Newbies Guide to Online Investing

Issuing a limit order

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Limit orders provide you with the convenience of not having
to constantly watch the market. They can also protect
you against dramatic movements in the market.
A limit order directs the brokerage to buy or sell stock when
the price drops or rises to a specific number. When you place
a limit order, the brokerage is limited to
n Buying the stock at the specified price or lower.
n Selling the stock at the specified price or higher.
For example, a limit order to purchase 500 shares of XYZ
stock at $40.00 a share means the broker may fill the order
at $40.00 or less, but not at $40⁄18 per share. Alternatively, a
limit order to sell at $40.00 means that the broker can’t accept
a fraction of a penny less than $40.00 for your stock.
84 CliffsNotes Getting Started in Online Investing
When you place a limit order, you need to specify whether
the order is a day order or a good till canceled (GTC) order.
A day order expires at the end of the trading day. A GTC order
doesn’t expire. You have to remember to cancel it, as I discuss
later in this chapter.
Placing a stop order
A stop order is a contingency order that becomes a market
order when the stock trades, is bid, or is offered at a specific
price. Stop orders differ from limit orders because stop orders
happen at a particular price rather than within a price range
like a limit order.
A stop order can help you stay in control of your portfolio
during a period of time when you can’t get to your computer
or reach your broker by phone. Stop orders are also very helpful
when the market is on the move.
For example, if you purchased XYZ stock at $45.00 a share
hoping it would go up, but now the price is dropping, you
may want to limit your losses by placing a stop order to sell
the stock if the price drops to $42.00 a share.
Understanding the complex stop
limit order
A stop limit order is a contingency order that becomes a limit
order when the security trades, is bid, or is offered at a specific
price. It helps you take advantage of sudden movement
in the market while limiting your risk. It’s more complicated
to understand than the other types of orders, but can be very
useful to you given the right market conditions.
An example of a stop limit order is “Buy 100 shares of XYZ
stock; stop at $120.00 with a limit of $1201⁄4.” This means
you want your order to be activated to purchase stock at
Chapter 7: Making Your First Online Trade 85
$120.00 per share, but not if it goes above $1201⁄4 per share.
Sell stops are used below the market price, and buy stops are
used above the market price.
The advantage of this type of order is that it gives you more
control over the price at which your order is filled. The disadvantage
is that your order may go unfilled if your specifications
can’t be met.
Another variation: Fill or kill
The so-called fill or kill instruction has a name that’s pretty
descriptive of its function. Some online brokerage services
allow you to specify that a limit order should expire — or be
killed — if it can’t be executed within a certain time frame.
Executing, Confirming, and Canceling
Orders
Are you ready to invest a chunk of your savings with a couple
clicks of your mouse? Indeed, all it takes is a few clicks to
reallocate or change the character of your portfolio.
Executing and confirming an order
Now that you’ve scoped out the market, you’re ready to make
a move. Fortunately, it’s easy to act with most online brokerages,
barring the occasional technological glitch.

Regardless of which online brokerage you use to place a trade,
you need to have the following information ready to enter:
n Quantity: Specify the number of shares of stock you
want to buy or sell.
n Ticker symbol: You must enter the ticker symbol for the
stock you want to trade.
n Price: Enter the price at which you want to buy or sell
the stock.
n Order type: Indicate whether you want to place a market,
limit, stop, or other type of order.
n Expiration: Specify when you want the order to expire.
After you place your order, a confirmation message appears
on your screen. If this message doesn’t appear, call the brokerage
immediately. If you simply repeat the steps you took
to enter the trade, you may end up owning twice as much
stock as you planned.
Don't forget this
Enter number of shares Enter price per share Specify date order expires
Enter ticker symbol Select order type
Chapter 7: Making Your First Online Trade 87
Canceling or changing an order
Changed your mind? Got cold feet? Fortunately, canceling
or changing an order online is not a complicated proposition.
All brokerages allow you to cancel an order before the brokerage
executes the trade — but most charge a fee. Normally,
canceling an order costs $10.00 or less, and you accomplish
it pretty much the same way you placed your initial order.
Canceling an order usually takes about as much time as placing
one. Unfortunately, scrapping your order can seem
painfully slow in a volatile market when you’ve changed your
mind. Don’t be surprised if your cancellation is confirmed
moments after your order is filled (and once your order is
executed, you can’t turn back). It’s nobody’s fault; that’s everyday
life in the world of online investing.

Opening Your Account: The Process

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Opening an account varies a bit from brokerage firm to brokerage
firm. But the basic process is the same. You must first
access the Web site for the brokerage firm. You then find a
link that says something like open an account now (this link
is unsurprisingly easy to locate) and perform some variation
of the following steps:

1. Complete a secure online application. The application asks
you questions like your Social Security number, whether
you’re opening a joint account, and other information necessary
to get you set up on the company’s system.

2. Return your signed application by mail. Some firms
allow you to receive an account number and begin trading
right away, but your signed application must be
received within three days of your first trade.

3. Fund your account. You can get money into your
account by mailing a check, providing a credit card number,
or authorizing the brokerage to create an electronic
check from an existing account, depending on the policies
of the brokerage.

Should you open more than one brokerage account? On one
hand, you want to avoid opening more accounts than you
need, because this tactic can increase fees. On the other hand,
the Gomez Advisors recommend that you consider opening
a second account with a smaller, less-heavily-trafficked brokerage
firm if your primary account is with a popular firm
that may experience periodic capacity overloads and transaction
delays.

Asking the Right Questions before Deciding on a Brokerage

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Online brokerage services are competitive and eager for your
business. They offer an ever-increasing and innovative range
of services to entice you to open an account with them.

