So you’d like to make a killing in the stock market, would you? If you read April’s post, you’re probably feeling all kinds of confident about the basics of stocks and market indexes, but how do you actually rake in oodles of cash? As fun as get-rich-quick schemes can be, it’s actually the get-rich-slowly folks who come out on top.
Hold back your groans of impatience. "I need money now" is a mentality that will only get you into trouble—ask any bank robber. When it comes to money, time is the most valuable thing you’ve got, so it would be prudent to learn the art of waiting. It’s true; largely due to the micro-wave oven, our society is finding it harder to be patient. Why would you slave over family recipes when you could enjoy the instant gratification of microwaved break-fast, lunch, and dinner burritos? But in terms of saving up a gargantuan nest egg, slow and steady wins the race.
So let’s first debunk something you may be tempted to do. There’s no doubt that at some point in your life, you’ll cross the path of a friend or neighbor who will brag about some hot stock he just bought, and yada, yada, yada, how analysts only expect its value to skyrocket. And sure, the thought of making some quick quid peaks your interest. You’re only human after all. BUT, this is a risky way to use the stock market. There’s a small chance you may hit it big, but most likely, you’ll end up sad, alone, and without money. Some people do get their kicks and giggles trading individual stocks throughout the day, but if your end-goal is a big ol’ wad of cash for, say, retirement, then picking individual stocks generally isn’t the way to go.
Last month you learned that you could buy ownership in a little slice of a company, i.e., purchase a company’s stock. By doing that, you might get a bit of their profits, and you’re hoping that you can sell them to someone who’s willing to pay more than you did originally. Let’s say that 10 years ago, you used all of your money to buy shares of Enron stock. Well, today you wouldn’t be a very happy camper. When companies go out of business, shareholders lose their money. You never know when a company has been built on sand, and could lose its value in a landslide. You’d hate to have your life savings go down the toilet with it.
Let’s say, instead, that you put all of your money into 10 companies. One of them pulls an Enron and loses all of its value. Bummer, sure; but guess what? You also own stock in 9 other companies that happen to be doing extremely well. All in all, you might not have lost very much money. (Keep in mind this is all on paper until you actually sell your shares).
So what if this principle were magnified, and instead of owning stock in 10 companies, you owned stock in 500 of the largest U.S. corpo-rations? Well, then if one of them went under, there would be no need to flip out—499 of them are doing just fine. The trouble with owning just a few companies is that there is no way to tell which of them will end up on top, and which ones will end up like Enron. The solution: own as wide a variety as you can, take the whole lot, diversify your portfolio, or as this guy John Bogle once said, "Don’t look for the needle in the haystack, buy the entire haystack."
Now, you may be thinking, "I’m not Oprah. I can’t afford to buy all this hay." And it’s true—if you were to go directly to those 500 companies to purchase their stock, they’ll probably make you buy at least 100 shares, you’ll have to pay fees for them, and it gets more and more unpleasant for your checking account the more you buy. BUT, here comes the magical solution: MUTUAL FUNDS! *Cue the Hallelujah Chorus*
Let’s say that you enter a conversation that’s entirely above your head. Coworkers are having a lively discussion about investing strategies, and you’re suddenly asked, "So, the Dow is down 100 points. How’s your stock portfolio doing in this turbulent economy?" Your eyes widen and slowly shift out of focus. You consider fabricating an answer, but the chance of follow-up questions seems likely. You mumble something along the lines of, "I have…stuff to do… elsewhere," and awkwardly exit the conversation.
If this sounds familiar, no need to hang your head in shame—it’s your lucky month! April has been declared National Financial Literacy Month, so what better time to brush up on investing basics? Read on, and at minimum, you’ll be able to hold your own in ego-centered investment conversations. But more importantly, you’ll be laying the foundation for a sturdy portfolio of your own.
So let’s address a basic question—what is a stock? If you’ve ever heard of the United States, you probably know that private companies play a big role in its wealth. Let’s say you would like a piece of that pie. Perhaps you’ve noticed that Microsoft seems to be doing rather well for itself. Sure, a lot of companies aren’t doing too hot right now, but all in all, Microsoft appears to be making lots of money. And you figure, "Hey, I like money. In fact, I’d like to have more money." So when you buy a share of Microsoft’s stock, you are basically buying a little sliver of Microsoft. That’s right; you own a little, itty, bitty chunk of Microsoft. Perhaps something equivalent to a secretary’s paper clip at headquarters. Now, because you are a shareholder in the corporation, you are entitled to a little, itty bit of its profits.
Let’s get technical for just a second. Assume that you bought 1000 shares and each share cost you twenty bucks, so you have $20,000 of your hard-earned money invested in Microsoft. When business is booming, you’re feeling pretty good. And because things are going so swimmingly, people are now willing to buy your shares at $25 per share—(the share price has increased). If you sell, you’ll get $25,000 for those shares, and can now go buy 5,000 things from the dollar store with your profits. This share price can change throughout the day. If a company is doing really well and people be-lieve it will continue to do well, then the price of that stock generally goes up.
But what if Microsoft doesn’t do well? What if Steve Jobs introduces the iPad 5000 that can surf the web and make you a sandwich, and people buy Apple products instead of Microsoft? You would still be able to sell your stock, but people may only be willing to pay $15 per share. That $20,000 you invested is now only worth $15,000. If you were to sell, you would lose money in the stock market. Ever heard of that happening? So if you’re wondering why people talk about the stock market almost as much as they talk about Lindsey Lohan, it’s because they are either losing their money or raking it in.
And what are people talking about when they mention the Dow, the NASDAQ, or the S&P 500? It’s likely that they are trying to sound impressive, but these are called indexes—or as some like to think of them: lists of companies. The Dow, a nickname for the Dow Jones Industrial Average, essentially tells you how well a list of certain companies is doing. Different indexes will tell you different things. For instance, the S&P 500 will estimate how well (or not well) 500 of the largest U.S. companies are doing at any given time. The Dow has 30 companies, while the NASDAQ Composite contains about 3,000 components. People use these indexes to estimate how certain areas of the economy are doing.
All right, so what does this have to do with you? Believe it or not, you can actually make a lot of money using the stock market if you go about it the right way. It’s not some get rich quick scheme; in fact, it’s more of a get rich slowly kind of deal. Unfortunately, one newsletter is not nearly enough room to scratch the surface of investing basics, but you’re heading in the right direction. Stay tuned for next month’s newsletter, and in the meantime, go ahead and hop into those coworker conversations with confidence.
