Stock Trading for Beginners FREE eBook: A Complete Guideline

An investment portfolio partners

Introduction

Most investors, particularly those investing on small-scale, lack the necessary expertise to make informed investment decisions. They may not be aware of the risk-return profiles associated with different investments. Consequently, they are unaware of the pitfalls to dodge while handling market intermediaries such as brokers. In addition, market realities and their obligations are a nightmare to them. The huge returns linked to some potential investments further heighten information inadequacy among small investors. Accordingly, wrong investment decisions lay a solid foundation for huge losses.

Among all types of investment, stocks hold the highest potential in the long-term. Stocks are not the only items on your investment portfolio – save for real estates, bonds, savings accounts, etc. – but they are the most valuable inclusion on it, whether purchased through stock mutual funds or individually.

Since early 1900s, stocks from large companies generated at least 10% average returns yearly. This rate caters for the low economic periods such as the 1987 Black Monday and its September 11 stock slide, and the Great Depression.

Beating the market is not the roadmap to successful stocks investment. Understanding the risk factor in all your investments is critical to create and maintain a balance between risk taking and prospective returns.

Therefore, the secret to an informed investment is gathering the right information, planning, and selecting the best option.

With this revised version, you will gain skills on how to develop a profitable portfolio, or incorporate stocks into your existing investment portfolio. You will sharpen your understanding on current market realities to help balance risk and returns. In addition, the guide will help you explore new investment opportunities while dodging the hurdles presented by poor decision-making practices in stocks investment.

This edition is suitable for novice investors with an urge to advancing their expertise in stock investment. However, an intermediate investor looking forward to better his skills in stock selection and management is welcome to follow along. The guide uses plain-English tips, with a rich background information on such concepts as exchanges, new rules, EFTs, investment channels, and a whole chapter dedicated to offer an insight into the current trends in the world of debt crisis!

Stock Trading for Beginners is an investment advisor and partner for anyone seeking a comprehensive approach to developing a successful portfolio and boost reward on investment in stock markets.

Understanding the Stock Market Investing
Chapter Overview

Stocks are equity investments. This implies that buying a share in a particular company makes you a part-owner. For instance, if an investor X bought one share of McDonald’s stock and McDonald’s owns 20,000,000 shares that are “issued and outstanding”, then investor X owns 0.000005% of the company. If at a later date McDonald’s is sold to another company, say Starbucks, for $25,000,000, then investor X would receive $125 for your share.

Therefore, as a stock owner, you are truly a business owner. You only have to care about optimizing profits while minimizing expenses. When businesses are good, companies make a lot of money and the prices of stocks rise proportionately. The opposite is true when businesses perform poorly: stock prices fall.

Stocks are publicized for issuance to help businesses raise capital. It follows that investors invest their money in the company by buying the company’s stocks. Stock buying increases the company’s capital for business expansion.

“I want to buy stocks.” What should I do? Inspite of the fact that stock issuer is a company; an investor does not invest directly into the company. The reason why you cannot buy stocks directly from the issuer is that stock trading is centralized through stock exchange.

Based on figure 1, an investor first issues an order to open an account in a brokerage firm which acts as an intermediary between the investor and the stock exchange. With an account, an investor funds the account to help buy stocks. Subsequently, the stock exchange executes the various orders from multiple brokerage firms in line with fixed rule. Upon completion of a transaction execution, the investor settles his or her trades via the brokerage firm.

Stock Exchange

A stock exchange provides a platform where you can buy or sell your stock shares. For example, in U.S., two major stock exchanges are NASDAQ (National Association of Securities Dealers Automated Quotation) and NYSE (New York Stock Exchange) located on Wall Street in New York City. In 2009, NYSE Euronext acquired and merged AMEX (American Stock Exchange).

Stock exchanges are vital in financial markets. When a company raises money through stock offering, it sells the shares directly to initial investors. However, when these investors no longer want to hold the shares, the exchange offers a place for buyers and sellers to meet and buy or sell the shares. This process is called liquidity.

If our investor X owns 1,000 shares of McDonald’s but cannot find a willing buyer, the shares would be worthless. However, investor X could call a broker who would send an order to a stock exchange where buyers would be on a stand by. This way, investor X would be confident to sell his or her shares to the highest bidder. The exchange, therefore, provides the liquidity, allowing sellers to get the highest stock price possible, and buyers get the lowest price possible.

Benefits of Investments

Through stocks, an investor makes money in twofold:

  • Through dividends to shareholders
  • Through a rise in stock price

Companies generating more cash than required to fund expansion strategies usually pay out a part of the reserve earnings to shareholders quarterly as dividends. A dividend is a direct cash outlay per share.

Often, the company would send a shareholder a check via an email. But based on investor preference, the company could further invest the cash dividend and buy additional shares in the company for the said investor. This will increase an investor’s shares over time based on stock pricing during dividend outlay and amount of dividends payable. You might have guessed right: as an investor, you will finally have fractional shares.

Common Approaches to Stock Investing

Chapter Overview

There are two types of stock investors based on their investment motive (growth and value). Growth investors invest in companies that provide strong earnings growth. On the other hand, value investors seek stocks undervalued by the marketplace. These are the two common approaches to stock investing. Since they complement each other, they can greatly diversify your investment portfolio when combined.

Growth stocks are evident in companies with above average gains in earnings in recent past. Although there are no guarantees, the companies are expected to deliver high growth in profits.

Close to growth companies are emerging growth companies – companies with greater potential to accrue high earnings growth, although they currently do not have an established earnings growth history.

Key Features of Growth Funds

  • Higher priced than broader market

Investors are willing to pay high price-to-earnings with a forecast to sell the stocks at higher prices as companies grow with time.

  • More volatile than broader market

The risk is that lofty prices can fall sharply on any negative news about the stock company, especially when the earnings do not please the Wall Street.

  • High earnings growth records

Growth companies may potentially continue achieving high earnings growth irrespective of slower economic improvements.

Value fund investors seek companies with good fundamentals and that have fallen out of favor. In addition, the value companies may include new company stocks that have not been recognized by investors yet.

Key Features of a Value Fund

  • Lower priced than the broader market

The reason behind investing in value funds is that the stocks will bounce back when the true value is realized by other investors.

  • Less riskier than broader market

Value stocks become more suited to long-term investors as the turnaround time closes in. however, they carry somewhat more risk of price fluctuation than the growth funds.

  • Priced below similar companies in the industry

It is believed that most value stocks are suitable to long-term investment and may carry more risk of price fluctuation than growth stocks

The question is: Which strategy realizes higher returns in the long-run, growth or value? The battle between these two approaches to investing has lasted for long, with either side providing statistical evidence to support its arguments. For instance, value investors hold that a short-term focus pushes stock prices to low levels, resulting in great buying opportunities for value investors.

Historically, growth stocks hold the potential to better performance when interest rates fall against rising company earnings. However, slower economic conditions can significantly punish such investments. Value stocks, on the other hand, are more likely to lag in a sustained bull market, with a potential to do well early in an economic recovery.

In a long-term stocks investing, some investors prefer combining growth and value stocks to increase the probability for high returns with minimal risk. Theoretically, this approach enables investors to gain across economic cycles in which marketplace conditions favor either of the investment style, thence smoothing returns over time.

Source: ChartSource®, DST Systems, Inc. Based on calendar-year returns from 1992 to 2016. Growth stocks are represented by a composite of the S&P 500/BARRA Growth index and the S&P 500/Citi Growth index. Value stocks are represented by a composite of the S&P 500/BARRA Value index and the S&P 500/Citi Value index.

From the chart above, both growth and value stocks have been, in turn, lagging and leading each other during different economic conditions and markets.

Reasons you Should Invest in Stocks

Chapter Overview

Stocks are one of the most probable ways to invest your cash. But why choose stocks over bonds, antique sports, or rare coins (or Bitcoin)? Most savvy investors invest in stocks due to their highest potential of returns. Accordingly, no other type of investment tends to perform better in the long-term.

When saving for far-off goals, it may be risky to not invest in stocks. When you are young, saving for a distant goal such as a retirement may seem ignorable. However, that is the best time to get started with saving. The more time you save, the more time it grows. The best way to allow your hard-earned money time to grow in the long-run is investing in any form of stocks – mutual funds, exchange-traded funds (ETFs), or a diverse of individual stocks.

Speaking about retirement, Ken Hevert, Fidelity’s senior vice president said that “In general, people should be more aggressive in their investment mix when they are younger—that is, tilt more toward stocks”.

Reasons to Invest in Stocks

If stock shy, the following are the reasons you should consider investing your money in stocks, especially when saving for a goal many years away such as retirement:

Stocks hold the most potential for growth

Inspite of regular market downturns, U.S. stocks have realized higher returns than bonds in the long-term. For instance, in tracking performance since 1926, S&P established that for $100, on average, stocks returned almost 10%, bonds 5.4% and short-term investments 3.5% annually prior to inflation.

Although it was not a consistent performance over the 1926-2016 periods, history holds that stocks offer more potential for growth in the long-run. This is why investing in stocks, stock mutual funds, or ETFs is important for a far-off goal savings.

