A Primer on Stock Market Investment.
If we want to achieve financial freedom, we need investment vehicles that will take us there. Not all investment vehicles, however, are created equal. Different investment vehicles run at different speeds. On this post, we’ll talk about the fast cars of investing: the stock market investment.
What is a stock market?
A stock market, aka equity market, is a market where shares of publicly held companies are issued and traded. Why do companies offer stocks to the public? Simply to raise capital by selling part of their company to interested investors, be they individuals or institutions. Every day, bajillions’ worth of company shares are being traded (bought and sold), creating wealth – or wiping them out -- for participating institutions and individual investors. Examples of stock markets are the New York Stock Exchange (NYSE), the largest in the world, NASDAQ, which is also in New York and the second largest stock exchange in the world.
Why invest in the stock market?
Because stock investing is a bold and aggressive stance in building wealth. Nowadays, it’s not enough that we work hard for money; we need our money to work hard for us, as well. Savings accounts and certificates of deposits can’t give you the returns that the stock market can. In fact, the money you put in your savings account are probably being invested in equities by your bank. They earn huge profits while you get a meager 0.5% per annum! If you want your money to compound, stock market investment is the way to go, especially if you are decades from retirement and can afford to take the risks.
Consider this fact:
“from 1928 to 2014, the S&P 500’s compounded rate of return was 9.8%, enough to transform a $100 investment at the start of 1928 to $346, 261 in over 87 years.” (1)
The S&P 500 (Standard & Poor’s) is a market index based on the market capitalization of 500 large companies in the NYSE or NASDAQ. If you had invested in an equity fund that tracks the S&P 500, you would have enjoyed such profits or cashed it in for your retirement fund. On the other hand, if you had stashed your money in the bank, its value would have depreciated as a result of inflation.
Ways to invest in the stock market.
There are two ways to put your money in stocks: directly or indirectly. Direct stock investing means opening your own brokerage account, funding it with your capital, picking which companies to buy, and paying your broker the commission for executing transactions. When you buy shares of a company, you become a “shareholder” of that company. You own a piece of the pie such as their assets and earnings. Indirect investing in stocks involves investing in equity funds or mutual funds whose portfolio is composed purely of stocks. Mutual funds are pooled funds, which means individual investors contribute money to that fund while professional fund managers do the investing for them in exchange for an annual management fee.
How to make money in a stock market investment?
There are two ways to make money in stocks: (1) capital appreciation and (2) dividends.
- Capital appreciation - when the value of a company’s stock rises, so does your capital. Profiting from the stock market can be summarized in the phrase: “buy low, sell high.” For example, Financial Rescue goes public in January 2015 and trades at an initial public offering (IPO) of $1/share. You want to own a piece of the company so you bought 3000 shares for a total of $3000 (fees not included). At the end of the year, the stock trades at $2 per share, so your $3000 has appreciated to $6000.
- Dividends - some companies distribute part of their revenues to their shareholders in the form of dividends. For example, Financial Rescue announces its earnings and wants to share them to its shareholders at $0.5 dividend per share. If you have 3000 shares, you earn another $1500.
How to start investing in the stock market.
Understand the risks.
The stock market is very volatile, which means stock prices can experience huge swings in response to different economic factors. It is a risky and chaotic place but as history proves, it affords investors the highest returns over time. Higher risks mean higher rewards, but to be able to enjoy the rewards, we have to accept the risks first. For individual investors to combat these short-terms risks, the best thing to do is invest in the best companies, ignore the short term swings, and stay invested in the long term.
Save for capital.
You don’t need millions to be able to invest in the stock market. Different stocks have different prices and you do not have to buy thousands or millions of share in one go. There’s an investing strategy called Dollar Cost Averaging, which means buying the same stock every month at smaller chunks. For example, this month you buy 100 shares of American Express Co. (NYSE Stock Code: AXP) and do it over and over again for 12 months.
Open a brokerage account.
Your broker is your middleman between you and the company you want to buy shares from. They provide the platform for you to be able to access shares of publicly traded companies. Brokers, nowadays, don’t have to be the stereotypical stock guru who gives advice and execute the buy and sell transactions for you. Those guys ask for expensive fees. With the development of the Internet, individual investors can now do their own research, decide, and transact on their own. Besides, brokerage houses do research and offer free stock advice to their clients. You could simply follow their advice as baby steps in your stock investing journey. Now, if all these sounds too complicated or take too much of your time, you could simply invest in equity funds, where you can contribute part of your salary every month. With equity funds, you get the sense of security that your money is being handled by professional investors, thereby reducing the risks and increasing your chances of making profits over the years. Stock investing is a great and exciting way to grow your money without you actively spending time on a job. If some of your assets aren’t invested in equities, you’re probably missing out on some huge gains. If you have not started investing in equities yet, we encourage you to do so. But of course, before investing in high risk/high reward assets, we also encourage you to tick off important matters on your financial checklist first: improve your cashflow, get out of debt and save money. If you’re doing all these now, then you’re ready to invest in stocks.