investments

    Where's the best place to find information on-line on stocks and mutual funds?

    From stock market information to financial and retirement planning calculators, from charting services to on-line portfolio tracking—there is probably something helpful to you somewhere on the Web.

    Finding it, though, is another matter. While many sites provide in-depth financial statistics, research, and other information, other sites are purely promotional, with little or no useful information; or even worse, pure junk. In addition, some sites have free access to useful information, while other sites charge a fee. Sorting through various sites to weed out the junk and to determine their value can result in an enormous investment of your time.

    AAII publishes an annual Guide to the Top Investment Web Sites, which presents sites that provide investment information or service that, in our view, is both useful and substantial to individual investors and available either for free or for a reasonable price. Sites are grouped by subject to help focus your search. For each major subject area, we list the top sites, give a summary description, and list the price range, if any. But the real meat of the lists is in the assessment we include: why we like each site and what about each site we don't like. This will enable you to pinpoint the sites you need based on specific factors you are looking for.

    Keep in mind that the Web is constantly evolving. Sites, even the "big" ones, can change drastically in a short period of time. Be sure to verify the source of information or provider of a service when using Web sites. And read the fine print on pricing before agreeing to pay for any data or investment service.

    Investing Basics: Dealing With a Broker

    How do I find a discount broker?

    See AAII's Discount Broker Guide, updated annually.

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    Where can I get a list of on-line brokers?

    AAII's annual Discount Broker Guide identifies on-line discount brokers. Along with allowing you to place trades on-line, an additional feature of brokers with a presence on the Internet is the availability of research reports on companies. The range of information offered is wide—from current quotes and news headlines to in-depth financial statistics. Some Web sites charge for this information, and others provide it free to customers. Most on-line brokers offer an electronic option of receiving information and placing trades through the customer's telephone as a backup to placing trades on-line. Some also maintain a staff of "live" brokers to take trade orders; however, commission fees may be higher for broker-assisted trades.

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    How do I check out a broker?

    The National Association of Securities Dealers (NASD) regulates brokerage firms and their employees. NASD BrokerCheck provides information on NASD-registered firms and their brokers that is required to be reported on the approved industry registration and licensing forms. It also includes disciplinary and disclosure information reported by regulators. Information that has not been reported, or that is not required to be reported or is no longer reportable on regulatory forms is not disclosed. Background checks on individual brokers or brokerage firms should be made by using both the FINRA BrokerCheck and by requesting information from your state securities regulator.

    Your state securities regulator can tell you if the broker is properly licensed within your state, can access the central brokerage registration database, and may be able to supply you with additional regulatory action taken under state securities laws. The North American Securities Administrators Association (NASAA) is an organization of 50 state securities agencies responsible for investor protection. Click on the Contact Your Regulator Link on the home page to obtain the address, telephone and Web site of your state regulator.

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    Where do I file a complaint against a broker?

    Investors who wish to file a complaint against a broker should first turn to the brokerage's in-house compliance department or legal counsel.

    When further action is warranted, the next place to turn is the exchange involved. Investors should also file their complaint with their state securities regulator. This department licenses brokerage firms and investigates charges against brokers.

    Whenever contemplating filing charges against a broker, be prepared to detail the specifics, including dates and times of securities transactions. Some offices require you to explain the complaint in detail in a letter, others provide forms to fill out and notarize.

    To contact the resources mentioned above, see AAII's Guide to Investment Information.

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    Investing Basics: Buying Stocks

    Can I bypass my broker to buy stock?

    A number of companies will sell initial shares directly to investors, so no purchases need to be made through a broker. See our annual Guide to Direct Purchase and Dividend Reinvestment Plans for a list of companies that will sell initial shares directly to investors.

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    How do I place a stock purchase order?

    The two common types of orders used when trading stocks are market orders and limit orders. A market order can be used to buy or sell stock at the best price that the brokerage firm can find at that moment, no matter how high or low that price is. A limit order tells the brokerage firm to purchase (or sell) the shares at a price not to exceed (or not less than) a certain amount, known as the limit price.

    One advantage of placing a market order is that the trade will be executed very quickly. Often a broker can confirm that a market order has been executed within just a few seconds of placing an order.

    The price at which a market buy order is executed will usually be the current ask price, which is sometimes called the offer price, and the price at which a market sell would occur is called the current bid price.

    These stock market quotes can be obtained from your broker before you place an order, so that you will have a fairly good, but not necessarily exact, idea of the price at which your trade will be filled. During times of heavy trading activity, though, the market may change between the time you hear the quotes and the time your order reaches the exchange.

    There is a cost for the speedy execution of a market order, and that is that you may be paying a higher price to buy a stock than you might otherwise pay.

