The Stock Market can be fraught with danger unless you know what you’re doing. For many people, the prospect of investing their hard-earned money in stocks, bonds, or other similar financial products is an intimidating proposition. Everyone knows the phrase “Buy Low, Sell High” but they don’t really understand what it really means or how to manage their investments accordingly. This world can be a complicated one for the uninitiated and those who have even a fleeting interest in buying in can soon feel discouraged by the amount of time it takes to see some kind of return on their investment.
The first thing to know about playing the Market is that it’s all about the long game. If you’re thinking you’ll put some money in solely to rake in huge profits after a few short weeks then you’re not ready to get involved. This type of investing can be a volatile process marked by dramatic fluctuations that depend on a measured approach through years of smart investment strategies.
Therefore, it’s crucial that you decide first on when you’ll need your capital available to you in the future. By determining at what time you should expect a return on investment, you’ll be able to make a better informed and realistic measurement of the amount you want to invest and for how long, in order to meet your financial goals.
But that’s not all you need to be aware of when it comes to investing in the Market. This handy guide will walk you through all of the important basics you really should know to get you started on the right path. So read on and we’ll break down the essential philosophies and fancy jargon inherent to investing in stocks.
Let’s Talk About Stocks
What exactly is a stock? When you buy stock in something, what is it that you are really buying? These are questions that every novice asks first (and should be asking to be perfectly honest). If you’re dropping a significant amount of money into something, you want to know just what you are getting in exchange for that capital.
The most basic and straightforward answer can best be described in one word: ownership. Stocks are issued by companies in order to raise money to continue the growth of their business. The reasons for issuing stocks can vary greatly, but the main impetus always remains the same: generate additional capital. Purchasing a stock or “security” to bring in revenue gives the buyer of the stock a partial ownership in the issuing company. Congratulations, you can now claim that you are a partial owner of that business and the amount of stocks you own in that company determines how much ownership you hold.
Investors now have equity in that company which brings with it certain perks and advantages. The first of these benefits obviously lies in the profits that stockholders can receive in terms of an increased share price. If the company is doing well, beats market expectations, or benefits from other industry or market trends, the value of the stock typically rises accordingly. So if you purchased a stock at a price of around $4.50 per share and the value of the stock is such that it is now worth about $6.25 per share, that increases the worth of your assets. Should you decide to sell the stock at that time, you would make a profit on the difference.
There are other advantages you can enjoy when you purchase stock including voting rights in the direction of the company and any issues of non-performance that might arise. But as we’ve said already, investment comes with risk. You have no guarantees when it comes to the principal you have put into a stock. The issuer could fail and cease business operations which would very likely result in the loss of your money.
Your exposure to risk is greater than if you held bonds in that company since stockholders are often the last ones to get any substantial repayment in the event of bankruptcy. Bondholders are made whole before stockholders but they don’t stand to gain as much if the company takes off. We will discuss more about bonds later.
Two Types of Stocks: Common and Preferred
When you purchase a stock you have a few types to choose from, but the two most widely held and traded are common and preferred stocks. Issuers also provide something called a classified stock. Focusing instead on common versus preferred stocks, the type you choose to purchase brings with it pros and cons in equal measure. Where some investors will find one stock more preferable to their needs and investment strategies, there are definite drawbacks that come along with that form of ownership.
Common stocks are aptly named because these shares are traded with the most frequency and purchased by a majority of investors in the market. The benefits of common stock ownership lie in their potential profitability through paid dividends or stock price appreciation. Owners of common stocks also receive a vote for every share they own which come into play during shareholder meetings where things like board of director elections are held and other company business is decided. This gives stockholders a proactive voice in the direction of the business and offer some form of control over the prosperity of the company and their investments in it.
The drawbacks of common stock ownership also come in the dividends you could receive as holders of these stocks have a lower priority to getting such payments and the amounts can vary. These are not fixed dividend payouts and the risk of losing your money is higher. So why do investors go with these types of stock? Simple – common stocks perform better than all other investment options available today. They have the most proven track record despite some of the disadvantages that come with them.
