The first thing I had to do after making the decision to become captain of my own financial ship was learn how to sail. So I began to ask friends how they invested their savings and it quickly became obvious they were as clueless as I was. Some real answers: “Stocks? No, I don’t own stocks. Too risky. I own mutual funds.” And “All my money is invested in a 401(k).” And “I’m going to buy an IRA when I retire.” Seriously?
At least I felt better knowing I wasn’t in the boat alone. Assuming you are in there too, here are answers to some questions you may have been embarrassed to ask. (If you already know this stuff, you can stop reading now but please come back in 2 weeks when we’ve moved on to another topic.) I did a lot of research and talked to mentors and here is the Cliffs Notes version of what I learned:
Step 1: Learn the lingo
- Asset: Anything of value that you own.
- Liability: Anything you owe.
- Net worth: The difference between your assets and liabilities.
- Liquify: Sell an asset and turn it into cash
- Capital: Another term for cash
- Portfolio: Your collection of assets. Note: Although it is an asset (probably your largest) it is generally not a good idea to include the value of your house in your portfolio because the only way to get money out of it is to sell it and you would need that money to put back into another place to live.
- Investing: Putting capital (cash) into something (such as the stock market) with the expectation of getting more back than you put in a.k.a. making a
A security is an instrument representing ownership that has value and can be bought and sold.
- Wall Street: The term we use for the financial industry in the U.S. no matter where it’s located
Different types of investments are categorized into groups known as asset classes. The big four are stocks, bonds, cash, and real estate.
An investment in knowledge always pays the best interest.
Step 2: Learn how to (hopefully) make money
There are only two general ways to make money from investing:
- Owning something that produces income for you (Ex: stocks, real estate)
- Loaning your money and earning interest(Ex: CDs, bonds)
- In this post we’ll talk about “ownership” type investments.
When a company needs money to operate or expand, it can borrow it or it can raise cash by selling pieces of itself a.k.a. shares. So buying stock is simply buying part ownership of a company. This is one case where size really does matter and companies come in 3 sizes:
Small cap: A new company with a small amount of money (capitalization) to work with and no track record. Small caps are riskier because new companies often fail. When that happens investors lose their money. If the company does hold the magic keys to success your returns are higher because you were willing to take a risk on them.
Mid caps: The next phase in a company’s growth—the teenage years where they haven’t reached maturity. Small caps and mid caps are known as growth stocks.
Large caps: Large established companies (like Coke, Apple, Wal-Mart) focused more on maintaining sales than growth. These companies share the profits by paying dividends to their owners (stockholders) so they are known as income stocks. Their stock prices are usually fairly steady.
To recap (no pun intended) you can make money from owning stocks in 2 ways: By receiving dividends (your piece of the profits pie) or from selling your stocks when they increases in value because the company you invested in is growing.
It would be except stock prices change constantly and it often has little to do with how the company is actually doing. Um, what???
There are several reasons why stock prices change. All public companies (companies which sell shares on the stock exchanges) must report their earnings every quarter. Stock analysts predict what they think the earnings will be in advance of the reports. If the company earns more than the predictions, stock prices generally go up. If the company earns less, even if only a few cents and even if the company is showing a profit, stock prices generally go down. Another reason is what I call the Chicken Little syndrome. Bad news anywhere in the world often panics investors into selling.
The bottom line is that stock is worth whatever the public thinks it’s worth—remember Beanie Babies?
Yes, you can buy property and rent it or flip it for profit. But if you’re not handy or if cleaning up debris after tenants leave in the middle of the night isn’t your idea of a good time there’s an alternative: REITs, short for Real Estate Investment Trusts. A management company uses a pool of investor capital to buy and lease commercial properties. Investors share in profits from rents and leases and sometimes from sales of properties. REITs may own all kinds of properties like shopping malls, warehouses, hospitals and hotels and they may be regional or spread across the country. As good as this sounds, REITS are not risk free. Consider the recent real estate bust.
Other types of ownership investments are precious metals, commodities (pork bellies, wheat, corn) and Forex but these are not for beginners. Ditto hedge funds. These are for wealthy people who are willing to take massive risks.
Investing has nothing to do with get-rich-quick schemes or making a killing in the market. It’s putting money to work for you rather than you working for it—safely, and in ways that will bring you a return that exceeds the rate of inflation.
In the next post we’ll talk about the “loanership” asset classes. And as always, if you have questions or comments let’s hear them!