Data source: Morningstar, Inc. 2017 (Jan-1926 to Dec-2016). Stocks are represented by S&P 500 Index, bonds by the U.S. Intermediate Government Bond Index, short-term investment by U.S. Treasury bills, and Inflation by Consumer Price Index. Numbers are rounded for simplicity

Probability to ride out stock market downturns

It is reasonable to own volumes of stocks. However, during market drops, though painful, if the stock market behaves in the long-run as evidenced by history, you will probably ride out. This is the reason why you should own stocks for longer periods. Despite of the fact that it might take decades to recover from worst declines in stock market, stocks, in overall, have offered most potential for growth provided the investor stays the course over the long-term.

If you save regularly and invest during market downturns, you probably will have additional savings during market dips. For instance, when the stock market recovers, you will be better positioned for stock growth.

Note: Losses are on paper until you sell your investment. So, why lock in losses when there is time to ride the market back up?

The periods that seemed worst in the economic history turned out to be the best times for stock investors. In the U.S. stock market, the best -5-year return began amid the Great Depression (May 1932) and the next during the worst recessions in U.S. economy (July 1982). See chart.

U.S. stocks during economic drops

Source: Ibbotson, Factset, FMRCo, Asset Allocation Research Team as of 31st March, 2015. Returns represented by total return of S&P 500® Index

You can diversify your portfolio

An appropriate investment mix depends on an individual investor’s financial health, time horizon, and risk tolerance. However, the rule of the thumb, investments with longer time horizons should have a significantly, broadly diversified stocks exposure.

Pecuniary returns are not the only reason behind stock investing. Investors can also enjoy corresponding rights as shareholders. For instance, gain the right to vote at shareholders’ general meetings and participate in the company’s joint decision-making process.

Further, investors gain interest in socio-political and economic happenings due to volatility of stock markets.

Accordingly, investors get a chance to analyze the stock issuing companies’ financial statements. This privilege to document analysis helps investors to make informed decisions on their investment portfolio.

In summary, despite your age and how far your future goal is, a diversified blend of investments with a broad exposure to stocks is desirable. Beware of riding the ups and downs of the stock market. An economic downturn can boost savings for regular savings over the long-term. The reason is that the same amount of money can buy more stock, stock mutual fund, or ETF shares at low prices.

Risk and Returns in Stocks

Chapter Introduction

The hook for investing in stocks is the potential to accrue attractive returns. The returns are in twofold: income gain and capital gain. Income gain, also called dividends, refers to quarterly, semiannual, or annual profits a stock issuing company gives to its shareholders. Capital gain, on the other hand, defines profits realized on a price increase – buying low and selling high.

The risk and return are the two sides of a stock investment. This is the first and most significant rule of the stock markets. Stock prices declining following a stock purchase is a possible event in stock markets. Also, companies may go insolvent.

Investing in stocks could lose your money sometimes. Therefore, before investing, it is advisable that you take time to understand the risks and decide which ones you are comfortable taking.

Risks in Stock Market

The first risk is that returns are not a guarantee. Despite having a historically good performance over long-term, stocks do not guarantee returns on your money at any given period. Various tools can be used to assess a stock. However, predicting exactly how a stock will perform in future is not possible.

There is no guarantee that stock prices will rise, or the issuer will pay dividends, or a company will survive an economic downturn.

Secondly, while investing in stocks, you must be comfortable with the risk that you might lose all your money. This is because stock prices fluctuate often for different reasons. For example, planning to invest over a short-term can be riskier than long-term stock investing. Even worse, you can lose more than what you invested if you rely on leverage to invest in stocks: e.g. short selling or buying on margin.

Stock Volatility

The stock market experiences ups and downs. A rapidly changing stock price is volatile. Such a price makes a stock riskier – causing your investment to lose money, especially when you are expecting to outlay your money in the short-run.

Inasmuch as you track a stock’s volatility daily, you should also consider monthly or quarterly performances ever recorded.

Volatility can be measured using:

  • Standard deviation: a measure of how widely a stock price has varied in the past from its average.
  • Beta: measures a stock’s performance against a benchmark such as the S&P TSX Composite Index. For example, a 1.0 beta informs a potential investor that a stock has been varying in resonance with the overall stock market. A beta ranging from 0.0 to 1.0 has smaller ups and downs while a beta above 1.p has wider price variations. Lastly, stocks with a negative beta are priced in the opposite direction to a benchmark.

Managing Stock Risks

Diversify your portfolio

You can reduce stock volatility by blending stocks from companies having varied characteristics. For instance, when stocks companies in a particular type of industry are struggling, those in a different industry could be rising.

Second, investing in companies with different sizes could reduce the overall risk since smaller startups could offer greater potential for growth, though riskier than stable companies with a good historical track of earnings.

Lastly, invest in different types of stocks. For example, preferred stocks offer lower risk and returns then common stocks. However, the former pay fixed dividends unlike common shares. Therefore, diversifying your portfolio with both preferred and common shares might help spread the overall risk.

Long-term investment

Stock market is subject to short-term price fluctuations. However, over long-term, stocks have a history of better performance.

Therefore, buying stocks for sell in a short notice may force you to sell at a low price, losing your money.

Never time the market

Timing a market can be risky. For example, a stock with increasing price could lure investors into buying it, further rising the price. However, the price could sharply decline as investors start selling for big gains.  To dodge such short-term price fluctuations, you may choose to hold your stock until the prices come back up.

If a novice investor, get advice

It is risky to invest without sufficient knowledge on how the stock markets work, or how investment strategy operates. A better understanding of the stock market realities could help you reduce the risk. If in doubt, consult a qualified advisor to help with selecting your stocks that are better aligned with your goals and risk tolerance.

Be Cautious with Private Stocks

Some companies do not trade their stocks publicly, but sell them through private actors. In such a scenario, a stock is owned by shareholders, and whose selling should be approved by all shareholders. Therefore, the shareholders have the mandate to set the stock price.

Buying private stock is risky since:

  • You cannot buy or sell stock when you feel like – consent must be sort
  • You may be needed to make a large investment
  • It may be a scam
  • Beware of offshore investment dangers

When investing offshore, the risk could be that the local banking laws do not protect you in a foreign country in scenario you are harmed. Thus you lose the protection. Therefore, be cautious of offshore investing, as some could be scams.

Caution!

If you do not have sufficient knowledge about an investment, avoid it. It might not be worth the risk.

Take action often:

i.        Diversify your portfolio

ii.       Invest for long-term

iii.       Do not time the market

iv.      If in doubt, consult a qualified investor.

Protecting your Investment Portfolio  

Chapter Overview

It is advisable to review your investment portfolio often. This has the advantage of ensuring that any price fluctuations are taken into account and make informed decisions based on market swings. It is a good strategy to look at your portfolio even if the economy is healthy. You should not wait until an economic downturn occurs to throw you into panic.

Portfolio Management Strategies

Often, prescribe to protecting your portfolio to realize the best from your stock investment. The following strategies can be handy in managing your portfolio against risk inherent in investments.

Reserve cash for short-term expenses

Your short-term money should not be placed in the stock market. Bills are there to stay and serviced. Putting all your money in stocks and plan to sell them over a short notice to a fallen market could make you bankrupt, unable to pay for your daily or monthly spending.

Plan to invest your money in stock market if you do not need it for short-term spending. Ensure that the money needed for the coming couple of months does not come from your investment portfolio lest you take too much risk with your savings.

 

Blend your portfolio with bonds

Although bonds do not receive applause as stocks do, investing in boring is often good for investments. High quality bonds, such as those issued by the U.S. government can provide a steady flow of returns irrespective of economic conditions. On contrary, stocks can decline more than 50% during worst economic drops.

Consequently, having a diversification of bonds and stocks could significantly save your portfolio. For example, bonds could edge up when the value of stocks fall.

To enjoy the smoother ride offered by bonds, most investors allocate at least 20% of asset allocation to bonds. In addition, short-term conservative investors may have a greater proportion of bonds on their investment portfolio.

In essence, a 100% stock portfolio can be too risky. Allocate some money to binds and harness the diversification benefit of your portfolio.

 

Diversify globally

When the local stocks are expensive, consider investing in overseas offers. For instance, the U.S. stocks are yielding dividends at 2% while an exceeding 3% is enjoyed in UK, Spain, and Australia.

Selecting and managing your portfolio on a global scale can be challenging. Because of this, consider investing in Exchange Trade Funds (ETFs) which holds stocks across various countries. This could greatly diversify your portfolio. Further, ETFs have relatively low expense ratio (fee), as low as 0.11% annually. If not comfortable to invest in a basket of ETFs, consider such providers as iShare for country-specific ETFs, though with varying expense ratios.

ETFs are discussed in the next chapter with stock mutual funds.

Commodity exposure

A strike of inflation can significantly harm both stocks and bonds. Having real estates on your portfolio could protect against such surprises. This is because real estates are assets whose prices change according to price level and their values remains unchanged.

Stock Mutual Funds and EFTs

Mutual Funds (MFs)

Overview

We have seen that investment involves taking risks. The risk is further heightened by lack of time, desirable skillset, or resources to select the right stocks or to monitor your portfolio and make informed decisions such as when to sell or exit the market. often, minimizing risks is key to a successful investment. This can be achieved through diversification, though even this mechanism requires substantial capital.

A mutual fund is an intermediary between an investor and a stock or capital market. A mutual fund defines an entity which collects funds and pools them together and, drawing support from competent professionals, invests the funds into several debt and equity schemes..

 

Investing in Mutual Fund

Investors receive units from the mutual fund for their investments. As a result, mutual funds charge management fee. The returns on investment (losses or profits) are proportionately shared among all investors. To some extent, mutual funds avoid the pitfalls associated with direct investing.

