It is Time

Of all investment options, the stock market will give you the greatest returns in the long run.  Yes, it's time to talk about the stock market, not only because I feel like doing so as part of the chronology of the blog, but because it is oh so relevant these days.  As we all know, the economy is in a downturn, and the stock market has reflected that in a huge way.  These economic downturns only come about once a decade, and are unprecedented opportunities for investors.  But then you ask, "Why should I buy stocks now, only to see them lose value in the next few months?"  A valid question, and through these next few posts, I actually won't answer it!  Instead, I'll give you a sense of when and how to invest in the stock market in a confident enough way, such that you won't need to ask this question.  

First, let's go over the basics.  What's a stock?  A stock, or "share," is what it inherently means...it's an ownership piece of a public corporation.  Hmm, that's an odd concept...imagine if you started a business, and then decided that you would give up the ownership of your business to a bunch of strangers.  Why would you ever want to do that?  Because yes, you're relinquishing ownership, but also selling it to raise a huge sum of money you can then use to grow the company.  And these people who are buying ownership, these shareholders, usually don't want to run the company, so you still get to do that (as long as they're ok with it).
 

When you flip on the news and they talk about the stock market, they usually refer to the Dow Jones Industrial Index (DJI).  What the heck is that?  Who's Dow Jones?  Well, actually Dow Jones refers to two people, Charles Dow and Edward Jones, two reporters who founded the publishing and financial firm, Dow Jones and Company, in the 19th century.  It was Charles Dow who established the DJI, a weighted average of a group of companies that would accurately reflect the performance of the industrial sector of the stock market.  The DJI since has evolved to capture the stock market as a whole, rather than just the industrial component.  It is important to understand, when you are investing in stocks, that you have the option of putting your money in an index fund, i.e. a fund which follows the performance of an index like the DJI.  This a more conservative way of investing in stocks, because you are more diversified by capturing many companies instead of picking a few. 

 

Other common indices are the Standard and Poor (S&P) 500 and Russell 3000.  To understand them, we have to define the term "market capitalization (market cap)," which is essentially the total value of a company as determined by the market.  The biggest companies are termed, "large cap" companies, and they, give and take, have a market cap of >$5 billion.  Mid cap companies are between $1-5 billion, and small cap ones are <$1 billion roughly.  The S&P 500 index is comprised of 500 of the largest companies, and is supposed to capture the performance of large cap companies as a whole.  Likewise, the Russell 3000 does that for small cap companies.  Standard and Poor and Russell also have indices reflecting mid caps.  Whether to invest in large vs. small cap indices is controversial.  The historical returns have been similar, but personally, I prefer the large cap companies, as they are more well known and easier to research.  If you are investing in individual stocks, large cap is definitely the way to go, at least for beginners.

 

So should you invest in index funds vs. individual stocks?  Most personal finance books would say index funds, because they want to give you the most conservative advice, so that you are not able to sue them if you lose a lot of money on individual stocks.  In my earlier posts, I mentioned that you get about a 9% return over a long term in the stock market.  That is referring to the DJI, and indeed, most average investors do not "beat the market," i.e. make more than a 9% yield investing in individual stocks.  Personally, I don't like to be very risky with my retirement money, so I put it in the DJI.  I would recommend you do the same.  However, you can allocate a portion of your non-retirement money for investing in individual stocks.  This portion of your non-retirement money has to be money you are willing to lose, because that definitely can be a possibility when you are dealing with individual stocks.  However, the probability of losing everything becomes very minimal, if you do your research and invest correctly, and often times, you will beat the market.  It is more rewarding as well, because you are actively managing your portfolio, rather than just passively following the stock market. 

 

Let's define one more term and call it a day.  The stock price is obviously what you pay for a share of the company.  Well, how does that get determined?  The stock price, if you think about, is basically the market cap divided by the number of shares of the company.  If a company is worth $100 (e.g. my lemonade stand when I was a kid) and there are 100 shares, the stock price would be $1.  Understanding this is important, because then you realize that the stock price is not just affected by how well the company does, but is also dependent on movements in the number of outstanding shares.  Sometimes a company, in order to raise additional capital, will put more shares in the market.  This is called a secondary offering, and it almost always results in a decrease of the stock price, because the market cap is being "diluted" with more shares.  Vice versa, if a company buys back stock, termed a share repurchase or share buyback, that usually results in an increase of the stock price, as there are less shares available.
 

Alright, that's enough for this post.  Til next time, may you make some moolah.