Accordingly, use the following checklist to determine which
services interest you, and remember to ask who offers them:

n Do quoted commission costs vary? Does the advertised
low commission vary with the size of the trade? Is there
a minimum charge for small trades? A surcharge for a
maximum number of shares?

n Are there other transaction costs? Does any “handling”
or “service fee” or other transaction charge apply in addition
to the commission?

n Are minimum deposits and balances required? What
is the minimum required initial deposit? Am I required
to maintain a minimum balance in the account?

n What types of orders are accepted? Does the online
brokerage accept the types of orders you may want to
make? What is the policy for cancelled orders?

n How quickly are orders filled? Does the brokerage have
the ability to quickly execute orders so that you can take
advantage of changes in the market throughout the day?

n How quickly are orders confirmed? Does the online
brokerage service give you immediate confirmation that
an order has been executed?

n What emergency communications are available? Can
you reach the broker by fax or by telephone in case you
can’t get online or get to a computer?

n What portfolio information do you receive? How
often is your account information updated? Will you
receive an income tax summary? A transaction summary?

n Does the firm pay interest on idle funds? If you maintain
a substantial cash balance in the account, does the
brokerage firm pay interest on “idle” funds? Some brokerage
accounts automatically “sweep” idle funds to a
higher-interest-bearing account.

n What research resources are available? Does your brokerage
make reports and research available to you? If so,
is this service subject to an additional charge?

n What checking and wiring services are available? Do
you receive free checking services? Can you wire funds
to and from the account free of charge?

n How is the brokerage firm rated by the experts? How
do the services of the brokerage firm measure up using
the online rating services I discuss later in this chapter?

n Do you get price quote information? Some online brokerage
services.

Commissions, Costs, and Fees

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Looking for a broker with low commissions? You should
always try to get the most for your money, but a broker’s
advertised commissions may not tell the whole story.

Questioning the advertised commission

Sometimes you’ll see a broker advertise a “flat-rate” commission
or “commissions starting at” a certain amount.

You need to make sure when you’re comparing commissions
that you’re comparing apples to apples. Make sure that you
ask whether advertised commissions change based on the
following:

n The type of order placed: Commissions may vary
depending on whether you’re placing a market or a limit
order. A market order directs your broker to buy or sell
shares at the best market price currently available. A limit
order directs the broker to buy or sell shares only at a
specified maximum or minimum price. Brokers may
charge a higher commission for executing a limit order,
but only advertise the lower fee they charge for a market
order.

n The kind of securities you’re buying: Sometimes
brokers charge a higher commission for buying or selling
an over-the-counter stock as opposed to a listed
stock. A listed stock is one that is traded on a major stock
exchange — such as the American Stock Exchange or the
New York Stock Exchange. A stock that isn’t listed is
called an over-the-counter stock. NASDAQ is the leading
market for over-the-counter stocks. (Most investors
afford NASDAQ stocks the same status and prestige as
stocks listed on exchanges.)

n How many shares you’re buying or selling at one
time: An advertised “flat-rate” commission may be good
only up to a certain number of shares. Find out how
many shares you can buy or sell before a surcharge
applies to the flat rate.

Looking for hidden fees and costs

You may think that commissions are the only costs involved
with online trading. Unfortunately, this isn’t the case. Several
types of hidden costs can nibble away at your investment
profits.

Here are a few fees to watch for, when opening an account,
all considerations being equal:

n Fees to close the account: Some brokerages charge a fee
of $50 or more to close an active account.

n Charges for a copy of your statement: If you need a
copy of a prior month’s statement that isn’t online or
simply would like to receive your statements in the mail,
you can be charged up to $10 per page.

n Charges for transferring funds to or from your
account: If you need access to the funds in your account
or plan to purchase additional securities by wiring funds,
you should inquire about any associated charges for these
types of transactions.

OPENING AN ONLINE BROKERAGE ACCOUNT

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Looking over Online Brokerage Services
You can purchase most things these days by entering your
credit card number on a Web site. But you can’t buy everything
this way. To trade stocks, bonds, mutual fund shares,
or other securities, you must first open an online brokerage
account through a brokerage firm.

In the world of Web-based trading, your online brokerage
firm is responsible for

n Executing trades: When you tell a brokerage firm that
you want to buy or sell stocks, bonds, mutual fund
shares, or other securities, the firm is responsible for
communicating with the securities exchange or entity
through which these securities are sold.

n Maintaining account records: The brokerage firm is
responsible for maintaining information about the assets
held in your account and updating this information
periodically.

n Providing updates and information: Your online brokerage
firm is an important link to the investing world.
The firm’s Web site should provide quotes, updates of
the market, and access to charts, news, and research
reports.
n Providing other convenient services: You may get the
benefit of free checking and other handy services with a
particular broker.

Finding a Reputable Online Broker

How do you find a broker that’s reputable? Protecting yourself
isn’t difficult, but traps for the unwary are still out there.

For starters, be sure to choose a broker that meets the following
criteria:

n SIPC insured: The Securities Investor Protection Corporation
(SIPC) currently insures securities and cash in
a brokerage account for up to $500,000 (but no more
than $100,000 of that may be in cash).

n Listed on survey sites: Select a broker that is evaluated
on the Gomez Advisors and SmartMoney Web sites
(which I discuss later in this chapter) or at least gets a
good write-up in a national magazine. Stay away from
brokerage firms that haven’t been prescreened on these
sites or by the media.

n Look for objective referrals: Steer clear of chat room
advice from unknown sources whose motives and credentials
you can’t discern. (As a matter of fact, you can’t
even tell when chat room information was last
updated.)Your goal is to avoid online sales pitches disguised
as “hot tips.”