Through mutual funds, you are not buying a company share as is the case with individual stocks discussed since the beginning of this guide. Instead, you are buying shares of a specific fund.

Accordingly, should the fund be invested in, say 5 companies, then your money is proportionately invested in the 5 companies. in addition, you do not have a voice to decide which companies to invest your money with, nor when to sell the shares. Such responsibilities are delegated to a fund manager. Therefore, if seeking convenience, then equity mutual fund is your place to put your money.

Returns from a Mutual Fund

Unlike stocks where you hold voting rights, there are no such privileges in mutual fund investing. This is because a mutual fund share represents multiple investments in various stocks (or securities) rather than a single holding.

Mutual fund investors earn returns in three ways:

  • Dividends and interest

Income is earned as dividends on stocks and interest on bonds included on the fund’s portfolio. All the income a fund accrues is paid out as a distribution. Investors have a choice to receive a check for the distribution or get their earnings reinvested to increase the shares.

  • Capital gain

A fund selling at an increased price realizes a capital gain. Most funds share the capital gains to investors in form of a distribution.

  • Profit

If a fund manager does not sell the fund holdings during a price increase, the fund’s shares are bound to increase in price. This can then be sold for a profit in the capital market.

Advantages of Mutual Funds

  • Professional management

A professional investment manager takes care of picking and managing investments. The fund manager does research and skillful trading. The investor is saved the hassle of such activities, saving time in portfolio management. A mutual fund is therefore suited for a small investor.

  • Diversification

Unlike owning individual stocks or bonds, investing in mutual funds spreads the risk across different holdings. Large mutual funds own lots of stocks in different companies and across various industries. Building such a portfolio can be impossible for an individual investor with small amount of cash.

  • Simplicity

Purchasing a mutual fund is simple, with some brokerage firms having in-house funds. Some companies have automatic purchase plans for investors to decide on a monthly scheme. Accordingly, brokers can be sought to buy listed mutual funds on behalf of an investor.

  • Economies of scale

Since mutual funds buy and sell lots of securities at a time, they incur lower transaction costs than direct stock investing.

  • Transparency

Mutual funds are regulated by industries. This ensures fairness and accountability to investors.

  • Variety

Mutual funds offer a wide range of strategies or asset classes.

The variety exposes investors to stocks and bonds as well as foreign assets, commodities, ad real estates via specialized MFs. Better enough; some funds such as bear funds accrue structured returns even during market falls. They therefore offer both domestic and foreign investment that might be inaccessible to ordinary investors.

Disadvantages of Mutual Funds

  • Costs and fees

Developing, distributing, and managing a mutual fund is expensive. Every undertaking, from portfolio manager’s salary to investors’ periodic statements requires money. Unfortunately, these expenses are passed onto the investors – which can have negative implications in the long-term if not carefully monitored.

  • Active management

Management is infallible. Even if the fund accrues losses, the managers are paid. Actively managed funds often suffer higher fees while passive index funds are gaining popularity – since they track a benchmark index such as the S&P Index, making them less costly.

  • Liquidity

Mutual funds allow an investor to request for cash for the shares held. Unlike stocks, mutual fund redemption can only occur at the end of the trading day.

  • Cash drag

A significant amount of cash is needed for the portfolio to meet daily redemptions by investors in form of cash. Therefore, a large proportion of the portfolio has to be maintained in cash to accommodate liquidity – cash withdrawals. Since the cash earns no return, it is called a cash drag.

  • Dilution

Too much diversification can result in poor returns on your money. Although invested in multiple companies, high returns from a few of these companies do not make significant difference in the overall return.

  • Taxes

A capital-gains tax is inevitable whenever a fund manager sells a security. Tax-sensitive funds or non-tax sensitive mutual fund such as 401(k) can help mitigate taxes.

Exchange Trades Funds (ETFs)

An ETF is a fund investment traded on stock exchanges like stocks. An ETF holds such assets as commodities, stocks, or bonds. However, it trades close to its net asset value (NAV). Trading like a stock, the NAV is not calculated every trading day as is the case with mutual funds. Often, ETFs track an index such as a stock or bond index. They are attractive due to their low costs, tax efficiency, and stock-like features.

An ETF owns underlying assets such as stock, gold bars, oil futures, bonds, foreign currency, etc. It then divides these assets’ ownership into shares. Shareholders do not own the shares directly, nor do they have a direct claim to the underlying investment embedded in the fund. Therefore, they indirectly own the assets.

ETF shareholders earn profits such as dividends or interest. In addition, if the fund is liquidated, the shareholders get a residual value. Since ETF shares are traded on public stock exchange, their ownership can be bought, sold, or transferred much like stock shares.

Advantages of ETFs

Owning an ETF share offers diversification of an index fund to investors. In addition, investors have an opportunity to sell short, buy on margin, and buy as little as a single share.

Secondly, the expense ratio is relatively lower than those of an average mutual fund. For instance, buying and selling an ETF requires that you pay same commission to a broker that you would otherwise pay regularly per order.

Thirdly, there is a potential for favourable taxation on cash generated via an ETF. This is because capital gains from sales within the fund are not passed onto shareholders as is the case with mutual funds.

Fourth, dividends from companies in an open-ended ETF are immediately reinvested. However, it is worth noting that dividends accrued from unit investment trust ETFs create a dividend drug since they are not reinvested automatically.

Lastly, since ETFs trade close to a fair value across the day, there is a lower potential for a wide price fluctuation. Arbitrage serves to track the price, keeping it close to the fund’s NAV.

Disadvantages of ETFs

Sometimes, and in some countries, investors could be limited to large-cap stocks due to a narrow group of stocks in the market index. This reduces the exposure to small and mid-cap companies, leaving potential

growth opportunities out of ETF investors’ reach. This limits ETFs to larger companies only.

Investors may not enjoy intraday pricing changes since long-term investment could last for a long time horizon, say like 10-15 years.

ETFs realize relatively lower dividend yields compared to high-yielding stocks. Although the risk associated with owning an ETF is lower, taking on the risk by the investor could leave dividends accumulated via stocks much higher.

Comparing trading ETFs with stocks, it can be found that the costs associated with ETF investing are higher. Even if the actual commission paid to a broker is equal in the two investing, there is no management fees associated with stocks.

In overall, ETFs are more beneficial compared to other managed funds such as mutual funds. However, before placing your purchase order for ETFs, consider the tax implications associated with the ETFs.

Mutual Funds vs. ETFs

ETFs provide investors with tax advantages since, being passively-managed portfolios; they realize lower capital gains than their actively managed counterparts – the mutual funds. Based on the way they are created and redeemed, ETFs are more tax-efficient than MFs.

Based on their passive nature, ETFs have lower internal expenses compared to many mutual funds. The expense ratio for ETFs range from 0.1% – 1.25%, which is relatively lower than other funds’ 0.01% – 10% annual rate.

The bottom line is that investors enjoy from a range of increased choice, product variations, and price competition among fund providers. Therefore, gaining a good understanding of how MFs and ETFs work can greatly influence your building and monitoring of your investment portfolio.

Analyze your Goals and Finances

Tips prior to Investing

Some investors make investment decisions more rapidly without considering their financial goals. Normally, accurately predicting market behaviour can be near to impossible. However, an investor should make informed decisions to better manage his or her investment portfolio. This chapter tips you into areas of importance to consider before making your investment decision.

Tip 1: Make a personal financial roadmap

Before making an investment, sit down and honestly look at your financial pattern. Outline your goals and tolerance to risk. You can consult a financial professional to help you with the analysis.

Tip 2: Assess your risk-taking capability

Every investment involves risk to some extent. While investing in securities such as stocks, mutual funds, or bonds, beware of losing some of even all of your money. Remember that the money invested in securities is not insured.

Taking risk has greater potential for higher returns as its reward. For instance, carefully investing in asset categories with greater risk such as stocks over long-term could likely earn greater investment returns. This is in contrast to restricting your investment to less risky assets like cash equivalents.

Nevertheless, investing in cash equivalent could be appropriate over short-term to meet routine financial goals. The only challenge with cash equivalent investing is the inflation risk. Inflation eats into your investment returns over time.

Tip 3: Blend your investments

Investing in asset categories with varying returns based on market conditions would protect your portfolio against losses. History has it that returns from three major securities – stocks, bonds, and cash – have never experienced up and downs at the same time. In this regard, market conditions that would cause returns from one asset to move up would make another’s to rise. Consequently, better returns in one category will offset a fall in another.

You should include enough risk in your portfolio. As an investor, you should leverage the power of asset allocation to earn large returns to your financial goal. Therefore, including stocks in your portfolio for long-term investment is considered prudent by most financial experts.

Tip 4: Emergency fund

Uncertainties are inevitable. Be smart when saving for long-term. For instance, a savings product would help you to cover an emergency like unexpected unemployment.

Tip 5: Be careful when investing heavily in employer stock’s share

Don’t put all your eggs in one basket. Always plan to diversify your investments to minimize losses and reduce fluctuations on investment returns.As a part of any healthy lifestyle, exercise should always be considered. However, if you’re planning on using intermittent fasting along with an exercise routine, there are a few things you need to keep in mind as well as some best practices for ensuring safe and effective exercise in conjunction with your fasting protocol. Further, exercise can also be a powerful tool for helping you get through the fasting period in multiple ways.

