Blog | Paper Assets

Pros and Cons of Investing in Stocks

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Why investing in paper assets may (or may not) be best for you

When you’re ready to start investing—to purchase things that will (hopefully) deliver that almighty cash flow of passive income—one of the first major decisions you’ll need to make is what type of investing you’d like to do. As you’d might imagine, not all investing is created equally.

There are four main assets you can invest in: a business, real estate, stocks (aka, paper assets) and commodities (e.g. silver, gold and oil). Obviously, you’re free to invest in any and all of these asset classes, but I think it’s a wise plan to begin with one since there’s so much to learn. If you start spreading yourself too thin and plunking money haphazardly everywhere all at once, you most certainly won’t come out on top. Worse yet, you might not even be aware of what exactly went wrong (since you wouldn’t have the ability to pay close attention to each one), so you could figure out what to do differently next time.

As such, my advice is to pick one asset class that resonates with you, learn as much as you can, and then start with a small investment (because you will most definitely learn more lessons along the way).

Today, we’re going to focus on paper assets—including the pros and cons of investing in stocks.

What is a paper asset?

To start, this is just a fancy term for pieces of paper that define ownership of an asset—examples include stocks, bonds, and money market accounts. Getting started in paper assets is actually very easy. Anyone today can go online and buy or sell a share of stock. The tricky part is deciding what and when to buy and sell.

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.” If you’ve ever made fresh orange juice, think of it this way:

  1. You slice an orange.

  2. You squeeze the juice out of the orange into a glass.

  3. 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. So, a large part of getting started in paper assets is learning the vocabulary of the world of stocks, bonds, mutual funds and all the derivatives included.

Where I went wrong hiring my first stockbroker

It’s obvious that I am a huge proponent of women getting financially educated, myself included. But 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 my decision to sell, but even more angry with myself for not trusting my instinct. How could I have let him persuade me from listening to my gut? I called up Mark and said, with an attitude, “Sell!”

Yes, that’s right. I let my emotions get the best of me, and took a loss. What else could be the reason I sold? I didn’t know anything to start with. You see, I knew I didn’t know, 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.” I declared I would never have anything to do with the stock market again. Famous last words!

Learning how to invest in stocks

Once I calmed down and had time to look back at the situation objectively, I realized I’d made some mistakes. The reality is that my losses were as much my fault as my broker’s. I also realized that I needed to learn about the stock market first, and then decide if it was a place I wanted to play.

So, I enrolled in some stock-option courses and day-trading seminars. I read books on the subject. I began to watch TV and read articles in order to stay up-to-date on what’s happening in the world of stocks, bonds and derivatives — it affects so much of the world economy, that frankly, it would be foolish not to do so. Now, I knew how to invest in the stock market and had the confidence to do so.

However, during this process, I learned that this was not a world in which I would choose to spend a lot of my time. There are others who love it, who flourish in it, and who have found their passion in the world of paper assets. It just didn’t ignite that spark in me or get my adrenaline flowing. I still wanted to participate in the game, I just don’t want to be a star player.

What a good stock broker looks like

Yes, there are good stockbrokers out there. But you have to do your research to find the true diamonds in the rough. I always start with these four tests to find good advice.

Robert and I have been working with our stockbroker, Tom, for many years. He has also become a dear friend. Why is he our stockbroker? For three reasons:

  1. He never comes to me with a “hot tip.”

  2. He thoroughly researches every recommendation he gives me. For instance, he organized a dinner in Los Angeles and invited Robert and me and a few of his other clients to meet with the founders of an alternative energy company he was considering as an investment. Why? He wanted to give us, his clients, the opportunity to ask the founders the tough questions.

  3. Tom has already invested in every single investment he suggests to me. That means he practices what he preaches.

Tom’s two rules for investing in stocks are:

  1. If you don’t understand how the company makes money, then don’t invest in that company.

  2. 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. Seek out someone like Tom to add to your own team; and avoid the Marks of the stockbroker world.

Why invest in stocks?

I get a lot of questions from women asking, “Why invest in stocks?” By now, you’re probably dying to know why investing in paper assets can be a great way to increase your wealth. I’ve outlined the pros and cons of investing in stocks below:

The Pros:

  • 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. Giving them the opportunity to learn alongside you will help set them up for a financial education they won’t get in school, and one that will pave the way toward financial independence as adults.

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.)

  • Volatility. 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.

After studying these two lists, hopefully it’s becoming more clear why investing in stocks may or may not be the right choice for you. The fact of the matter is, paper investing isn’t for everyone. But for some, it’s everything!

The best way to decide if it’s right for you is to do some homework and study. You may need to make a small investment to really understand the process and whether or not you enjoy it. That’s one of the reasons we started The Rich Dad Company — to provide a financial education for those seeking to find what investment class is right for them.

If you feel the pros outweigh the cons and you want to learn more about investing in stocks before you begin, Rich Dad Advisor on stocks, Andy Tanner, has a special offer. Click here to get a free copy of his book 401(k)aos. His revolutionary book will teach you why it's more important than ever to take control of your retirement... and how to do it.

Original publish date: April 08, 2014

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