Ask a Fool
We've dipped into the rich stream of questions the Fool receives and pulled out a couple to share with you: “What do you do when a hot stock tip freezes up?” and “What do you do with a big IRS refund?” Short answers: Don't touch hot stock tips and, for goodness sake, don't let the IRS hang on to more of your money than you owe it!
By Barbara Eisner Bayer (TMF Venus) and Ann Coleman (TMF AnnC)
October 10, 2000
The Motley Fool and the Foolish Four team answer more questions than Batman when the Riddler's on a crime spree. Two questions in particular are asked often, in one guise or another. Do you see yourself in either of them?
"Some months back, I was advised by my sister to invest in [a high-tech start-up]. I was told she had insider info on this group and that I should get in before they do their SEC filings because, once they were approved, the price would skyrocket and I'd make a killing. I invested $500 at $12.80 per share. Since that time, this stock has plummeted drastically. What should I do? Should I hang in there for the long term? Was this lousy advice? I am less than a novice when it comes to stocks."
Looks like you've gotten yourself into a bit of a pickle. An unkosher one at that. Luckily, it's only $500 dollars.
Anyone who trades a stock based on knowledge of material corporate developments that haven't been announced publicly is breaking the law. Bet you weren't expecting that one. The crime is called "insider trading."
Remember Ivan Boesky, a big-time insider trader who spent three years inside prison? Even if your hair looks fabulous with stripes, that's a lifestyle you'll want to avoid.
Insider trading laws apply not only to a company's management, but also to those with knowledge of confidential developments -- including investment bankers, lawyers, printers of financial disclosure documents, or relatives of managers and executives who learn of these material developments.
If your sister had "insider information" and passed it on to you, she broke the law and could be arrested. Yikes! But since her information was inaccurate, it probably wasn't the real thing. Most likely it was passed on by a bogus source possibly trying to manipulate the stock price (also illegal). Sis needs to find some new friends.
Which brings us to you. Why were you taking hot stock tips from her in the first place? If you don't know how to swim, and someone told you there was a pot of gold at the bottom of a swift and deep river, would you dive in for it? That's a rhetorical question, by the way. You are supposed to say "No."
OK, so what to do now? So far, you've just lost some money. It's only money. Another way to look at it is that you paid some tuition for a valuable lesson about hot stock tips. In other words, don't let your bad first experience sour you on all investing. Heck, most of us Fools have similar stories of our first dives into the investing river. Next time, do it in a more enlightened (and legal) fashion. We're here to help. Start with our Fool's School -- tuition-free!
Next time you hear about a "hot" stock tip, don't think "hot" as in sexy, desirable, fun. Think "hot" as in burn, pain, avoid, no-no, and don't touch. Any two-year-old could tell you that. Or any Fool.
"Many publications, etc., come out with their articles/suggestions on what best to do with your income tax refund after the income tax season has started. Would you consider putting together a piece with some helpful suggestion and running the story some time in November/December? This could certainly help an acquaintance of mine who gets $3,000-$4,000 each year and has virtually $0 a few days later."
An acquaintance, eh? If you say so.
First, just how much does your "friend" like the IRS, anyway? Enough to loan it thousands of dollars a year, interest-free? Believe me, the IRS doesn't need it. Your friend must really like those big refund checks, and probably uses the IRS as a kind of savings club to fund a spring bender each year. To each his own. But, a far, far better idea would be to adjust his withholding allowances so that the money isn't being taken out of his check to begin with. That needs to start now, not next spring.
Then comes the tricky part. Keeping the money out of his checking account, so it doesn't go bye-bye before he even realizes it's there. Fortunately, there are any number of brokerages, banks, and mutual fund companies willing to spirit that money out of his account and put it to work. He can start looking for one in our Discount Brokerage Center. Most banks will set up automatic transfers from checking to savings accounts, and virtually all brokers will set up an automatic deposit program where (with your permission) they snatch that cash out of danger and stash it safely in some kind of investment. Even a plain money market account would be an improvement on the current plan. But there are better options.
If your friend hasn't joined his 401(k) plan at work, that's a logical place to start, especially if his company matches contributions. If he's already taking full advantage of his 401(k) at work, but doesn't have a Roth IRA and qualifies for one, that would be the first place to stash the cash. But since the maximum contribution for an IRA is $2000, he'll have some cash left over, unless he's married and his spouse also qualifies for a Roth IRA -- then all $4,000 can be stashed away to grow tax-free.
If he has adequate rainy-day savings, the extra can go into short-term savings for his next spring bender, I mean, next major purchase. Being a Fool, though, I'd suggest putting it into a brokerage account instead. For suggestions on what to do with the cash once it gets into that Roth IRA account or the regular brokerage account, see 13 Steps to Investing Foolishly.
Your friend may not be crazy about giving a broker the ability to automatically withdraw a set amount from his checking account every month. Some people find that idea disturbing, but I don't find it any more disturbing than letting the IRS hang on to all that cash for a year -- and then blowing it.
Fool on!
