By Guy Norman
I believe that stocks are the best tool for the long term investor. So, in a series of articles for Nina I hope to create an effective guide for those of you who are unfamiliar with the stock market.
As a keen amateur investor, I thought it would be useful to share what I have learned over the last few years. Essentially, I want to turn the idea of investing your money in stocks into something that is possible for you– and not just a thing that others do. So, even if you aren’t an expert, please read on. The beauty is, of course, that investing is a completely democratic operation. Irrespective of gender, race of religion, as long as you have access to some money and basic know-how you can get involved!
Please note I am only going to attempt to explain investing in stocks, not any other investing instruments. Also, the information below is designed to be a guide. It doesn’t constitute advice re investing in any specific product or stock. Always consult an expert before you invest your money in anything.
Why Should I Invest In The Stock market?
The stock market is a great tool for anyone to invest their money. According to Jeremy Siegel’s “Stocks Over the Long Run” over the past 200 years in America, stocks have returned between 6.5% to 7% after inflation. Imagine leaving $10,000 in a savings account that paid a 1% return after inflation for 10 years, and investing another $10,000 in the stock market which increased by 6.5% annually on average after inflation for those 10 years. After 10 years the price of your stocks would be $33,085 whilst there would only be $12,081 in your savings account. The typical return from the typical stock should probably be more than that from the typical bond or savings account, over the long term.
One of the things that makes stocks a wonderful investment is how ‘liquid’ they are, ie they can be easily bought or sold. You go online and just a few clicks can connect you to a seller of a stock in seconds . At the end of your investment you can then (again with a few clicks), sell that stock online to a buyer. Withdrawing your money is easy when compared to going into business with a neighbour or lending money to a friend. However, this ease has the disadvantage of making people do things that they wouldn’t do if they were investing in a business physically close to them. In the stock market people often sell at the first hint of bad news and will buy stocks at ridiculous prices. The biggest risk when investing in the stock market is paying too much. The important thing to know is that if you’re investing your own money then the stock is market is quick, convenient and will probably get you better returns than a savings account or bonds will.
What Is A Stock?
A stock is a contract to own a small part of a corporation. A corporation is a business in which the public can buy stock. Normally when you buy a stock you don’t buy it from the corporation, you buy it from a previous owner. The money you pay goes to the previous owner of that stock. The money that a corporation has to invest in its businesses is usually not directly related to its stock price nor the money involved in buying/selling its stock. Usually when your corporation needs money, it will borrow it, perhaps by going to a bank or by selling bonds.
How Is The Price of a Stock Related To The business?
The value of a stock is the amount a well-informed business person would pay for the entire business. This is divided by the numbers of stocks. If a knowledgeable person in the same trade would pay $1,000,000 to own the business and there are 1,000,000 stocks issued then each stock in that business is worth $1. Stocks can occasionally be overpriced or under-priced. For example, when investors are ‘depressed’ about the value of a business the market price for the stock can be too low. When investors are ’exuberant’ about the value of the business the market price can be too high. Essentially, while the price may diverge from the value for some time, in the long term the price of a stock will move to the value of that stock. (I will explain the basics of valuing a business and thus valuing a stock in part 3).
Isn’t The Stock Market Risky And Unreliable?
It can be. However if one follows a sensible strategy then the stock market remains the saver’s best friend.
Historically the prices of stocks in general have gone up, but not uniformly. A look at any historical graph of general stock price levels will show you that price levels will rise for years and then fall for years. This is probably due to changing trends in investor sentiment – at one time too optimistic at another too pessimistic. Over the long term the owners of stocks will probably see the prices of their investments rise. They may however have to wait for many years whilst the price in the market for their stocks is lower than what they paid.
Where then is your guarantee that your investments will not fall in value and price? Well your stocks will rise in value if your businesses grow and the stock prices will in the long term reflect the values of those businesses. Historically corporations in the stock market have over time been profitable and either returned those profits in the form of dividends or re-invested profits into their business. The values of corporations have thus gone up, and the stock prices have followed. Nothing I know about the world or history, suggest that this trend of public corporations gaining profit from their businesses will stop any time soon.
The biggest risk in the stock market is the risk of paying too much. If you use all of your savings to buy stocks in one go then you might very well have bought at a time when investors have been too optimistic. Historically many experts have been unable to recognize that the general price level of stocks has been too expensive. Spending all of your money on stocks in one go therefore runs the risk of paying too much for them. The solution to this problem is simple. Regularly invest a portion of your savings each year into the stock market. Do not spend all of your money on stocks at once! At times you will pay too much for your stocks and at times you will get a bargain. You might be unable to tell the difference at the time. But you don’t to be able to tell the difference to achieve an average result for an investor in the stock market. And an average result in the stock market is, over the long term, a very satisfactory result indeed.
If you want to find out more in the meantime, a free course about investing in the stock market is offered by Udemy.com. https://www.udemy.com/value-investing-code/
Part 2 – out 19h March: Where Do My Returns Come From? How Long Should I Invest In The Stock Market? The choice of different funds.
Part 3 – out 31st March: Stock Picking,. A Brief Introduction To Valuing A Stock. How Can I Find A Stock Broker In Iraq?
Questions? Get in touch with guy at twitter, @the21stgman. He is happy to answer any questions.