Getting Ready to Invest-Minyanville

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Getting Ready to Invest

Matt Ford Jul 21, 2009 8:25 am


		Check your debt and cash levels first.

Market meltdowns of the past 12-24 months have prompted many individuals to view lower stock prices as a buying opportunity. Big declines in shares of Bank of America (BAC), General Electric (GE), and multitudes of other issues suggest that stocks and equity-based mutual funds are on sale.

Perhaps they are. But whether you’re brand new to the markets, or someone who’s been investing for years, make sure you’ve satisfied 2 prerequisites before buying stocks in this market environment.

Low Debt

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Ask most people whether they would ever borrow money from their broker in order to buy stocks (a.k.a. margin loan), and you’ll generally receive a resounding ‘no.’ However, if you own stocks while carrying debt of any kind (mortgage, car loan, credit card, etc), then you are indeed operating from a leveraged position.

When prices are moving in your favor, the increased exposure to financial assets you obtain from borrowed funds serves to magnify returns. However, in markets where prices are moving against you, leverage works in reverse to amplify losses. In extreme cases, leveraged losses may challenge your solvency and force undesirable actions like selling other assets or further borrowing in order to make payments on your debt.

Current credit market problems demonstrate the risks associated with buying financial assets while leveraged. To a large degree, big losses realized recently by firms such as AIG (AIG) and Citigroup (C) have been a function of their highly leveraged positions.

Data indicate that households are still carrying historically high levels of debt. Should markets resume their declines, then this leverage will amplify wealth destruction among debt-laden households that are invested in stocks.

To mitigate this risk, reduce leverage before owning (or buying more) stocks or equity mutual funds. Start by retiring all credit card debt in which you’re carrying monthly balances. Other loans (car, student, etc) come next. If you currently own stocks or mutual funds, consider selling some to facilitate the process of debt reduction. Got a mortgage? Make sure you’ve built considerable equity (at least 20-30%) before putting money into stocks and mutual funds.

In difficult market environments such as this one, the value of freedom and flexibility increases. Debt reduces this freedom.

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Comments (4)

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Fred Nappi

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07-21-2009, 8:39 am
Good advice, that you think would be common knowledge. Unfortunately, some people view the market as a way of getting out of debt, much like a trip to Atlantic City. Read More

Pete Sutherland

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07-21-2009, 2:30 pm
Hi Matt Great article, to the point, brutally honest and a reminder as to how the game has to be played. Something it appears many players big and small have lost sight of and you guys are the best at keeping it real.Thanks mate it is al Read More

Matt Ford

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07-22-2009, 2:56 pm
Many thx for the feedback, Pete. Often the most important stuff is the basic stuff... Matt Read More

Patrick Downs

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07-24-2009, 3:47 pm
Matt: I got out of the market completely last Sept. I missed the agony many suffered, watched the insanity of 500+ point up and down days thru the fall wondering if I had the skill and the stones to trade, and realized I didn't. Akin to surfing Read More


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