Finding Treasuries on the Web

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After you decide to buy Treasuries, your research is far from
over. The U.S. government offers you lots of choices. You can
select from the following:

U.S. bonds, notes, and bills are called Treasuries because
they’re sold by the Treasury Department through its subagency,
the Bureau of Public Debt.

n Treasury bills (T-bills): T-bills are short-term bonds
with maturities of 13 weeks, 26 weeks, and 52 weeks.
The Treasury periodically holds an auction in which it
posts notices of new issues and makes them available to
the public on the Web. The 52-week T-bills pay interest
semiannually, and the 13- and 26-week varieties pay
interest when they mature. T-bills come in minimum
denominations of $1,000.

n Treasury zero coupon bonds: These bonds earn interest
to reach their stated face value upon maturity. For
example, you may purchase a $10,000 bond for $5,000.
They’re a favorite for college savings. Because these bonds
don’t pay interest until you cash them in, you don’t have
to report the interest as income before you redeem them.

n Treasury notes: This type of bond has a maturity date
of two years, five years, or ten years. You’re paid interest
semi-annually and have to invest at least $1,000.

n Treasury bonds: This type of bond represents the government’s
longest-term bonds, having a 30-year maturity
date. The Treasury sells them three times a year in
multiples of $1,000. They pay interest semiannually.

n Inflation-indexed notes: These bonds are the new kids
on the auction block — they were first introduced in
January 1997. They pay a fixed rate of interest plus an
extra amount to reflect the current inflation rate. The
inflation adjustment is based on the consumer price
index. These notes pay interest semiannually, have a tenyear
maturity date, and are auctioned every three
months.

Differentiating notes and bills

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Often when investors and Web sites talk about bonds, they’re
referring to instruments technically and correctly called notes
and bills. You’ll see these terms on the Web, and knowing
what they mean is important.

Bonds, notes, and bills are called fixed-income securities
because the amount of income you earn is predetermined.
Whether a fixed-income security is a bond, note, or bill
depends solely upon its maturity date. The distinctions are
as follows:

n Bonds: The maturity date is more than ten years from
the issue date.

n Notes: The maturity date is between one and ten years
from the date of issue.

n Bills: The maturity date is within one year from the issue
date.

Understanding Bond Variations and Features

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Although bonds have a nice-girl reputation as low-risk investments,
many types of bonds are as risky as any stock. Thousands
of variations are out there. Many brokers make their
living speculating and trading in bonds based on these variations
and the ever-fluctuating interest rates.

A checklist of bond features
Here are a few of the different bond features you can find by
perusing the Web:

n The credit rating of the entity issuing the bond: This
rating reflects the likelihood that the issuer will default
on the bond.

n Coupon rate: The rate of interest that the bond pays.

n When interest is paid: The interest may be paid quarterly,
semi-annually, annually, or upon maturity.

n Maturity date: This refers to the date when you get back
your original investment plus any unpaid interest.

n Whether the bond is indexed for inflation: If the bond
is indexed in this way, the bond pays an amount above
the interest to compensate for inflation.

n Premiums and discounts: These amounts reflect the
value of bonds on the secondary market due to fluctuating
interest rates.

n Call features: These features allow the issuer to pay the
bond earlier if interest rates go down. (This feature never
works in the investor’s favor.)

Taking inflation into account

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An insidious, creeping threat to your bond portfolio is inflation.
Because bonds pay a fixed rate of interest, rising interest
rates and inflation can drive down your purchasing power.
If you have a well-diversified portfolio, your stocks and other
equity investments should rise in value to offset your losses from
inflation. Additionally, in 1997, the U.S. Treasury began to offer
inflation indexed notes, which I discuss later in this chapter in
the section titled “Visiting the U.S. Treasury Web site.”
Inflation and interest rates also determine how much a bond is
worth on the secondary market. The secondary market consists
of bonds sold after they’re originally issued but not yet matured.
If interest rates have risen since the bond was issued, the bond
is worth less and sells on the secondary market at a discount.
For example, a $1,000 bond paying interest at 5 percent
(called the coupon rate) when interest rates are 6 percent may
actually sell for $900 — a $100 discount.

If interest rates have gone down, the bond sells at a premium.
It’s worth more because it pays higher-than-market interest.
The yield for a bond is the return you actually receive on your
investment based on what you paid for it and the coupon
interest rate. Yield is calculated by dividing the amount of
annual interest by the bond purchase price. For example, if
you purchase an 8 percent bond for $1,000, your yield is 8
percent ($80 divided by $1,000). If you buy the bond for
$900, the yield is 8.89 percent. The higher the yield, the better
your investment.

Looking at the bond issuer

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The promise to repay is worth only as much as the credibility
of the entity making the assurance. If an entity becomes
insolvent, it may be unable to pay even its guaranteed obligations.
For this reason, the most important characteristic of
a bond is the issuing entity. The following types of entities
issue bonds:

n U.S. Treasury Department: This debt is backed by the
full faith and credit of the U.S. government and is literally
the safest investment in the world.

n Other U.S. government agencies: From time to time,
state and local government entities and agencies issue
bonds to finance their projects and agendas. Examples
include Federal National Mortgage Association (FNMA)
Bonds and Student Loan Marketing Association (SLMA)
bonds. Most (but not all) of these obligations are backed
by the full faith and credit of the U.S. government. You
need to ask the issuer to find out whether a bond is guaranteed
by the U.S. government.

n Corporations: Corporations issue debt to finance their
operations. They offer higher interest rates than government
obligations because they’re considered riskier.

n State and local governments: These agencies issue
bonds to finance government projects and activities and
use tax revenue or revenues generated by the project or
activity financed to retire the bonds.

n Foreign governmental entities: These bonds are guaranteed
by the governments of issuing countries, and they
often offer a higher rate of return than U.S. obligations.
However, they may be much riskier, depending upon the
political climate and solvency of the issuing country.

BUYING BONDS ONLINE - What’s a Bond?

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Who says bonds are boring? True, bonds don’t offer the cyberthrills
you get from watching stock prices soar and plummet
on your computer screen, but bonds are especially important
for the compulsively thrill-seeking online investor — they
counteract riskier investments and still provide handsome
profits.

You can’t afford to ignore bonds — experts say bonds should
make up at least 30 percent of your portfolio. This chapter
explains how bonds buffer market risk and how to surf the
Web for the ones with the most profit-making potential.

What’s a Bond?