Preferred stocks are the preferred choice of some investors because of the routine fixed dividend payments that come with ownership. These stockholders also get priority when it comes to receiving those payments and they have a higher repayment priority in the event the company goes bankrupt. But what you get with those financial considerations comes with drawbacks in the form of no voting rights in elections or other decision-making procedures. In addition, owning preferred stock puts you at the discretion of the issuer to “call back” or repurchase the shares away from you. This stipulation comes with some restrictions but it is something to consider when selecting the stock you wish to purchase.
Classified stocks are a bit more complex in that they work in the same way as common or preferred stocks but they come with certain grading levels, usually marked as A or B shares along with some C or D variations as well. Each class brings with it different privileges and perks to ownership. One tier of stock may hold one vote whereas a higher grade may hold five or ten. These stocks may also bring with them higher dividend payments based upon class rating. The purpose of issuing classified stocks is so the issuer can retain a majority of voting rights or create opportunities for stockholders to buy shares at multiple levels.
Stocks vs. Bonds
Selling shares of stock isn’t the only way that companies raise money – they can also issue bonds to investors. Though similar in theory, bonds are actually a much different type of investment that brings with it certain advantages and some investors prefer these instead for a variety of reasons. For starters, bonds have a higher priority for repayment in the event the issuing company goes bankrupt. In the hierarchy of reimbursement, bondholders are made whole before stockholders.
The thing to know about these types of investments is that they are a method for borrowing money that the company promises to pay back in full at a future date. Until that time, bondholders receive interest payments on the money they have provided to the issuer and, unlike dividend payments, these are more assured of being received on a routine basis since they are due regardless of whether or not the company is performing well. Dividend payments are less assured of being distributed on a routine basis because they are discretionary and not mandated to be paid on any sort of timetable.
But bonds do have some limitations. The first being that bondholders do not get any voting rights, but they do have legal recourse to get their money back should the issuer fail to repay the bond. Unlike stock investment which is designed for increasing the value of your assets and brings with it a higher level of risk, bonds come with lower risk to your assets and income is in the form of interest payments made on your capital. You’re also going to get your initial principal back in full at some time in the future. That’s not something you can count on with stock ownership.
Maybe you don’t feel entirely comfortable investing your money in a specific company. You read all of those options above and weren’t entirely sold. That’s fine, there are plenty of other ways to invest your capital. Instead of buying stock in a corporation, you could put that money into commodities, which are raw materials that are consumed in their current form or utilized in the manufacture of other products that we all use every day.
There are a wide range of commodities that are traded daily including oil, gasoline, timber, agricultural products like orange juice and coffee, and precious metals like gold and platinum. Many investors find these investments far more attractive because these are resources that are in constant demand, however, this market can be incredibly volatile and unpredictable.
Commodities investing can be done in a multitude of ways. Investors can buy certain quantities of these materials based on how they think each will perform over a certain span of time or they can purchase something called futures contracts or exchange traded products (ETP’s) that track the performance of a certain commodity on its particular index.
Like any investment there are risks and rewards that should be considered. On the one hand, the return on investment is much different than with stocks or bonds and the fluctuation of commodity prices can be affected by things like supply and demand, inflation, and the condition of the economy as a whole. These are also a smart method of diversification of your portfolio. On the other hand, those many influences listed can also have an adverse effect on your principal and even the smallest bit of unrest somewhere in the world can have a significant impact on your investment.
Exchange Traded Products (ETP’s)
The previous section mentioned something called Exchange Traded Products or ETP’s. These are bought and sold in much the same way as a share but are used for tracking certain stocks or commodities along specific indices upon which such investments are traded.
There are many types of these products but the most popular is probably the ETF or Exchange Traded Fund. These investment funds are traded just like shares on common exchanges and these can comprise stocks, bonds, and commodities. But the most important aspect to keep in mind about an ETF is the word “fund”. These products are built through funds which is an entity that owns a variety of assets and ownership shares in that fund are distributed to shareholders who wish to invest in that particular combination of assets. These shares can be bought and sold during the normal hours of a trading day through a broker and shareholders get many of the same reports and dividend participation as they would with any typical stock they might purchase.
You may be familiar with this term through even a casual interest in investing. Diversifying your portfolio is one of the best strategies for investment success because it helps to ensure that some element is always growing and building wealth and you don’t have all of your proverbial eggs in one basket. A well-diversified portfolio incorporates a variety of investments, stocks, bonds, commodities, cash, any combination of carefully considered asset options that have shown different directions and rates of return.
