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Getting Ready to Invest


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

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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No positions in stocks mentioned.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

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