When you buy a bond, you’re not buying a share of a company
— you’re issuing a loan and becoming a creditor of the
company. Because you’re not an owner, you don’t get to vote
or divvy up the profits. But, no matter how badly things go
for the entity, you are entitled to receive your principal and
an agreed-upon rate of return on your investment (as long as
the issuer is solvent).

Buying Mutual Fund Shares Online

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Have you finished your fund research and decided you’d like
to buy some shares? You have two choices when it comes time
to make the purchase. You can either get your funds through
a brokerage or directly from a mutual fund company.
If you purchase your funds directly from the mutual fund
company by accessing its Web site, you can save the cost of
the brokerage commission that a broker may charge. You’ll
still be charged a transaction fee, but it’s usually a lot less than
a broker’s commission.

Finding a Fund That Meets Your Objectives

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There’s a smorgasbord of funds out there — and you need
to have several types on your plate to be diversified.

n Large-, mid-, and small-cap funds: I discuss market
capitalization of stocks — the price of a share of the
company’s stock multiplied by the number of outstanding
shares. You can buy funds that specialize
in large-, mid-, and small-cap stocks. Smaller
capitalization correlates with higher risk and higher
potential returns. The NAIC recommends that you select
funds that specialize in a variety of market caps.

n Aggressive growth funds: Fund managers look for funds
that have the highest growth potential. These stocks may
be highly volatile, and you shouldn’t invest in them if
you may have to sell them at a time when the market is
down. This type of fund may also include risky options
and futures.

n High-performance funds: These funds are less riskoriented
than aggressive growth funds, but the fund
manager’s main objective is still performance and growth.

n Income funds: These funds focus on companies with
high dividend-paying potential.

n Sector funds: These funds purchase stocks in particular
market sectors of the economy — such as health care or
consumer goods.

n Tax-efficient funds: These funds are managed so as to
minimize taxable gains, and they include bond funds
that invest in federal, state, and municipal bonds.

n Socially conscious funds: These funds invest to be consistent
with investors’ personal as well as financial objectives.
I tell you how to use the Social Investment Forum
Web site at www.socialinvest.org to research these
funds later in the chapter.

n International funds: Managers of international funds
undertake the complex research necessary to profit from
overseas markets, which can be risky and complicated
but can offer high returns.

n Emerging market funds: These funds are a high-risk
version of international funds — specializing in Latin
American, Middle Eastern, Asian, and other economies
with volatile currencies.

n Index funds: Besides the Standard & Poor’s Index, index
funds are available that invest in small-cap index, international
index, mid-cap index, bond index, and others.

Considering Bond Funds

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Stocks aren’t all you’ll find when you look at mutual funds.
Bond funds offer professional management and diversification
as well.
I discuss bonds more fully in Chapter 5, but a bond is basically
an IOU from a government entity or corporation. You
lend them the money, and they promise to pay you interest
and principal. The riskier the bond investment, the higher
the rate of interest. You can search for bond funds using the
Quicken.com Web site at www.Quicken.com — click
Investments F Funds F Popular Searches F Bond Funds.
Bond fund managers offer professional expertise in balancing
the risk and return of various types of bonds. There are
three major differences between investing in a bond fund as
opposed to purchasing an individual bond:
n Diversification: Bond funds offer you the advantage of
a calculated mix of bond investments.
n No fixed maturity date: Individual bonds mature on a
specific maturity date; bond funds do not mature. You
decide when to sell your shares in a bond fund.
n Fixed return: When you purchase an individual bond,
you know how much interest and principal is to be paid.
When you buy into a bond fund, you may ultimately sell
your shares at a gain or loss.

Finding out about fund fees

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Fortunately for you, the investor, all the information you
need to know about a fund’s fees is in one place — the
prospectus. You should never invest in a fund without reading
its prospectus.

After you download this document, scrutinize it carefully to
ascertain your obligations for the following:

n Load fee: A load fee is a sales commission or charge you
pay when you purchase a fund — generally around 5
percent. A no-load fund is one that does not require you
to pay a commission or entry fee to invest in the fund.
Most experts recommend no-load funds because a
load fee immediately diminishes the amount of your
investment.

n 12b-1 fees: These are an alternative to load fees, used to
compensate the person who sells the fund shares. A fund
that charges a 12b-1 fee of less than .25 percent is considered
a no-load fund.

n Redemption fees: A redemption fee is often charged
instead of a load fee. You pay this fee when you sell your
mutual fund shares as opposed to when you buy into the
fund. Typically, redemption fees decline over time to
encourage you to hold onto your investment longer.

n Annual operating expenses and administrative costs:
These fees cover the basic costs of running the fund and
are generally disclosed in the prospectus.

n Management fees: These fees cover the costs of all those
lawyers, accountants, and bookkeepers that make sure
the fund complies with SEC rules. These, too, are disclosed
and estimated in the fund prospectus.

Index funds tend to charge
lower fees than mutual funds. The reason for the lower fees
is that after choosing stocks to mirror a given index, the funds
require little management. Table 4-1 compares the performance
of actively-managed funds with the performance of an
S&P 500 stock index fund over a three-year period.

Advantages and disadvantages of mutual funds

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Mutual funds offer you great returns without the effort of
shopping the Web for individual stocks and monitoring
them. But they also have a few characteristics that can come
back to haunt you.

On the whole, mutual funds are one of the safest, most effortless
investments you can make. They offer the following
benefits:

n Professional management: Mutual funds offer the professional
expertise of sophisticated research analysts. You
can search and view a list of funds that have a specific
manager group by using the Standard & Poor’s Micropal
Web site at www.micropal.com. You can then review
the performance of each manager’s funds. I tell you more
about the Micropal Web site and how to use it later in
this chapter.

n Instant diversification: When you buy a fund, you buy
an interest in a variety of stocks or bonds all at once
rather than one at a time. This variety helps you meet
the objective of a diversified portfolio. The fund prospectus
(which you can download from the Web) tells you
exactly which investments and sectors the fund holds.
n Low entry costs: You can invest as little as $250 in a
mutual fund. You can use the Quicken.com Mutual
Fund Finder (shown in Figure 4-3) at
www.Quicken.com. Click InvestingFFund FinderF
Popular Searches to search for funds that require investments
of $250 or less or $500 or less.

n Shareholder services: The fund may offer check writing
and other useful privileges. The fund’s Web site usually
promotes the services offered or includes a link so that
you can e-mail a service person to find out about them.