Bracing Yourself to Invest

Goal setting is central to life, and particularly in financial planning. Before investing your money, take time to consider and set personal financial goals. For example, ask yourself these questions: do you plan to retire early? Would you like to start a new business in the near future?

Answering the above questions will open the road to making informed investing decisions. For instance, the goal of the money you invest in view of early retirement could be different from the goal of the money you invest for a prospective business startup.

To develop an appropriate financial plan, determining the time horizon, risk tolerance, and liquidity is of significant importance.

  1. Time horizon

When will you need the money back? Time horizon significantly impacts the type of investment – whether long-term or short-term. The rule of thumb is: The longer your time horizon, the more risky

[and potentially more lucrative]

investments you can make. A longer time horizon offers more opportunities to ride out fluctuations in your investments.

A very short time horizon would be vital in circumstances where you need greater reassurance of money when needed. However, such an investment will offer lower returns. A short timeframe may deny you time to try recouping the losses incurred, if any.

  • Risk tolerance

How comfortable will you be in times when your investment fluctuates? Risk aversive investors hold that inspite of a possibility of a greater return; a large loss would lead to forgoing of an investment. On the contrary, risk seekers are more willing to take chances of a large loss provided there is a potential for higher returns. All in turn, take into account your time horizon as explained above!

  • Liquidity needs

How quickly you need your returns converted to cash will influence your investment decision. When liquidity is a factor to go with, then investing in cash and cash equivalents such as money market accounts would suffice.

Liquidity needs will determine your investment type. For instance, a lack of short-term liquidity needs will allow you to invest your money in long-term securities.

Investment goals: Income, Growth, Stability

Determining your financial goals is a precursor to investment goals. You should think of how your money will help meet your individual financial goals. Three key investment goals should be taken into account prior to outlaying your money in the name of investing.

  • Income

Income is the periodic interest (also called dividends) earned on the money invested. The income can be spent of reinvested. The downturns in growth-oriented investment can be offset using cash payments.

  • Growth

This is an increase in the value of an investment, also called capital appreciation. Capital refers to the money you initially put in your investment. For example, if you bought stock shares worth $2 and later sell them for $5, then the additional $3 constitutes the capital appreciation or growth.

  • Stability

Also called capital preservation, stability ensures that your investment does not depreciate its value over time. This is a goal when you want your money to be the same over time for a definite spending. This ensures that your money is there on demand..

Surveying Sectors and Industries

How to Identify Investment Opportunities

Whether planning to start a business or make an investment, identifying the right opportunity is integral. Surfing the Internet will probably give you plenty of brilliant ideas on investment. A lot of opportunities will be presented for you to invest in. However, take caution as some of them may be scams, bogus ads. Therefore, it is up to you to seek the wheat from the chaff.

Before investing, consider the following:

  • Market ups and downs

Stocks are traded on stock exchanges. Depending on supply and demand forces, stock prices move up and down. If there are more buyers willing to sell, the stock prices increase. The opposite is true when there are more sellers than buyers – the price falls.

A stock price reflects the investment society’s opinion of stock. Often, the price is not the actual value of the company. Accordingly, short-term stock prices are greatly influenced by people’s emotions rather than factual data of the market conditions. Further, prices fluctuate based on information, misinformation, and rumor.

As an investor, your goal is to buy stocks that will increase value with time. For instance, a company that grows its sales and increase profits has a higher potential to get more investors buying its stocks. If the stock prices increase, you can sell your shares for a profit.

  • Stock trading terminologies

Stock trading terms help you in conditioning your order to buy or sell stock:

  • Ask price: also called offer, is the lowest available price when attempting to purchase stock shares.
  • Bid price: or simply the bid is the highest available price you can find when selling your stock shares.
  • Market order: a request to buy or sell a security immediately at the best price on the market. Placing a market order requires you to pay the ask price as a buyer. if selling, the market price you receive will be the current bid price. Remember that your order could be executed at lower or higher price that you expect. The immediate order execution is guaranteed, but price is not.
  • Other orders: besides the market order, you can place conditions on your buy or sell price. A limit order is a request to buy or sell a stock at a specific or better price. A stop order is a request that turns into a market order once a certain price is reached.

Research the Market

Companies of interest

The first step is finding your company of choice to invest your money with. This can be accomplished by reading investing publications and websites such as Wall Street Journal or Investor’s Business Daily. In addition, to gain an understanding of stock rankings, websites such as Stockchase.com can prove useful. Start off by searching through Blue Chip companies – companies with stable track of record of generating profits and well-funded with a competitive edge. They are usually recognizable, making products and services that are known to customers. Although they present some risk, blue chip companies are less volatile. They include Google, Wal-Mart, McDonald’s, and Apple.

Investment research

When deciding to buy stocks, you should do some research. There is plenty of information on the Internet that can help you get started. However, finding useful information can be tasking. To be on the safe side, consider some tools to carry out market analysis and select your best stock.

First, browse the issuing company’s corporate website to understand the company’s business model and financial results. Secondly, use websites that offer essential information about the company such as Morningstar. Morningstar, for instance, offer easy-to-understand information such as balance sheet, income statements, and cash flow statements. Third, use Google search to gain insight into the company through news and bulletins on the company’s financial performance.

Select the best performer

Once you identify a good candidate, review its key financial indicators. Compare such indicators vis-à-vis the competitors’ to determine how competitive your candidate is in the market. Assess such indicators as profit margin (ratio of net income to sales), return on equity (returns on investment), past and expected growth, historic rate of earnings against its competitors, company’s debt, and debt-to-equity ratio.

Picking a Stockbroker

Who is a Stockbroker?

A stockbroker is an intermediary between the seller and buyer of stocks. A stockbroker executes buy and sell orders as requested by the investors. Stockbrokers create liquidity in the market by trading on behalf of companies and individuals. They charge a flat fee for their services, which accounts for a percentage of the sale or purchase price.

With the advent of the Internet, there has been a proliferation of discount brokers for makes it easier for the general public to invest. However, the discount brokers do not provide all the expertise and services a stockbroker offers. This is because they attend extensive training on securities and pass licensing exams. The licensing specifies the type of securities to trade in like commodities.

Stockbrokers advise clients whether to buy, hold, or sell securities. Through research, stockbrokers make recommendations based on the client’s financial situations. Since they charge a commission, it is therefore worth determining if the services are worth the pay, since the fee eats into the investment returns.

 

 

Tips on Picking a Stockbroker

  1. Accessibility

Pick on a stockbroker who is easily accessible. If not easily reachable, then find whoever covers him or her. It is crucial to have access to the broker especially during busy trading days.

  • Type of stockbroker

Determine whether you are seeking a full-service or a discount broker. A full-service broker provide additional investment support, but for a fee. On the other hand, a discount broker charges commission on each purchase, although with little advice. For novices, a full-service broker may help with advisory role on investment. Besides, a discount broker may be appropriate for small investment amounts due to low fee.

  • Available market information

Brokers charge brokerage fees for the information and advice given. Some of the information may be generic (non-professional). It is up to you to identify and select best stockbroker for your money.

  • Shop around

Meet several brokers and select who you feel comfortable working with. Creating a good rapport with your broker is significant in your partnership. Never ascribe to anyone you don’t like.

  • Broker’s fee

Every transaction attracts a broker fee. The fee is an agreed percentage of the total amount accrued from an investment transaction. Besides broker’s fee, other mandatory charges include VAT, sales tax, etc. However, the later fees may not vary between brokers. For instance, get a commission schedule stipulating how much and when you will be paying the fee. Find out extra fees and charges likely to be paid.

  • Minimum balance requirement

As an investor, you are required to put down a deposit and maintain a minimum balance in your account. The balance largely depends on your financial profile. If investment funds are a limitation, then choosing a broker with low minimum balance is essential.

  • Referrals

Ask around and find someone with a reputation on the market. Identify brokers commonly used by others and find the reasons behind their suitability as stockbrokers.

  • Withdrawals

Consider how easy and fast it is to move money from your share trading account to the savings or current account. For instance, securities firms take longer to process your money, unlike bank’s brokering divisions. Nevertheless, you will always get your money, though the speed varies, making it a critical factor to consider particularly in emergencies or urgency.

  1. Stability and trust

It is important that your chosen broker is registered with the relevant authorities such as your national Stock Exchange. This will ensure that you don’t give your money to a corn or a scam.

The Bottom Line

Select a stockbroker you are comfortable with based on their reputation, fee chargeable, available market information on the broker and their mindfulness of interest on investment. Remember, if you are unhappy with the services of a broker, you can always make a change for better.

Investing for Income vs. Long-term Growth

Short-term vs. Long-term Investing: What is the Difference?

Often, investment performance frustrates investors. For instance, they expect growth in capital, only to accrue income. These frustrations can only be overcome by understanding the nature of investment: short-term or long-term?

Long-term investments are held over a year – usually for multiple years. On the other side, short-term investments last for a year or less. The two types of investment differ along the following lines:

  1. Expectations

When expecting your investment to be held for many years, it is advisable to invest your money over long-term. However, when expecting income like increase in value or return, then a short-term investment is your option. Short-term investments offer higher degree of principal protection.

If you are a youngster, just getting started in your career, a blend of both short-term and long-term is preferred. This is because the short-term investments may pay for immediate needs such as a deposit for a home, while long-term investments may cater for your resources after retirement. When old, it is preferable for you to invest over short-term to realize the returns over a short range to meet your needs and wants.