In other words, you don’t want all of your investments to have the same history of performance or are rooted in similar industries, that way if one part of your portfolio is declining or losing value, you can rest assured that you’ve chosen dissimilar investments that might be on the rise. This helps to mitigate some of the damage that your portfolio would take from those investments that aren’t performing as expected. Every good investor knows that diversification is a key component to a smart investment strategy because if you’ve put all of your capital into the same types of investments and those products are all on the decline, you’re going to lose a lot of money. Diversifying can help soften the blow and prevent you from absorbing major losses en masse.
Ask the Right Questions
Beginners are going to need to be well informed before they invest and there will be many questions that may arise while their money is tied up for extended periods of time. If you are considering putting a sizable amount of capital into the Stock Market you do not want to do it alone. Even the savviest investors have someone they trust to give them the best financial advice based on the current trends of the market.
So don’t feel as if you’re making a rookie move by seeking out help, in fact it’s expected of you to ask the right questions and rely on the advice and guidance of a professional. The quickest way to lose all of your money is by not bringing an analytical and exploratory approach to your investing strategies. Since you’re new to the game you’ll want to get as much advice as possible but be careful to let your emotions dictate your decisions either. There are a lot of ideas and opinions out there and the more you seek, the more you’ll hear.
A good investment adviser or stockbroker that you trust will be a dependable ally in the growth and management of your wealth. These financial professionals have different distinctions as to whose best interests they have in mind. Investment advisers are typically obligated to protect your interests while stockbrokers will offer advice on products that they may be trying to sell you in pursuit of placing someone else’s best interests before yours. That’s not to suggest that they’re trying to swindle you out of your money, but they will offer you the best advice based on how many resources you have at your disposal. They may also try to get you into certain securities that their brokerage firm may have some kind of interest in moving.
Keeping a Clear Head
Investing requires you to use your head more than your heart. Emotions can have as much of a volatile impact on your investment strategies as trends in the Market. This is why it’s important to have a solid game plan in place before you invest any of your capital. That means deciding ahead of time how comfortable you are with risk and how you’ll react to the performance of a stock well before you invest any money.
The more money you pump into investments, the more likely you’re going to feel nervous. Just prepare yourself for the ride because you’re going to experience dramatic fluctuations in your portfolio from the get-go. You may not like the direction things are going at first or conversely you may be overjoyed by how things are progressing. If you’ve done your homework up front, before you put down that capital into your investments, then you may experience better performance and growth. That comes with knowing why you’ve selected those stock or bonds or whatever it is you’ve chosen in the first place.
When you pick a stock to invest in, you have to decide what makes that thing more attractive than the other investment options available and then you can act on your reasoning. This will inform your thought process as to strategy for when you buy, sell, or hold a certain stock. If you see an investment plummeting, your first inclination might be to sell it immediately and stem the bleeding before it gets worse. On the flip side, a certain stock will start to soar and you may want to sell it fast to gain as much profit as possible.
Frankly, neither of these strategies make sense for a long term investment strategy and both come from taking an emotional approach to your investing. Instead, you’ll want to set some parameters for performance which you can then rely on for making a more clear-headed decision on that stock. Just because it falls in one day doesn’t mean it won’t rally back and even outperform projections in six months or a year, perhaps even longer. The same goes for a well performing stock. Do you want to get out as it continues its upward trajectory? Just because it’s doing well now doesn’t mean it won’t do even better later, even if it does drop slightly after a strong rally.
But if you set those parameters up front, you can sit back and watch how your portfolio performs and then pull the trigger one way or another when the prices hit a predetermined level. This way you can avoid making knee-jerk reactions born from panic or elation and get more bang for your buck in the long run…and remember, the long run is what this is really all about.
Our Final Thoughts
This is just a beginner’s guide to give you some of the basics that you need to know from the start. Take this information and build your knowledge from it in order to educate yourself about the many different ways to get involved in the Stock Market. This can be an incredibly exhilarating experience and a good way to manage your wealth for the near future and your retirement as well. It doesn’t matter how old you are either, anyone can get in the game and invest a little bit or a lot. But age might play a determining factor in the type of strategies you may adopt for your financial outlook. The younger you are, the more likely you are to take higher risks on your money. Getting closer to retirement may prevent from riskier strategies. So there’s no time like the present to get started!