Alas, there is no perfection in the world of investment, and
mutual funds come saddled with inherent risks and baggage —
just like any other opportunity. When investing in mutual
funds, beware of the following:

n Fund managers who quit: After you invest in a successful
fund, you need to keep up with changes in management.
For example, when star manager Peter Lynch
ceased to manage the Fidelity Magellan fund in the
1990s, the value of the fund plummeted in relation to
the stock market as a whole. You need to stay current and
check out press releases announcing management
changes. You can do so by reading the business section
of your newspaper or looking at Web sites devoted to
reporting investment news, such as Morningstar at
www.morningstar.com, which I discuss later in this
chapter.

n Loss of control over income tax issues: Because the
fund manager controls when stocks are sold, you may
not always be able to defer your capital gains to years
when they’ll be taxed at a lower bracket or offset by other
losses. (When you invest in individual stocks, you have
the ability to control when you sell them.)

n Misleading sales materials: Advertising materials for
funds may create an erroneous impression as to how the
fund is actually managed and what investments are
included. For example, a fund advertised as low risk may
actually contain some pretty speculative stuff. Download
a copy of the fund’s prospectus and carefully review it to
see what investments are actually included in the fund.
n Hidden fees and costs: Be sure you understand the fees
associated with the fund, as disclosed in its prospectus.
For example, a fund may charge a steep fee when you sell
your shares.

How Mutual Funds Work

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Would you rather buy a cake from an expert baker or make
one from scratch? This is the sort of self-assessment you do
when you choose whether to buy a mutual fund.
Mutual funds are ready-to-serve portfolios that contain a mix
of stocks or bonds selected by a fund manager on behalf of a
group of investors. These funds provide immediate investment
diversification that you may not otherwise be able to
afford. As always, convenience comes at a price — a variety
of mutual fund fees. You also have lots of disclosures and performance
data to evaluate. Fortunately, getting information
about mutual funds is easy on the Web.

Learning mutual fund basics on the Web

Do you need to start with the basics when it comes to mutual
funds? If so, you can visit a Web site dedicated to educating
mutual fund novices.
The Investment Company Institute is a trade group for the
mutual fund industry. The ICI has a financial interest in
making sure consumers understand enough about mutual
funds to feel comfortable buying them. To this end, it maintains
a fact-filled Web site located at www.ici.org.

Reviewing a copy of the fund prospectus
Mutual funds are legally required to tell all when it comes to
n Past performance of a fund
Used with permission of the Investment Company Institute (www.ici.com)
n The stocks, bonds, and other assets the fund holds
n Any fees associated with the fund
The document that reveals all of this information is called a
prospectus.

RESEARCHING MUTUAL FUNDS

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Mutual funds are a gregarious type of investment — ideal for
the type of person who wants the benefit of other people’s
expertise and research time. But even if you’re a loner who
prefers watching stock data stream across your screen, the
impressive returns on many of the more successful mutual
funds may make you come out of your shell and consider
investing in the company of others.

Brainstorming with Other Investors

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If you’re looking for someone to talk to about investments —
without paying a commission — you can find plenty of sociable
investors like yourself on the Web.
The NAIC has teamed up with Yahoo! to create online
investment clubs. These clubs allow you to make cyber-buddies
with whom you can chat online and pool investment
knowledge. You can share investment strategies and results,
and more importantly, your common interest in investing.
To take a look at a sample club, go to www.
better-investing.org and click the Yahoo!Clubs
hyperlink.

Reviewing a company’s SEC filings

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Reviewing a company’s SEC filings
The government is on your side when it comes to getting
information about publicly traded companies.
The Securities and Exchange Commission (SEC) requires all
publicly traded companies to file an annual report. You can
get the annual report from the company itself. Publicly traded
Enter search request Select database
companies are not only required to provide annual reports
to investors (as I discuss in Chapter 2); they’re required to file
several other types of reports with the SEC during the year.

Looking at annual reports

If you’re a shareholder of a company, then you automatically
receive a copy of its annual report each year. If you’re not a
shareholder, you can either call the company to request an
annual report or access it from the company’s Web site. Usually
the company has a hypertext link that you can click to
download a copy of the report from the Web site.
Annual reports are gold mines of information because they
include the following financial statements and information:
n Income statement: Discloses all of the company’s earnings
and profits for the year.
n Balance sheet: Identifies all of the company’s long- and
short-term assets and liabilities.
n Statement of cash flows: Tells you all of the company’s
sources for and uses of cash for the past year.
n Research and development expenses: Tells you a lot
about where the company’s headed in the future.
n Overhead expenses: High overhead expenses relative to
total revenues can signal inefficient management or lagging
markets for the company’s products or services.
If you’re researching several companies, you can order copies
of all their annual reports at once using the Public Register
Annual Report Service (PRARS) Web site located at
www.prars.com. The PRARS Web site is a sort of clearinghouse
for the distribution of annual reports. In exchange
for entering certain information about yourself and completing
a survey, PRARS will mail you copies of annual
reports for the companies you’ve specified. You don’t even
have to pay postage!

Viewing other SEC filings
In addition to annual reports, the SEC requires companies
with more than 500 investors and $10 million in assets to
make other filings during the year. Some examples of required
SEC filings include:
n 10-Q: A quarterly form published three times a year to
supplement the company’s annual report.
n 8-K: The SEC requires that this form be filed to provide
notice of important financial events during the year that
may affect shareholders’ interests.
n 10-K: A report that companies must file annually at the
close of the fiscal year. It is a sort of unembellished
annual report that lacks the fancy graphics and promotional
hype included in the shareholders’ annual reports.
You can search and download recent SEC filings for a company
using the SEC Electronic Data Gathering and Retrieval
Service (EDGAR). They’re posted on the Web at
www.sec.gov/edgarhp within 24 hours after SEC
receives them.