    Most brokerage firms charge the same commission for limit orders as they do for market orders, but a few charge more for limit orders since they represent more work. Since a limit order often does not execute immediately, it means that the firm may have to call you back later to report that the order was executed. Furthermore, since the order may remain open a long time, the firm has to keep track of the open limit orders. Some firms allow a good-till-canceled limit order to remain active for up to 60 days.

    To figure out whether you should place a limit order or a market order, you need to think about three things:

    • The price at which your order will be filled if you place a market order,
    • The chances that a limit order at a specified limit price will be filled, and
    • What will happen to the price of the stock if your limit order does not get filled.

    The first of these is pretty easy to estimate from the current quote. As long as your order size is smaller than the amount of shares quoted, then you are fairly assured of getting the quote or better.

    Calculating the probability that a limit order will be filled is much more difficult. Here are some general guidelines for deciding whether to use a limit or market order when buying and selling stocks:

    First, ask yourself how anxious you are to make this particular trade. In general, if you think that the stock is about to make a major move, then you are better off getting the immediate execution of a market order rather than running the risk that your order may not be filled and the stock may run away from you. If you can be patient, then your patience may allow you to get a better price for your trade through placing a limit order.

    Second, find out what the bid and offer quotes are when you are about to place a stock order. Also, look at the recent trading volume to get a sense of how active the stock is. A limit order is more likely to be filled if the stock is actively traded.

    If the spread between the bid and the offer is more than one tick, consider placing a limit order with a limit price between the bid and the ask prices. Sometimes it is worthwhile to place a limit buy order at the bid price, but only if there are not many shares quoted at the bid.

    If you really want to buy the stock, do not place a limit order with a limit price below the current bid price, since the probability that the order will be filled is so low that it is rarely worthwhile. Limit orders are best viewed as a way to bypass the market makers and save on transaction costs, not as a way to buy stock at windfall prices.

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    What are stop-loss orders?

    The "stop-loss" order is a market order that is triggered when a stock trades at or below a pre-specified price known as the stop price.

    The stop price is very different from the limit price of a limit order. With a stop-loss order, the fall of the stock price to the stop price triggers the order. However, stock prices do not always move continuously, so that the stock price may have fallen below the stop price before your order is filled.

    You can also place a stop-limit order; such an order is triggered by the stock reaching the stop price, but will not be executed unless a price better than the limit price can be obtained.

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    Investing Basics: Dividend Reinvestment Plans

    What are dividend reinvestment plans?

    Dividend reinvestment plans are custom-made for long-term buy-and-hold investors. Instead of sending participating investors cash dividends, the company applies those dividends to the purchase of additional company shares.

    There are several advantages to stock market investors who participate: Dividend payments are put to work, transaction costs are eliminated or held to a minimum, and the additional shares are purchased gradually over time—an easy-to-implement form of dollar cost averaging.

    For more information see AAII's annual Guide to Direct Purchase and Dividend Reinvestment Plans.

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    Measuring the Risk of Mutual Funds

    What does a fund's beta coefficient measure?

    This modern portfolio theory statistic measures a fund's volatility relative to a broad benchmark, commonly the S&P 500 index. Although betas are normally associated with stocks, they are also used for bonds.

    Beta is typically calculated on the basis of monthly returns over the past three years. A fund that seesaws in perfect sync with the market has a beta of 1.0. Portfolios that are more volatile relative to the S&P 500, such as aggressive-growth funds, have betas greater than 1.0; more conservative investments, such as utility funds, have coefficients of less than 1.0. Beta readings for gold, international, and other funds that move independently of the S&P 500 are not meaningful, so it's wise to check the standard deviation along with beta when you're examining volatility. Both are found in AAII's Individual Investor's Guide to the Top Mutual Funds and at Morningstar.com.

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    What is standard deviation?

    The most insightful and dependable barometer for all funds, standard deviation reflects the degree to which returns fluctuate around their average. It is usually based on monthly returns over the past 36 months. The higher the number, the greater the volatility; for a stock fund that has an average annual return of 12% and a standard deviation of 20%, you can expect to earn between 32% and -8% in about two out of every three years.

    A useful investing basics summary statistic, standard deviation allows you to make comparisons across as well as within fund categories. The standard deviation generally tends to work better than beta because it is a purer, more universal number; it is not based on the relationship of return to fluctuations in an index. For bond funds, standard deviation is a more comprehensive yardstick than duration because it reflects all sources of volatility, not just interest-rate risk.

    AAII provides a useful 'risk index' based on the standard deviation of a fund relative to the average standard deviation for its category in the Quarterly Low-Load Mutual Fund Update Newsletter. A fund with a risk index of, say, 1.4 is 40% more volatile than its group average.

    A Caveat: Risk statistics are based exclusively on historical numbers and are not necessarily predictive. The period used to calculate the measure may not be representative of the future investment climate. While a fund's risk is generally more predictable than its return, major changes in the way it is managed can cause its future volatility to differ strikingly from past ups and downs.

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