NEW YORK (MainStreet) — If you ask any great investor the "secret" to getting rich, you will often hear conflicting advice. However, they will all tend to agree on one thing – the earlier you start, the better.
Investing as early as high school or college can massively increase your savings and standard of living later on in life. But, as it is often said, "If it was easy, everyone would be doing it."
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The most difficult part of starting an investment portfolio as a student is finding the money. You may have enough money for one or two stocks, but very few students are in a position where they can create a properly diversified portfolio. Even if a student has $1,000, in order to diversify you'll have to spread the money thinly over five or so stocks. At this point, assuming your broker charges around $10 per trade, your investments will have to rise 20% just to break even! There is a better way.
Creating a properly diversified portfolio requires a decent amount of capital—generally a few thousand dollars. Since students often do not have this capital, we must use leverage to increase the amount of stock we "control." To achieve this leverage, we purchase options, instead of regular stocks. An option is a contract between you (the buyer) and a seller that allows you to buy or sell a specific security at a certain price, in a certain window of time.
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Here is an example of a diversified portfolio using only traditional stock:
Company | Share Price (close 9/11) | Shares | Total
Morgan Stanley| 28.25 | 7 | 197.75
BP | 42.29 |5 | 211.45
Sprint | 6.50 |30 | 195
Pfizer | 28.67 | 7 | 200.69
Wendy's | 8.25 |24 | 198
Now, here is an example of a similar portfolio, using options (adding leverage):
As you can see, we control more than ten times the amount of stock simply by using options. We can control leverage, risk, and reward, by adjusting the strike price, expiration date and number of contracts.
In the first example, if we include commissions, each stock you purchased would need to rise 20% just to break even. In the second example, if each stock rose 20%, you would make many times your initial $1,000 investment.
Options allow you to control large amounts of stock, with small amounts of money. Successful option investing is the way to make a sizeable impact on your life. Buying plain old stock simply won't give you the returns you desire.
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Interested in learning more? Don't even try a Google search. The information you will find will be both confusing and overwhelming. In all my research, I have found very few resources that explain options in simple terms. The best place to start, in my opinion, is chapter 7 in Jim Cramer's Getting Back to Even (Simon & Schuster, 2009).
Options are not the easiest investment to understand, but taking the time, doing your homework, and investing wisely can help you reap massive rewards.
--Written by Alex Pottmeyer for MainStreet