An even more valuable government site than the EDGAR site
is the FreeEdgar site, which collects several years’ worth of SEC
filings for each company and organizes them into comparative
reports and charts. Using the data located at
www.freeedgar.com, you can get a sense of a company’s
earnings, profits, and sales history over time. You can even sign
up to receive e-mails from the FreeEdgar Web site alerting you
each time a specified company has made a required filing.

Evaluating the Stocks You’ve Screened

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After you screen a list of finalists — all the stocks that meet
your initial screening criteria — it’s time to put those beauties
under a microscope. You want to look for hidden flaws
and profit-making potential.
Reading what the analysts have to say
You can’t believe everything you read on the Web. If you do,
you’ll be broke in no time.
But certain Web sites, online newsletters, and so-called e-zines
do merit your time and attention. These resources can help
you narrow your focus when multiple stocks meet your criteria
and you need to decide which ones you should pursue further.
They can tell you what’s happening in the real world
beyond the four corners of the company’s balance sheet.
The most helpful and comprehensive Web site to consult when
looking for newsletters and online publications known as ezines
is www.investorama.com, as shown in Figure 3-3.
The Investorama Web site offers you a database of thousands
of articles and over 12,500 links to other Web sites. You can
search for the name of a company in which you’re considering
investing or do a keyword search describing the kinds of
stocks that interest you. You’re rewarded with a list of articles,
newsletters, and commentaries that meet your search
request.
The Investorama Web site is an ideal starting point whether
you’re looking to see what analysts have to say about a particular
stock or you’re interested in an overview of the market
in general. The site’s also a great place to find and order
free samples of publications.

Screening Your Stocks

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How do smart, savvy (and wealthy) investors pick a stock?
Invariably, they identify criteria for the types of stocks they
want to own. Then they decide which stocks meeting those
criteria are good buys. The process of coming up with a list
of stocks that meet your personal investment criteria is called
screening. Online research beats any traditional investing
approach cold when it comes to screening stocks.

Creating a checklist of stock screening
criteria

Investing philosophies are as controversial as political views.
When it comes to predicting which stocks will double in
value over the next five years, two mainstream “parties” exist.
The NAIC approach recommends that you focus on past performance
and current ratios. The second school of thought
is that you should mainly look for companies with undervalued
share prices relative to the assets that appear on their
financial statements. Both schools of thought rely on screening
criteria to identify stocks that fit with their approach.
You can screen stocks by using software designed for the purpose
or by using statistical information from a source such
as the Value Line Investment Survey.

The Value Line Investment Survey is a publication that you
can pay to subscribe to at www.valueline.com. You can
also use Value Line for free at your local public library. Value
Line contains information on over 1,700 stocks, and it ranks
them according to safety, stability, earnings predictability, and
other factors. The Value Line rating system is highly regarded
by financial experts.

RESEARCHING STOCKS ONLINE

2007-06-29T06:45:00.000-07:00

Where do the hottest stock tips come from? The people
with the coolest heads — and the most background information
— generate them. And truly hot tips don’t come from
people with ulterior profit motives or newsletter subscriptions
to sell. In fact, you may be your own best tipster. This
chapter gives you pointers on how to separate the hot tips
from the lukewarm losers when it comes to picking stocks.

Diversifying Your Portfolio
Diversification is free insurance. It doesn’t protect you against
every conceivable risk, but experts unanimously agree that
your online stock screening criteria should promote a diversified
portfolio. A diversified portfolio insures you against
market swings affecting one company, industry, or economic
sector.
Diversifying according to sector
With a diversified portfolio, the value of your entire stock
portfolio doesn’t plummet if a single industry in which you
own stock is on the skids. To diversify, purchase stocks that
represent different components of the economy, called
sectors. A sector is a category of related industries.

You don’t need to buy stocks in every economic sector — just
a healthy array of unrelated industries. According to the NAIC,
you can have a well-diversified portfolio by purchasing stocks
in just a half a dozen sectors. Economists all use different criteria
for categorizing businesses into sectors. Table 3-1 provides
a list of 12 sectors listed on the Market Guide Web site (go to
www.marketguide.com and click the What’s Hot link) and
examples of the industries they represent.

Diversifying according to size
Small companies’ stock prices tend to be more volatile than
those of large companies. Even within the same industry,
stocks of companies of different sizes tend to increase and
decrease at different times. When large-company stocks are
up, small-company stocks may be down, and vice versa.
A company’s size is determined by its market capitalization,
or market cap. Market cap is determined by multiplying the
current price per share by the number of shares of the company’s
outstanding stock.
The three levels of market cap are as follows:
n Small cap: Less than $500 million
n Mid cap: $500 million to $5 billion
n Large cap: Greater than $5 billion
At least half your online portfolio should be made up of midcap
stocks, and the remaining half should be split equally
between small- and large-cap stocks.

Self-Assessment for Online Investment

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Doing a Self-Assessment
Investment strategies are as different as fingerprints. You need
to do a pretty thorough self-assessment to resolve the following
issues:

n How much can you afford to invest? If you have a lot
of credit card or other high-interest debt, your best
investment may be to pay it off first. Paying off a credit
card with an interest rate of 22 percent gives you an
automatic annual 22 percent return on the money you
spend toward paying it off.
n When and how often will you invest? Weekly, monthly
or annually? Investing incrementally and systematically
over time (for example, each month) reduces risk attributable
to market fluctuations. You’ll purchase some investments
at market highs and others during a decline. With
systematic, smaller investments, you don’t have to worry
about the day-to-day or month-to-month fluctuations.
n What are your investment goals? NAIC guidelines recommend
that you seek to double your investments every
five years in working toward larger goals such as college
savings or retirement.
n What is your tolerance for risk? Risk is inherent in all
investments. Many investors, when confronted with
unanticipated risks, start selling assets in a panic. This
reaction compounds their losses. The best approach to
assessing your personal risk tolerance is to identify the
direst worst-case scenario you can psychologically and
financially handle and not invest in a way that would
increase your losses beyond that.
n What industries and types of investments should you
include in your portfolio? Diversification is an important
step toward minimizing risks. It means that you
hold as many varieties of investments purchased at as
many different times as possible in your portfolio. You
should attempt to diversify the types of industries and
sectors of the economy in which you invest, the types of
securities you purchase (for example, include bonds and
mutual funds as well as stocks), and the timing of your
investment purchases.