  • Goals

A long-term goal like leaving a legacy or planning for a retirement may call for a long-term investment. When projecting to get money for a need in the near future, then short-term investing may be the best option.

  • Risks

All investments bear certain degrees of risk. A major risk associated with long-term investment is volatility – fluctuations in the markets that may lead to loss of value on your principal. On the other hand, purchasing power risk is inherent in short-term investment. Purchasing power risk is associated with failure of the investment’s return to keep up with inflation.

 

Putting it All Together

The advice is to keep a mix of short-term and long-term investments on your portfolio. Grasping the differences between these categories defines your expectations form the investments. This knowledge is significant in making your investment choices and decisions thereof.

Income vs. Growth

Investing for income

For people approaching retirement or already retired, getting income is the norm. In addition, those investing to supplement their salary or wages often do so for income.

Popular forms of income-oriented investments include cash and fixed income (bonds) investments. These investments attract a regular rate of interest. Besides, you can realize income in form of dividends on individual stock shares and equity funds. Equity funds can be configured to be income focused.

Investing for growth

If expecting capital growth over time, then adopting an equity fund with a growth style is for you. However, consider the risks involved because equities are more volatile than other forms of securities.

Often, growth funds pay lower or even no dividends. However, inspite of higher degree of volatility in the short run, growth funds offer greater returns over the long-term.

Which is Desirable: Income or Growth?

The choice depends on your investment timeframe and financial goal. For instance, if expecting a smooth inflow of income, then consider funds that will help you realize this. However, if not in a hurry to get immediate income, then allocate more money to long-term, growth-focused funds.

Whichever your preference, beware of economic ups and downs that significantly impact your investment portfolio and returns thereof.

Trend Analysis: Technical Skills

What is a Trend?

A trend is a general direction a market has taken during a particular period of time. Trends can be upward or downward, relating to bullish and bearish markets. Although there is no timeframe to consider a market direction a trend, the longer the direction a direction is maintained, the more notable is the trend.

Trend Analysis

Trend analysis is a technical aspect of predicting the future stock movement based on past data. It is based on the idea that the past happenings in the market projects future happenings. This gives investors of how the stocks will move in future to plan their purchases, sales, or holdings. The trends analyzed can be short-, intermediate-, or long-term.

Trend analysis is a comparative strategy that examines the current market conditions to predict future ones. For instance, gains in a particular market segment may be likely to continue based on market conditions, or even influence a trend in another market sector. Inspite of involving volumes of data, there is no guarantee that the results will be valid.

Applying Trend Analysis to Stock Market

Before assembling data for analysis, it is desirable as the first step to determine the market segment to analyze. A market segment could be a particular industry such as automotive sector or a specific type of investment like a bond market. Once identified, it is then possible to analyze the general performance of the sector. The analysis may involve the impact of internal and external forces on the selected sector. Using this data, analysts attempt to predict the direction a market will take in future.

How is Trend Analysis Important?

As a stock investor, it is advisable to understand stock trading trend. This will help you to trade along the trends, rather than against the trends in the market. Trend analysis is beneficial because when moving with the trends, and not against them, will lead to profit for an investor.

 

How to Buy and Sell Stocks

Overview

When you buy a stock, you gain ownership in the company that issued the stocks. As a stockholder, you have rights in the company, for instance, voting rights during board meetings and earning dividend if the stock issuer generates sufficient earnings. Accordingly, you have the potential to sell your stock shares for a gain. You can buy a stock mutual fund or individual shares of stock.

Buying Stocks

When buying shares, there are two options: own shares yourself or pool your money with others in a collective investment called a fund. For novice investors, pooling your money is considered a safer option since you are not putting all your eggs in one basket. You will be spreading your risks as your money will not be invested in a single firm!

For a company to be listed on the stock exchange, it must move from being a private to a public one. To do so, it is required to complete an Initial Public Offering. You can safely buy stocks from such companies – this is the basic principle of stock investing.

Before making a stock purchase, it is advisable to take time and select your stock issuer, analyze the company’s financial records, research on stock purchases and decide whether you need a broker or you will buy directly from the issuer.

Making an Investment in Stocks

  1. Buying directly from issuer

Investigate the possibility of purchasing stocks directly from the issuing company. Some companies allow you to buy stock without involving a broker. This is made possible through direct stock purchase plans (DSPPs). If you plan to purchase small amount of stock, then such a plan could be just for you. This strategy saves you lots of time and cost of brokers: online search for a suitable broker and the fees thereof. DSPPs allow you to automatically reinvest your dividends if you desire to do so.

  • Choose a broker

If you can’t buy directly from a stock issuer, then the alternative is to buy through a broker. As discussed before, a discount broker is less expensive than the full-service broker, though the latter has added services like investment advice.

  • Open a brokerage account and deposit funds

Contact your preferred broker to open an account with them. You will be required to document your personal information along with your risk tolerance and investment experience. Once you have an account, deposit some funds to enable your broker to purchase your first stock shares. Next, make an order to notify your broker of the company you are interested in. The order is usually confirmed. Keep the confirmation documents as record of your purchases.

Selling Stocks

Once you have stock shares, the best way to make profit is through selling, but at a higher price than the purchase price. This is capital appreciation. However, you can earn dividends, although these can be wiped in a day due to market volatility.

An investor should beware of various sell orders to better sell your stock shares. The market order guarantees that your sell order will be filled, though price is not guaranteed. Often, you will hope for a price closer to the last price, but if your stocks do not have much trading volume, you might not. Also, when the market is moving quickly due to a news event, you might get a price that is very different from the entered sell order.

The famous “buy-and-hold” approach to investing involves holding high-quality stocks indefinitely. However, that does not mean you will never sell. A stock becoming overvalued, re-balancing a portfolio, or harvesting a short-term tax loss are the reasons that would prompt you to sell your stock shares.

  1. Selling when a stock is overvalued

The first step is comparing the market value and intrinsic value. The market price defines the share price during a stock purchase or sale. on the other hand, an intrinsic value refers to the company’ value, which is independent of the people’s willingness to pay for at the current time. A stock’s true value is equivalent to the sum of its future earnings. In calculating the intrinsic value, also determine and compare the profit-to-earnings (P/E) ratio to the industry average P/E.

If the stock is trading at a higher P/E ratio than its rivals, then it is the best time to sell. but if you realize significant profits on the stock, and believes in the company’s long-term futures, then withhold 50% of your position and maintain the rest of the shares.

A stock is overvalued when its market value exceeds its intrinsic value. For example, a stock trading $55 and with an intrinsic value of $40 is considered overvalued. At this time, the stockholder will be more willing to sell since the market value is trading in line with the company value.

  • Selling to re-balance a portfolio

First, assess your asset allocation goals. Depending on your investment goals and appetite for risk, your portfolio should have a balanced ratio of the various categories of assets: cash, bond, and equities (ETFs, mutual funds, and individual stocks). Experts advise that maintaining a portfolio of 75% bonds, 15% stocks, and 10% money-market funds or cash equivalents would be appropriate. on the other hand, when balancing the risk and return, a portfolio of 50% stock, 40% bond and 10% cash would be reasonable. However, for high-risk takers, an 80-90% stocks and 10% bonds or cash will be appropriate.

Re-balancing helps you to restore your asset allocation or establish a new asset classification. In so doing, you must calculate how much of a particular asset class you should sell to keep the balance. All in all, you should have a good reason to sell rather than only balancing your portfolio as you can sell an undervalued stock share!

  • Selling to harvest tax losses

When selling stock for a profit, then you are subject to capital gains tax – a tax on your profit. The taxing can be twofold, depending on the duration of holding. For stocks held over a year, the profit will be taxed as capital gains at the tax rate. However, if you hold stocks for less than a year, the profits will be taxed as normal income based on your tax return regulations.

Tax loss harvesting is the selling of stock at a loss to offset the capital gains tax. This is a tool you can use to reduce the overall taxes. Tax harvesting can be useful when selling a stock that has lost value. As stated before, sell a stock at a loss for a good reason. Also, understanding the wash-sale rules could be paramount. A wash-sale is selling a stock at a loss then re-purchasing the same stock or similar stock over a short-term.

Stock Accounting

Types of Stock Transactions

There are three types of stock transactions:

  • Sale of stock for cash
  • Stock issuance in exchange for non-cash assets or services
  • Repurchase of stock

Sale of stock for cash

Par value is the legal capital per share, usually printed on the face of your stock certificate. The structure of your journal entry depends on the size and existence of the par value.

When you sell a common stock, you record a credit into the Common Stock account for the par value of each share sold. Further, any additional amounts paid by the investor are credited in the Additional Paid-in Capital account. Lastly, cash received is debited on the Cash account. If selling preferred stock the entries will be similar to those of common stock, except that they will be identified as preferred stock accounts.

For example, Apple sells 1,000 shares of common stock for $10 per share. The stock par value is $0.01. Apple records the following entries:

          Debit Credit
Cash 10,000  
Common stock ($0.01 par value)   10
Additional paid-in capital   9,990

Stock issued in exchange for non-cash assets or services

A company issuing stock for non-cash assets and/or services should determine the share value. First, if there is a trading market for the stocks, the company determines the market value of the shares. If there is no trading market, the shares are assigned a value based on fair market value of the non-cash assets or services received. Once the shares have a value assigned, journal entries are made as in our previous example, except that a different account, rather than the Cash account is debited.

