Stock Investments 101
This morning I spoke at a local high school on how investing in stocks work. Just like most things, this can be a very complex topic, but I will focus on the high-level points that will allow you to establish a basic understanding of how investing in stocks work.
My interest in investing led to me becoming the financial planner I am today. It was 2009 when I decided I wanted to move out to Colorado to finish up my degree. I had to come up with a personal game plan to make it happen and I identified stock ownership as one way to make my money work for me and possibly help speed up the process. In hindsight, I now realize I was taking a lot more risk than I knew of at the time, but luckily it all worked out and I’m able to educate others on how to plan more appropriately. More on that later.
What’s The Point Of Investing In Stocks?
You work really hard to earn income. If you’re to the point where you can begin to save, then wouldn’t it be nice if you can begin to have your savings start to work for you? Investing is when you decide to commit resources, AKA money, to something that you think will provide value that what you initially invest.
Have you ever wanted to own a company? Purchasing shares of stock in a company allow you a partial ownership in a company, which in hopes, allows you to share in the companies successes. There are two main ways to make money off of your investment in a stock: increasing in your stock shares price or by receiving dividend distributions.
Companies decide to offer shares of their company to the public for many reasons. The top reasons are it allows original owners to exit the company and be well compensated for what they’ve built or because it allows the company to raise funds and increase cash flow so they company can pursue new opportunities.
Is Investing In Stock Like Gambling?
Some people fear to invest in stock because many compare it to gambling at a casino. Although there is risk involved, there is also a BIG difference between gambling at a casino and investing in stocks. The main difference is that at a casino you rely solely on random probabilities and with stocks you are relying on a company to be successful.
The success of a company can be impacted by many things, but what everything boils down to is a company’s current profitability and future expectation of success. If a company is not profitable or expected to have less success in the future, then this will likely result in a share price falling and cause owners’ shares to be worth less.
If you remember the recession that began in 2008, many successful companies also lost value as there was a lot of concern about the overall economies, which shows you that there are additional factors that play into pricing the stock of a company.
Ways To Reduce Risk?
Have you ever heard the saying “don’t keep all of your eggs in one basket”? That speaks to having diversification rather than concentration. Diversification allows you to spread your risk out over multiple companies.
The process of diversification will tend to make your investments not bounce around at the same rate that owning a single or small numbers of stocks would. This smoothing action is typically preferred to “riding or dying” with one company.
Know Your Time Horizon-
This is where I personally took more risk than I was aware of back in 2009 and 2010. I knew I wanted to move ASAP to Colorado to finish school. With my short-term horizon, there was a high probability that due to the general economy, I was just as likely to lose money as I was to gain money over such a short period.
Since stocks values can bounce around, they are not a great place for short-term planning needs. Typically, investing in stocks it is recommended that you have a timeframe greater than 5 years.
How To Get Started
Due to the complexity of choosing investments, I recommend you do additional research to better screen what companies you should invest in. This is a service that I, as well as, other financial planners help their clients navigate.
If you are confident in which companies you want to invest in there are many companies you can use to place trades. Fidelity & TD Ameritrade are companies that allow you to create an account and begin to trade on your own.
Want To Take Your Investing Education To The Next Level? Research these additional topics, which I hope to write in my own words for future blogs.
- Mutual Funds http://www.investopedia.com/terms/m/mutualfund.asp
- Exchange Traded Funds (ETFs) http://www.investopedia.com/terms/e/etf.asp