Basic Online Investing Principles

2007-06-29T06:42:00.000-07:00

You can’t help but be interested in hearing what the analyst
du jour has to say about how to make a killing in the stock
market. But avoid the impulse to allow a piece of news or an
opinion to send you scampering to your computer to buy or
sell stocks.

Online investors may occasionally guess right about the
movement of a particular stock and succeed in buying low
and selling high over a short time period. Bear in mind, however,
that the vast majority of investors who try to use the
Internet to anticipate the stock market on a day-to-day basis
(the beat-the-market approach) lose money in the long run.
A day-to-day trading approach is also more time-consuming
and stressful.

You should, instead, according to the NAIC, focus on using
your computer to find investments that you reasonably
expect to double in value over a five-year period. The NAIC
recommends that you stick to the following four basic online
investing principles.

Principle #1: Invest online systematically
Online investing should never be done on impulse. Snap
decisions can be a real danger, because after you establish an
account, you can buy or sell any stock in less than 60 seconds.
And thousands of Web sites offer you hot tips and
advise you to purchase something that is currently “undervalued”
or “about to take off.”

The NAIC recommends that you invest “regular sums
of money once a month in common stock” rather than
taking the beat-the-market approach. This systematic
approach encourages discipline. More importantly,
systematic investing increases your odds of making a profit
through the benefit of dollar cost averaging.
Dollar cost averaging presumes that the market goes up and
down over day-to-day and month-to-month periods. But
over a period of several years, dollar cost averaging assumes
that the trend is upward. The assumption that the market (as
a whole, not necessarily stock by stock) is likely to rise in
value over longer time periods is borne out by the past performance
of the stock market.

If you purchase large amounts of stock in a particular month
and the market goes down two months later, you’ve lost
money. (And you’ve agonized over your big purchase and the
stock’s subsequent decline.) However, if you systematically
purchase a small amount of stock each month, you can actually
benefit from declines in the market. In the months when
stock prices are down, you buy at a lower price, which, barring
fundamental problems at the company, is a bargain.
By making a commitment to buy, you don’t need to stay
glued to your computer screen, biting your nails over when
to buy and when to sell. Instead, you systematically identify
good stocks and make regular purchases each month without
worrying about short-term fluctuations.

Principle #2: Diversify your online
investments
Fortunes are made and lost on the principle of diversification.
Diversification means that you invest in different types
of industries and types of investments instead of just one.
This principle is especially important in the fast-paced environment
of online investing.

Diversification, according to the NAIC, “spreads both risk
and opportunity.” For example, if your technology stocks
suddenly take a nosedive due to the outbreak of an insidious
global computer virus, you’ll be glad you haven’t risked everything
and chose to diversify your stock portfolio to include
manufacturing, retail, and other types of stocks. If the entire
stock market is affected by the computer virus, you benefit
even further if you’ve diversified to include bonds in your
portfolio as well.

Principle #3: Reinvest your online profits
You can accelerate the process of building your wealth without
increasing the time and effort you spend online. Reinvesting
your dividends, interest, and the profit you derive
from selling an investment compounds your earnings. Compounding
occurs when you earn profits on your profits, and
it makes your assets grow exponentially.

Principle #4: Select online investments
for long-term growth
Day trading is a strategy where investors try to profit from shortterm
daily fluctuations in the stock market. According to USA
Today, only one out of every five day traders makes money.
Financial experts agree that you should focus on long-term
growth potential. You probably see the wisdom in purchasing
only those stocks that you believe have the potential to
double in value over the next five years.
The problem is that when you’re investing online, it’s easy to
become influenced by temporary market fluctuations as
opposed to the long-term growth indicators on which you
need to focus. Continuous quotes scrolling across your screen
showing your stock going down can make even the most
committed investor jittery about staying the course. The next
section of this chapter gives you a few pointers on how to
research the long-term potential of a stock.
Focusing on purchasing investments that you intend to hold
for a year or more provides important tax benefits as well. If
you hold an investment for 12 months or longer before you
sell it, the profits are taxed at favorable capital gains rates.
Capital gains rates are substantially lower than regular tax
rates

Online Investment Tips

2007-06-29T06:41:00.003-07:00

Look for relevant information. Trying to read everything
online about an investment isn’t a good use of your
time. Your goal is to look at relevant information — such
as the current price, historical value, past profits, and
management capabilities. (In the section titled “Getting
the Answers,” later in this chapter, I tell you what information
to research and where to get it.)
16 CliffsNotes Getting Started in Online Investing
n Look for objective information. To determine if a Web
site is offering objective information, you need to ask a
few basic questions. Is the Web site trying to sell you a
subscription? Does anyone get a commission from investments
they’re advising you to look at? Who’s paying for
site advertising? The presence of the profiteers can be subtle!
With so much information on the Web, bypass the
promotional stuff in favor of objective information.
n Take advantage of not-for-profit Web sites. The advice
that analysts offer is interesting, but the most enduring
investing principles and strategies are available for free.
Several not-for-profit organizations, such as the American
Association of Individual Investors at www.
aaii.com (see Figure 2-2) and the National Association
of Investors Corporation at www.betterinvesting.
org, maintain Web sites devoted solely to
educating investors. These organizations offer memberships
for a nominal cost, which entitle you to use all areas
of their Web sites as well as other support services they
provide.