For example, Apple goes public and its stock trades at $8 per share. It issues 2,000 shares to its product design firm for services received. The stock has $0.01 par value. Apple has to make the following journal entries:

  Debit Credit
Outside Services expense 16,000  
Common stock ($0.01 par value)   20
Additional paid-in capital   15,980

Re-purchase of stock (treasury stock)

When the board of directors elects the company to buy back its shares from shareholders, then this gives rise to treasury stocks. The buyback reduces the volume of outstanding stock on the open market.

Usually, a cost method is used to account for the treasury stocks. The cost of the buyback is listed in the treasury stock account. This is recorded in the stockholder’s equity section of the balance sheet as a deduction. Therefore, it is a contra equity account. On selling the repurchased shares, any sale amount above the buyback cost is credited to the additional paid-in capital account. However, in case of a shortfall, such shortages are charged to the remaining additional paid-in capital from the previous treasury stock transactions, and then retained earnings if there is no additional paid-in capital.

For example, if the Board of Directors at Apple decides to buy back 500 shares of its common stock at $9 per share, the entry is:

  Debit Credit
Treasury stock 4,500  
Cash   4,500

If Apple’s management decides to permanently retire treasury stock originally recorded under the cost method, it backs out the initial par value and additional paid-in capital associated with the original stock sale, and charges any remaining difference to the Retained Earnings account.

Back to our previous example, if the 500 shares had a par value of $0.01 each had originally sold for $4,000 and all were to be retired, the entry will be:

  Debit Credit
Common stock 5  
Additional paid-in capital 3,995  
Retained earnings 500  
Treasury stock   4,500

If Apple later decides to sell the shares back to the investors at $10 per share, the transaction is as follows:

  Debit Credit
Cash 5,000  
Treasury stock   4,500
Additional paid-in capital   500

Document Analysis

Collecting Key Documents for Analysis

Since companies create plenty of financial documents, it is good to understand which ones are important for analysis as you make your investment decisions. Consider the following list to help with your fundamental analysis:

 

Earnings press release

Often, a company spells out its quarterly performance in press releases. For the investors, the company hands out an earnings report. The report includes key financial measures such as profit, expenses, and revenue. These measures make the document critical for analysis, especially for potential investors.

Quarterly financial report

After a press release of earnings report, a company provides an official version of the report. The quarterly report outlines the finalized figures for the just-completed quarter. This report contains all the information as was in the press report, however, at a higher level of detail. For example, a press release does not contain a cash flow statement, which is mandatory for quarterly financial report.

Annual financial report

This is the most important and complete document for analysts. It outlines all developments at the company and full-year details of financial statements. Accordingly, a company produces a colorful version of the report to shareholders, called annual report.

Balance sheet

This is the corporate version of the net worth statement. It stipulates what the company owes (liabilities) and what it owns (assets).

Income statement

This document shows how much revenue a company makes and profits saved after expenses.

Statement of cash flows

What matters most to an analysis is the cash a company makes into its doors, not the huge profits. Even though most investors start their analysis on balance sheet and income statement, a cash flow statement is critical since it is subject to fewer distortions from rules of accounting.

Key Things to Analyze in an Annual Report

  • Compare cash flows with net income. Ensure the company is bringing nearly the same amount of cash as its reported profits.
  • Compare the current year’s annual report with previous year’s annual report. Determine if the company achieved its goals. This gives a trend of the company’s future
  • Consider gross and operating margins. Consider the amount of profits generated vis-à-vis revenue realized. These are the measures an analyst should pay close attention to during investment decision-making phase.
  • Look for any deterioration. Consider a company that is actually growing, rather than that with growth prospects. A basic analysis of the company’s fundamentals like earnings and revenue will give you a clue on the company’s deterioration, if any.
  • Consider the CEO’s paycheck. Most annual reports ship with proxy statements – stipulating how much salary top executives are paid. Be careful of huge management compensation as this may mean the executive is out for themselves, rather than you. This is a background check beyond mere financial statements to grasp the company’s position and performance.
  • Inquire into potential conflicts of interest. Examine the proxy statement to ensure the directors have business dealing with the company. Voting for directors is a strategy to safeguard your interest in the company.

Top Sources of Analysis Data Online

  • SEC.gov: This is a repository of financial information provided by Securities and Exchange Commission. You can access and download your selected company’s financial statements
  • Nasdaq.com: This is a leading stock market exchange – a platform where buyers and sellers exchange stocks. It provides summaries of companies’ financial statements, stock quotes, and trading information.
  • Morningstar.com: This is a research firm that monitors mutual funds. However, it contains some information on stocks.
  • Moneycentral.msn.com: This provider has a powerful screening tool to customize your search on stocks and companies.

Economic and Political Dimensions

The Stock Market and the Economy

Basics

Stocks are ownership interests in companies and as such, they are important both to businesses and individuals. For instance, they are an important component of a personal retirement portfolio. Businesses use stocks to raise capital for operational and strategic reasons. Stock prices significantly influence consumer and business confidence, which impacts the economy. Conversely, economic conditions influence the stock market.

Stock price fluctuations have a psychological bearing on businesses and individuals. For example, rising stock markets (bull markets) may create confidence on the direction of the market (trend). If stock prices rise, investors will be more willing to come to the market, building the market momentum. On the contrary, falling stock markets (bear markets) cause people to be more pessimistic about the economy’s future. Media reporting often create panic. As a result, people invest their money into low-risk assets rather than in stocks, further depressing stock prices.

 

Business Investment

Stock prices influence business investment. Businesses make money during rising market values (bull markets). The management may be more operationally flexible is stock price increases result in increased consumer spending. Mergers and acquisitions are more pronounced during bull markets as companies turn to and use stocks as currency. Initial Public Offerings (IPOs) increase as private companies take advantage of the higher market value to raise capital

Bear markets (falling market value) makes businesses and individuals less confident about investing in new plans. Merger activities declines as well as number of new company listings. Overall, reduced business activity slows the economy.

 

Consumer Spending

Bull markets create wealth because people are more confident as their portfolios increase in value. They spend more on non-essential items such as home. On the other side, bear markets reverse the wealth effect. A drop in portfolio value creates uncertainties about the future of the economy. People hold back their spending on non-essential assets. The overall effect is reduced economic growth since consumer spending is an integral part of the Gross Domestic Product (GDP).

 

Summary

Stock markets affect the economy, among other factors. Interest rates impact the economy since rising rates reduce the rate of borrowing due to higher costs. Business investment and consumer spending slows down, thence reduced economic growth. Declining interest rates induce economic growth.

Fiscal policy affects the economy. For instance, huge budget deficits may reduce government purchasing power and investments, slowing down the economy. Currency fluctuations can raise export prices, which can hurt export-driven economies.

Stock Markets and Politics

Terror attacks, extreme weather events, and worries of nuclear war precipitously lead to a fall in value of stock markets. For instance, August 2017 terrorist attacks in Barcelona, Spain led to a 275-point drop in the Dow Jones Industrial Average.

There is a complicated relationship between political conditions and the stock markets. Politics have a negligible effect on the stock markets other than short-term knee-jerk reactions.

 

Short-term vs. Long-term Effects

While investigating the impact of politics on the stock market, it is worth noting the timespan. What may be considered good in the short run may not bear the same good news over the long-term. For example, a proposal to increase infrastructure spending may be good for the economy over the short-term, but detrimentally harm the economy, stock market, and society in the long-term.

The pace of modern media environment can mute the effect of most individual market events. The world is becoming more resilient to weather calamities and terror activities as investors brace themselves for greatness.

As an investor, you should be aware of other factors that impact the stock market such as interest rates, company earnings, and world economy expectations. Knowing the context of a market drop is paramount, rather than ascribing to any news event. The major driver of stock markets is the corporate earnings growth. For example, if companies continue growing their profits, the economy will follow suit.

 

For Investors

Investors should beware of the big-picture investment strategies as they evaluate price fluctuations amid a political event. They should not get too caught up in every turn and twist of the market. Remember that there are stocks that are smart and stable investments irrespective of political crisis – the fiscal cliff, debt ceiling, etc.

In addition, investors should be advised of market corrections twice or even thrice a year inspite of positive economic conditions and robust political situations. A rule of thumb is to be globally diversified across bonds and stocks. This diversification will help you as an investor to ride out the inevitable ups and downs of the stock market.

Common Pitfalls in Stock Trading

Costly Stock-buying Mistakes

Investing in the stock market directly offers greater risk, but potentially higher rewards. Below we discuss stock-trading pitfalls to watch out.

  1. Insufficient capital

A key strategy to stock investing is diversification. This safeguards you against losses from a particular class of assets whose price has fallen. For novice, investing in equity-driven mutual funds is the best bet for you. Remember a warning against putting all your eggs in one basket?

  • Buy high, sell low

Everyone understands that stock investing’s appetite is to buy low and sell high. To avoid buying high due to emotions and later sell low, you should assess your investment goals and timeframe.

  • Overtrading

Just because short-term trading is called “day trading” does not necessarily mean you have to trade on a daily basis. Even if trading on your own rather than through a broker, there are costs associated with each transaction. For instance, if you frequently turn your stocks in search of a quick profit, you might be generating fees that would eat away your returns.

If you decide to become an active trader, think twice. This is a tough game, only attempted by seasoned investors. However, it is beneficial in that you can gain advantage of accessing special equipment that is less readily available to average trader.

