Thinking of investing in stocks? Let us teach you the basics first
Investing definitely doesn’t have to be a topic to avoid at the dinner table—it shouldn’t be scary if you’re willing to teach, listen or learn. And it certainly shouldn’t be a designated job title to ‘impress’, which is what it tends to be in the egotistical society we live in. That being said, it is you, in slow motion, gambling with your hard earned money. You can deplete it entirely, but you can also double, triple or quadruple it. So for all the beginners out there who are interested in learning more about it, here’s what there is to know about investment.
What is investing?
First of all, what is investing? In short, it’s a way to set money aside by strategising it to work for you while you’re busy having fun doing other things, until you’re ready to use it. In other words: it’s the process of buying assets (with money that you can buy them with) that will (hopefully) increase in value. These assets will then provide returns in the form of regular income payments or capital gains. The idea is for your money to grow in numbers, over time. The reason why it’s similar, yet so different to gambling is the nature of time itself. You are effectively placing a bet on an asset you presume to be a ‘winner’, which means you are gambling with the odds, but investing is no short lived experience—and gambling tends to be just that. Keep that in mind.
There is a fine line to tread, because investing, like gambling, can be exciting. A win on the markets can get you hooked and looking for the next win. Markets move in patterns and trends. Investing comes in many different forms, and on a sharp note, I would leave a stockbroker’s job to them: this is a professional trader who buys and sells shares on behalf of clients, and to them the market patterns make sense. To many of us, they don’t.
Investments, like I said, can be seen in a larger sense as spending money, or time for that matter, to reap some reward. However, in financial terms, it’s the purchase of securities, real estate or items of value to reap income and capital gains (capital meaning financial assets).
How does investing work?
Without mentioning the many grey areas, investing centrally works when you buy an asset at a certain price, and then sell it at a higher price. The return on your investment is a capital gain and the margin between the two prices is your profit. When your investment gains, or becomes more valuable between the time that you buy assets and sell them, it is also known as appreciation.
Investments are long term achievers, and it’s arguably safer to invest in stock and shares than it is to leave your money sitting in a bank—of course, ‘cash is king’, but like anything, it’s subject to inflation (or the decline of purchasing power). The point here is to not invest using money that you might need in the next, let’s say, five to 10 years. If you do have money in the bank, open a savings account and put any spare cash in there.
What are stocks and shares?
Stocks and shares are two different things, albeit their differences are blurry. Shares can be bought and owned within several kinds of financial instruments, such as mutual funds, trusts, real estate, etc. Technically, shares represent units of stock. Stocks refer to equity markets—an equity market, also known as the stock market, is where shares of companies are issued and traded, giving them access to grow their business and in turn, investors may realise their investment gains depending on the performance of the company that they’ve invested in.
Investors often use the word ‘stocks’ as synonymous with publicly traded companies. For example, if you tell your broker to buy you 100 shares of a specific public equity, you will have 100 shares of it. If you tell your broker to buy 100 stocks, you would be buying an array of different companies. Another thing to note is that when investors speak of stock, they are most likely referring to what is called ‘common stock’, which is a security that represents ownership within a corporation. So let’s say a company goes bankrupt, but you have invested in it, when the company goes into liquidation, the ‘common stockholders’ will only receive whatever assets are left after creditors, bondholders (an investor or the owner of debt securities) have been paid, which may be less that what you put in.
The stock market
This is where buyers and sellers meet. Securities that are traded on the stock market, as I said earlier, can be: public stocks—these will be listed on the stock exchange—or private stocks, which will often be traded through dealers. The buying and selling of private stocks, through dealers is called an over-the-counter (OTC) market, and they are primarily used to trade the likes of bonds, currencies, derivatives, or, when companies can’t meet the requirement to be traded on the stock exchange, they are unlisted stocks (also called pink sheets).
For a company to issue stock it must begin by having an initial public offering (IPO) where an investment banking firm will help determine the type and pricing of the stock for the general public to then be able to purchase.
When it comes to the stock exchange, the largest stock (or equity) markets in the world (in no particular order) are currently the New York Stock Exchange, NASDAQ, London Stock Exchange, Euronext, Hong Kong Stock Exchange, Shanghai Stock Exchange, Shenzhen Stock Exchange, Toronto Stock Exchange, Bombay Stock Exchange, and Tokyo Stock Exchange.
Trading on the stock market
An investor will bid for stocks by offering a certain price, and sellers will ask for a specific price too. When the two prices match, a sale occurs. A buyer might pay any price for the stock they want to buy, which means they are buying the stock at market value—same goes for the seller, if they sell at any price for the stock, they sell at market value.
When a publicly traded company offers stock on the market, each stock represents a piece of ownership, so if the company does well, the investor’s stock will go up in value as the company’s stock rises. The company may not do well and the stock value then falls. Activity that surrounds stock also impacts its value, such as trends for example. When there is a higher demand to invest in a certain stock, the price tends to go up, and the same happens in vice versa.
A stock exchange does not own shares, it is a market. The stocks that are traded are mostly traded through brokers, and equities, commodities or bonds among other things are what is actually being traded. There are auction exchanges, where buyers and sellers place bids and offers simultaneously. Brokers and traders will be communicating verbally on a trading floor or ‘pit’, but this system is slowly getting replaced by electronic systems.
The New York Stock Exchange (NYSE) still uses the prior, although some functions have been transferred to electronic trading platforms. ‘Designated Market Makers’ are the specialists physically present on the trading floor, each responsible for buying and selling stock in the auction. There is a NYSE Closing Auction which happens at the end of the trading day, when the price for stock is finalised for that day.
Electronic exchanges don’t require a physical location where buyers and sellers meet. Nasdaq is one of the leading electronic exchanges. Dealers carry their own inventory of stock, and they buy and sell stock on the Nasdaq as well as post their bid and asking prices. Both electronic and ‘old school’ have listing and governance requirements, and if a company listed on the stock exchange market doesn’t meet the requirements, such as falling below a minimum price, it can be delisted to an OTC market.
Market values can and do fluctuate a great deal, and are influenced by the business cycle, such as recessions and bull markets. It is a live environment, with affect.
Diversification, portfolios and saving accounts
When you start to invest, diversify your portfolio (the collection of financial investments like stocks, bonds, commodities, cash, and cash equivalents). Not putting ‘all of your eggs in one basket’ is a bumper sticker quote that just keeps on giving. This is the same for non-investors, if you have one bank, open an account with two others. By doing so, you reduce the risk of one investment, or clump of cash, hurting your overall investment or saving performance. You should also learn more about what a commodity supercycle is and how to manage the phenomenon.
When choosing a professionally managed investment fund that pools money from many investors (potentially you) to purchase securities with, choose one with a diversified portfolio in stocks. Compare the commissions that these brokers charge, read through their performance sheets, and read through what and who they invest in, with your money, to decide if first of all you agree with the company that they invest your money into, and how they themselves perform. There is a level of trust, research and projection involved from your end. It doesn’t hurt to follow the markets, don’t take day to day fluctuations on board as much as the overarching patterns that you will begin to recognise.
In the meantime, think about opening a basic, instant withdrawal, low interest savings account with your bank, and potentially another bank, because funds that are in savings accounts are federally insured. Then do your homework from there.