The Start of Online Investment

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The real secret of profitable online trading is preparation.
Your success depends mostly on what you do before you
make a trade. In this chapter, you learn how to wade through
financial data at the more than 10,000 Web sites devoted to
online investing. You also apply basic principles of investing
to online trading and identify factors every investor should
consider when analyzing a potential investment.

Navigating Online Investment Web Sites
Even the most basic Internet query can turn up hundreds of
online investing Web sites purporting to give you hot tips
and insights you can’t get elsewhere. If you turn on your television,
you’re confronted with commercials telling you that
you are losing out by failing to check out yet more investing
sites. Where do you start?
Online investing requires researching and evaluating information
on the Web — not just clicking your mouse to make
a stock trade. But you certainly can’t read all the information
that’s available online. There’s just too much information.
Here are a few pointers for sifting through the proliferation
of Web sites for golden nuggets of online investing wisdom:
n Don’t pay for information you can get for free. Does
the Web site ask you to subscribe? Take advantage of trial
subscriptions offered by many reputable organizations,
such as the Lycos Investing site (www.lycos.com/lycos/
quote.asp) shown in Figure 2-1, to evaluate any subscription
you’re considering. Determine if the information
is already available to you someplace else for free. For
example, the inside financial scoop on most companies
is available for free in their annual reports. Free stock quotes
are on the Web site of each exchange and the NASDAQ.

Finding out about minimum balances, fees, and costs

2007-06-29T06:40:00.001-07:00

Finding out about minimum balances,
fees, and costs

Traditionally, brokerage firms have required a fairly substantial
minimum balance to open an account — upwards of
$1,000. Online brokerage firms tend to be far more liberal
about minimum balance requirements. You can generally
open online accounts with nominal minimum balances.
Chapter 6 explains how you open an online account.
Each online brokerage firm has to post a schedule of all its
commissions, fees, and service charges on its Web site. Online
brokerage commissions and fees are almost always
Chapter 1: Scoping Out Online Investing 7
substantially lower than the costs associated with traditional
full-service or discount brokers.
Lower online commissions and service fees are due in large
part to lower overhead — fewer buildings to maintain and
decorate to impress clients, and fewer brokers sitting in them.
The competition of having so many brokerage firms posting
their fee schedules on the Web also drives costs down. (Chapter
6 tells you more about how to compare fees and services
for various online brokers.)

Scrolling Through Online

Investment Options
When people think of investing, they usually think of stocks.
But one of the basic goals of sound investing is to accumulate
a diverse portfolio. Your portfolio is your collection of
assets, and it should include an array of investments with
different levels of risk — maintaining this variety is called
diversification.

Comparing Online Investing to Traditional Investing

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Online investing reduces the money you have to pay a broker
to trade securities. You can also react to market conditions
more quickly because you don’t have to contact your
broker to execute a trade. However, when you take charge of
your own investing strategy, you need to start doing your own
homework to substitute for the research and advice you get
(or are supposed to get) from a broker.
What’s different about online investing?
Both online investing and traditional investing are supposed
to make you money. You have to decide for yourself whether
you profit more handsomely from doing your own online
research and trading or from the services of a broker. Table
1-1 helps you compare the online investing medium to traditional
investing.
Table 1-1: Comparing Traditional Investing and
Online Investing
Traditional Investing Online Investing
The phone is your most The computer is your most
important investment tool. important investment tool.
Investors buy and sell Investors buy and sell
makes the purchase on securities themselves by
the investor’s behalf. using a computer to access
the brokerage’s Web site.
Investors pay their brokers a Investors pay their brokerage
commission on each trade. a fee that’s normally a fraction
of a full-service broker’s fee.
Brokers monitor your portfolio You monitor your own portfolio
all day long, sometimes calling by using a variety of online
to inform you of a danger methods.
or opportunity.
Careful research and planning Careful research and planning
is necessary. is necessary.
Evaluating the role of the broker versus
the computer
Before you give your broker the boot so that you can go
online, evaluating the services you actually get for the cost of
your broker’s commission is a good idea. You may decide that
you’re getting some benefits from using a broker that you’re
not ready to forgo.
You may feel more comfortable, for example, relying on the
advice of an experienced broker who monitors the market all
4 CliffsNotes Getting Started in Online Investing
day (while you’re away from your computer doing other things).
And your broker has the lines of communication to gauge what
other brokers are feeling and advising their clients to do.
Sometimes dealing with a broker is more practical than using
a computer. For example, you may like to pick up the phone
occasionally to ask a question and talk to the same person
each time. Or, if you travel frequently (particularly overseas),
you may not always have access to a computer.
Online investing and traditional brokerage services aren’t
mutually exclusive. You may even consider maintaining more
than one kind of account, giving you access to differing levels
of service.
Brokers are licensed and registered with the Securities and
Exchange Commission (SEC) to regulate the quality of the
advice they give you. Brokers have to pass a rigorous test to
receive a Series 7 license. The SEC can discipline brokers who
fail to follow SEC rules and standards in giving advice. The
SEC cannot discipline you for failing to properly research
your own online investments. By investing online, you
assume the responsibility and the risk.

A note about Online Investment

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Are you ready to take control of your own investments by
going online? You can save hundreds or even thousands of
dollars in commission costs each year by opening an online
brokerage account. You can also enjoy the flexibility and sense
of independence you get by managing your own assets.
Online investing, though once perceived as fast-paced and
risky, is now viewed as the mainstream, economical investing
alternative. Even if you have a long-established, comfortable
relationship with a trusted broker (who happens to
be your brother-in-law), online investing is a trend you can’t
afford to ignore.

A newbies guide to Online Investment

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Online investing takes you to the epicenter of financial markets
all over the world with a click of your mouse. It also
affords you instant access to the kind of sophisticated research
and analysis you could formerly get only by paying substantial
commissions to a full-service broker. Now you can execute
your own trades at your convenience — even after the
exchanges have closed for the day — at a big discount.