  • Research skimp

Like any other purchase, stock shares should be researched extensively. Ensure that the company is successful and financially stable. Learn the importance of key financial ratios like price-to-earnings and return-on-equity to better judge whether a company is trading below, above or at its intrinsic value.

  • Lack of commitment

If investing directly, you should be committed to track and monitor it. You should study and follow market trends, the news, and the entire industry but not the ticker for your stock shares. If you buy-and-hold your stocks, then it is necessary to review the holdings on a quarterly basis. However, for day trading investors, you should commit to tracking them even better than your full-time job.

 

Bottom Line

As an individual investor, implement a rational investment strategy you are willing and comfortable sticking to. Be proud of your investment decisions and in the long-term, your portfolio will reflect the decisions’ soundness.

Selecting Winning Stocks

Stock Picking

This section examines time-tested strategies for finding good stocks. Stock-picking strategies are based on a combination of criteria, with a sole aim of realizing greater rates of return. There are many reasons that make stock-picking a thrilling venture. These include intangible lots of information; many reasons influence a company’s financial health – making it difficult to construct a prediction formula; and irrational element inherent in human cognitive capability affects the behaviour of the stock market.

5 Tips to Stock-picking

Tip 1: Price Earnings

This ratio reveals a company’s trading based on per-share earnings. Most investors will not buy stock when P/E ratio is above a certain level like 15 times. The only inherent problem is that earnings can be manipulated to include all write-downs and/or special charges.

Advice: In as much as you assess the P/E ratios, look beyond the mere figures!

Tip 2: Price to cash flow

This is a better metric than earnings. First, cash flows cannot be easily manipulated as is the case with earnings. Second, cash flow hints on the company’s ability to continue paying out dividends – which is key for dividend investors. Cash flow is important for companies seeking buybacks or acquisitions.

Advice: First consider cash flow then earnings.

Tip 3: Price to book

Value investors often use this metric. They compare the accounting (book) value and the price of a stock. Occasionally, they buy stock at a price far less than its true value. The major drawback to this strategy lies in determining whether a book value is real. For example, some companies such as those in energy and mining industry are falling and as such, take huge write-downs on assets.

Advice: This is a key ratio to consider; even Warren Buffet considers it key!

Tip 4: Technical indicators

The secret behind technical analysis lies in reading and interpreting trading charts and volumes. After fundamental analysis, an investor goes on to consider technical indicators such as “break outs” where the prices move above certain moving averages. However, only analyzing trade charts and volumes is not sufficient to decide whether a stock is a buy or a sell.

Advice: Consider fundamental analysis in combination with technical (trend) analysis.

Tip 4: P/E momentum

Often, momentum investors seek positive change. They seek companies beating earnings estimates – with corresponding increases in trading volume and price movement. The only problem is that momentum stocks are very expensive and should the momentum fall, the stocks are hurt severely.

Advice: Even for new stock ideas, watch momentum trends always.

Identifying and Avoiding Scams

Overview

Investment scams usually involve luring you into putting your money into a questionable investment, or even worse, those that do not exist. Often, you may lose some or all of your money. Let us discuss common scams in stock trading:

Common Investment Scams

  1. Advance fee scheme

The victim is persuaded to pay money upfront to enjoy higher returns for an offer. The catch is that scammers take money and disappear into thin air and the victim never hears from them ever.

Often, scammers target investors who have experienced a loss in a risky investment. They contact them and offer them an opportunity to recover their money lost from previous investment.

  1. Forex scam

The foreign exchange market is the largest and most liquid financial market of all. Investors purchase and sell currencies with a focus on making money when exchange rates change. However, the dealings can be very risky. The forex market is dominated by well-resourced international banks with highly trained professionals. It is near impossible to consistently beat these tech-savvy professionals.

Some forex trading schemes can be fraudulent or illegal. Since they are web-based, unregulated firms may market their services outside the local country’s rules. You may be required to wire your money into an offshore account, which may not be invested as claimed, making it hard to access them. There is a likelihood of losing some or all of your money.

  • Exempt securities scam

On their own, exempt securities are not scams. However, some scammers pitch fraudulent investments as “exempt” securities. Exempt securities are those allowed to sell without filing a prospectus with securities regulators in a particular country. Beware of unsolicited phone calls claiming a tip on promising business yet to go public.

  • Pump and dump scam

Scammers promote an incredible deal on a low-priced stock through a list of potential investors. You don’t have an idea of whether the contact owns a large amount of the said stocks or whether the business is itself legitimate. As more investors purchase the stocks, the value of the stock increases tremendously. Once at peak value, the scammer sells the shares and stock value plummets. As a result, you are left with worthless stocks.

Warning: Signs of a scam

  • Hot tip or insider information
  • Seller not registered to sell investments
  • High returns and low risk
  • Pressure to buy stocks now.

Advice

Always check the seller’s registration through your local securities administrators, for instance, Ontario Securities Commission or Canadian Securities Administrators in Canada.

Tips for Higher Investment Returns

Chapter Overview

That stock certificate is your share of the company’s ownership, a claim of the company’s earnings and assets. Today’s technology has resulted in a proliferation of information for the would-be investors – but with hard-to-decipher suggestions. Here are tips for novice investors who expect higher returns on their stock investments.

Stock Investing Tips

Think risk vs. return

The higher the returns, the more risk your stocks carry. If you are risk-averse, then you will settle for stocks with lower returns. Most savvy investors fall in the midst of risk-ready and risk-averse breeds.

Assess your financial position

Before you commit to stock investing, ensure you have enough capital. The rule of thumb is to have little or better, no debt as well as 6-month expenses in an emergency savings account to live by. Ensure you have a good financial base before getting started on the investing.

Diversify

Be smart. Diversify your portfolio by mixing stocks with different types of funds having varying volatility. Remember the warning against putting all your eggs in the same basket?

Assess a stock’s volatility

Consider the company’s rolling one year standard deviation over a 10-years window. Simply put, assess the stock’s average performance over the timespan. A normal deviation is 17% – implying that the stock value fluctuates by 17% about its intrinsic value.  

Buy low, sell high

The advice is simple: buy stocks when they are priced low, sell them when highly priced. To protect your portfolio, harvest good performing stocks and put the returns in underperforming stocks. This will help rebalance your portfolio.

Invest in reputable companies

Usually, past performance is not a guarantee of future results. However, it is a good indicator to go by. Companies managed by experienced management which is nosy for new opportunities always thrive and expand. A company with a reputation for consistent performance speaks positively to its future prospects – although it is not guarantee. Always assess your financial situations (see #b above).

Get advice

To be successful, go through some training. This will help you to determine which investment is profitable: ETF or a mutual fund. The knowledge will help you understand the risk vs. return. Good resources for self-training can be accessed from The Wall Street Journal, Morningstar, Investopedia, and Kiplinger.

Advisory agencies like Garret Planning Network and Northwestern Mutual provide investment advice to all investors irrespective of income levels. You can get more advice from online community such as Bogleheads.org.

Understanding Brokerage Orders and Trading Tactics

Know your orders

The growth in digital technology and the Internet has led to many investors buying and selling stocks for themselves rather than using brokers and advisors. However, you must understand the various types of orders and the appropriate time of application.

  1. Market orders

This is an order to sell or buy stock immediately at the best available price. This order does not guarantee price, but guarantees immediate execution of the order. Normally, you pay an ask price when purchasing stock and a bid price when selling stock. This order is common for individual orders who like buying or selling stock without delay.

  • Limit orders

This order sets the maximum or minimum stock price an investor is willing to buy or sell. A buy limit order can only be executed at the limit or lower price while a sell limit order can only be executed at the limit or higher price.

For example, an investor may purchase shares of Apple stock for at most $10. The investor could submit a limit order for this amount and it will only be executed if the stock price is $10 or less.

  • Stop order

This is also called stop-loss order. This is an order to buy or sell a stock once the stock reaches a specific price called stop price. When the stop price is reached, the stop order becomes the market order.

  • Buy stop order

This order is entered at a stop price above the current market price. Generally, investors use buy stop order to protect a profit or limit a loss on a stock sold short. A sell stop order is entered at a stop price below the current market price. A sell stop order is used to limit a loss or protect a return on a stock owned.

Trading Tactics

Here is what you ought to know about trade order execution.

Just as you have an option for a broker, your broker has the following options to execute your order.

  • A broker may direct your order to the exchange, a firm (market maker) or another exchange if it is listed on a particular the stock exchange.
  • A stock trading in an over-the-counter (OTC) market may have your broker sending the order to an OTC market. Most OTC market makers may pay the broker for the order flow.
  • Your broker may send your order to another division of his/her firm. This is called internationalization.
  • A market maker is a firm that is on standby to buy or sell stock listed on an exchange at publicly quoted prices. Market makers may pay your broker for routing orders to them as a means to attract them. The pay is called payment for order flow.
  • Your broker may route your order to electronic communications network (ECN) that automatically match buy and sell orders at set prices. More often, limit orders are routed this way.

You can direct your orders by calling the broker and recommending a particular market maker, ECN, or exchange. However, some brokers may charge a service fee. Some brokers offer this option to active traders.

Safeguarding your Money – The Taxman

Overview

Besides sales tax, property tax, exercise tax, payroll tax, an income tax, individuals who buy and sell stock investments must pay capital gains tax. Capital gains on stock investment depend on two main factors: your total income and how long you have held the stocks. Capital gains realized on short-term investments are taxed at your marginal tax rate.

Capital gains rates can be as low as 0% and as high as 39.6%. Therefore, it is important to understand strategies to keep such taxes at a floor.

Reasons you do not have to Pay Tax

There are reasons why an investor may not pay capital gains tax.

  • If you owned stock over a year and you fall under 10% or 15% tax bracket, your tax rate is 0%.
  • If you own stock in a tax-advantage account like IRA, you won’t owe any tax. However, if it is a traditional IRA, you will pay tax on eventual withdrawals.
  • If you have capital losses, you can use such losses to offset the capital gains. This is a strategy called tax-loss selling.

If none of the above circumstances exist, then you have to pay capital gains tax.

Strategies to Reduce Capital Gains Tax

  • Wait over a year before selling stocks

If your investment qualifies for long-term status, you qualify for a lower capital gains tax rate. Therefore, holding your assets longer than a year will have lower rate than the marginal rate.

  • Marginal rates of 10-15%, pay capital gains rate of 0%
  • Marginal rates of 25%, 28%, 33%, or 35% pay capital gains rate of 15%
  • Marginal rate of 39.6% pays capital gains rate of 20%

For example, if you sell stocks that fall in the 33% tax bracket and sell them at $4,000 capital gain. The difference is as follows:

You are taxed at 15%: $4,000 x .15 = $600.

Therefore, holding your stocks for long-term could lower your tax burden by more than half, based on your marginal tax rate.

  • Reduce your taxable income

Since your capital gains tax is based on your income, general tax-saving strategies may prove important to lower tax burden. For instance, maximizing your credits and deductions before filing tax returns is a good strategy. Accordingly, you can donate some cash or assets to charity or take an expensive healthcare procedure before end of the year.

If contributing to a 401k or traditional IRA, garner huge deductions by contributing full allowable amount. If investing in bonds, consider municipal bonds rather than corporate bonds. This is because municipal bonds are exempt from federal tax and thence excluded from taxable income.

  • Time capital gains and capital losses

In any year, capital losses offset capital gains. For instance, earning a $20 capital gain after selling stock X and then experience a $15 loss in sell of stock Y, then your net capital gain is the difference: $20 – $15 = $5.

  • Sell when your income is low

Based on the above list of tax rates, your marginal tax rate is determines your capital gains rate. Therefore, selling long-term capital gain assets in may lower your capital gain rate and save you money.

  • Go UGMA

Use the Uniform Gift to Minos Act to open a brokerage account for your child. The first $950 of annual income is tax free and the next $950 is taxed under the kid’s low tax bracket. The only worry is that the junior may take ownership but fail to use the money as intended.

  • Become a cheapskate investor

Cut fund manager’s fees by haggling. A dollar saved this way is a dollar earned tax-free, unless other miscellaneous deductions come into play, though unlikely.

Recognizing a Great Stock

Identifying Undervalued Stocks

When buying stock, you should evaluate its current price to help determine if it is below or above its worth over the long-term. Value investing identifies undervalued stocks.

Motley Fool defines value investing as:

Value investing consists of investing in stocks trading at prices below their intrinsic value. Value investors, therefore, are essentially buying stocks at a discount to what they believe they are worth; in hopes these investments will eventually rise to reflect their intrinsic value.

Tips to Selecting Great Stock

  • Quality rating: Stocks with better or average quality rating is preferred. A quality rating of B+ or better is recommended.
  • Current ratio: Buy stocks with a current ratio of 1.5 or higher.
  • Debt to current asset ratio: Select companies with a low debt burden. Also, select companies with a total debt to current asset ratio of 1.1 or less.
  • Price to earnings ratio: Select stocks with a low P/E ratio. A P/E of 9 or less is preferable.
  • Positive earnings per share growth: Look for positive earnings per share growth to avoid unnecessary risk.
  • Price to book value: Consider the stock’s current price with regard to its book value. It gives you a strong indication of the company’s underlying value.
  • Dividends: Seek companies that consistently pay dividends. Undervalued stocks may click as other investors figure out their worth.

Bottom Line

The best strategy is to buy undervalued stocks. However, this should be backed up with an evaluation of the company’s underlying conditions. For example, a stock may be undervalued because the company belongs to a dying industry.

Blending Stocks with other Investments

Chapter Overview

Individual investor’s asset pool may not enable him or her to tolerate short-term stock price fluctuations. A strategy to address this issue is diversification.

Diversification is a risk-management strategy achieved by mixing a variety of securities within a single portfolio. The primary goal is to cushion the impact of poor performance of any asset class on the whole portfolio. Therefore, diversification lowers the overall risk associated with your investment portfolio. Although diversification is beneficial, its application in the practical world can be complex. The following practices can be handy.

Types of Portfolio Diversifications

This section presents the forms of diversifications for your investment portfolio:

  • Individual company diversification: You can use different index funds to get a diversified allocation of stocks.
  • Industry diversification: Balancing your securities across multiple industries in the economy is important. Beware not to diversify in an industry you are less familiar with.
  • Asset class diversification: Different assets (bonds, stocks, commodities, cash, etc.) perform differently in different economic conditions. For instance, stocks will perform better during economic recovery, while bonds may shelter you during economic recessions and deflationary environments when held over long-term. In addition, cash and commodities can provide protection during inflation.
  • Geographic diversification: There are benefits associated with international diversification. For instance, some oversee countries may have their stocks perform better than home-country or other international states.
  • Strategy diversification: It is preferable to mix various strategies such as momentum, high quality, value, and small-cap within your asset classes. The rule is to avoid being 100% committed to lagging strategies, plus 100% hot strategies are not guaranteed.
  • Time diversification: Also called dollar-cost averaging. Continuous contribution to your investment can reduce the effect of poor investment behaviour or unlucky timing. Experts say that a 70% of the time investing a lump sum is preferred over an over-time investing.

“Dollar cost averaging takes the responsibility of poor timing decisions out of your hands. It’s not the perfect solution, but it helps you move from short-term guessing to long-term planning”.

Practices to Optimize Diversification of a Portfolio

  • Divide your portfolio among several investments, including bonds, stocks, cash and cash equivalents, mutual funds, etc.
  • Vary your securities according to industry and sector. The effect is to reduce the impact of industry- or sector-specific risk.
  • Vary the risk level in the securities you invest in. Select investments with differing risk levels. This will ensure huge losses are offset by gains in other asset classes of the portfolio.

Conclusion

Investing in the stock market may be accomplished through the brokerage firm or by directly working with the issuing company. When conducted via a broker, a brokerage account is needed with an initial deposit for your broker to purchase initial stocks for you. Often, an exchange is used to buy and sell stock shares between buyers and sellers.

Stock investing can be for value or growth purposes. With growth investments, the issuing company should have strong earnings growth. Value funding investors seek undervalued stocks. People invest their money for growth, income or stability.

Since investing in stocks involves risks, safeguarding your portfolio is paramount. It is advisable to diversify your portfolio with other securities such as bonds, cash and cash equivalents. Often, losses from poorly performing securities will be offset by those performing better. In addition, different securities perform different in different economic conditions.

Before investing in stocks, assess your financial goals. This will help you avoid the inconveniences of financial shortages for your routine utility bills. After making a decision to invest, screen sectors and industries to determine which one is performing and will continue performing better – a process called document analysis. Document analysis can be backed up by trend analysis; which identifies how the market is moving.

Like any other investing, investing in stocks have its challenges. Identifying and dodging some of the pitfalls may see your money grow. The pitfalls to beware of include lack of commitment, insufficient funds, overtrading, and buying high and sell low. To overcome such drawbacks, pick winning stocks – those with greater potential for higher returns. Accordingly, avoid scams that might get all your money lost. To keep your capital gains higher, beware of strategies to avoid unnecessary capital gains taxes. For instance, become a cheapstake investor; harness the power of UGMA; and selling when stock prices are above the intrinsic value.

References

Briston, Richard J. (2017). Stock exchange and investment analysis. S.l.: Routledge.

Emshwiller, J. R. (2000). Scam dogs and mo-mo Mamas: Inside the wild and woolly world of Internet stock trading. New York: HarperBusiness.

Fisher, S. Y., & Shelly, M. G. (2011). The complete idiot’s guide to stock investing. New York: Alpha.

Fontanills, George. (2001).The stock market course. New York: Wiley.

Guppy, D. (2013). Better stock trading: Money and risk management. Hoboken, NJ: Wiley.

Hurd, M., & Rohwedder, S. (2012). Stock Price Expectations and Stock Trading. doi:10.3386/w17973

Lai, P. (2013). The Calculation of Illicit Profit in US Insider Trading Cases. Journal of Stock & Forex Trading, 02(01). doi:10.4172/2168-9458.1000105

Le, D. D. (2013). Preferred stock investing.

Mladjenovic, P. J. (2016). Stock investing for dummies.

Rutterford, Janette. (2007). An introduction to stock exchange investment. Basingstoke [England: Palgrave Macmillan.

The Stock Exchange and Investment Analysis. (2017). doi:10.4324/9781315149189

Thomsett, M. C. (2013). Getting started in stock investing & trading. Singapore: J. Wiley & Sons.

Thomsett, M. C. (2013). Getting started in stock investing & trading. Singapore: J. Wiley & Sons.

Wang, W. K., & Steinberg, M. I. (2010). Insider trading.

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