Investing in Stocks Chapter 31
You can only get poor quickly; getting rich takes time
Investing is putting your money to use in order to make money on it
Putting money in a savings account is a form of investing. Buying stock from a company is another form of investing. Stock is a share of ownership in a business.
Types of Stocks Common stock Primary form of ownership in a corporation All corporations must issue common stock and many issue common stock only Preferred stock Gives certain privileges that common stockholders do not have. If the company pays dividends, dividends on preferred stocks are paid before dividends on common stock
Return on Stocks The return on an investment, or yield, is the amount of money the investment earns Dividend Capital Gain Capital Loss
Dividend Share of a company s profits If a company makes a lot of money over a certain period of time, it distributes the profits among its shareholders in the form of dividends.
Capital Gain A capital gain is recognized when the stock is sold Purchase 100 shares @$10 each = $1,000 Stock goes up to $20 a share and you decide to sell all 100 shares. Sale price is 100 shares x $20 = $2,000 Capital Gain is $2,000 - $1,000 = $1,000 You will pay tax on the $1,000 capital gain
Capital Loss A capital loss is recognized when the stock is sold Purchase 100 shares @$10 each = $1,000 Stock goes down to $5 a share and you decide to sell all 100 shares. Sale price is 100 shares x $5 = $500 Capital Loss is $1,000 - $500 = $500 Taxable income will be reduced by the $500 capital loss
Rate of Return Measures the change in the investment expressed as a percentage Purchase 100 shares @$10 each = $1,000 Stock goes up to $12 a share. Investment is worth $1,200 Rate of return is ($1,200 - $1,000)/$1,000 $200/$1,000 = 20%
Stockbroker A person who acts as a go-between for buyers and sellers of stock Brokers process the purchase and sale of stocks for a fee Charge a transaction fee Discount broker charges less Examples: Charles Schwab
Stock Exchanges Where stocks are bought and sold NYSE New York Stock Exchange NASDAQ AMEX American Stock Exchange
Stock Indexes DJIA Dow Jones Industrial Average The most widely used indicator of the overall condition of the stock market a price-weighted average of 30 actively traded blue chip stocks The 30 stocks are chosen by the editors of the Wall Street Journal, a practice that dates back to the beginning of the century.
S & P 500 tracks how the top 500 companies are doing Wilshire 5,000 the most comprehensive measure of the stock market The benchmark is designed to represent the performance of all U.S.-headquartered equity securities with readily available price data
Mutual Funds Allows an investor to participate in the stock market without buying stocks in one specific corporation. Mutual funds purchase from several companies
Example American Century Ultra Fund Sector Weightings Information Technology 24.27% Consumer Discretionary 21.04% Health Care 18.79% Financials 15.90% Consumer Staples 12.43% Industrials 4.82% Energy 2.59% Materials.16% Total 100.00%
Diversification A strategy designed to reduce exposure to risk by combining a variety of investments If one stock performs poorly, the loss is limited and can be made up by other stocks Mutual funds help an investor diversify
Where to Begin? There are many ways to begin accumulating wealth. You will need to decide: where to invest for how long how much risk you are willing to take
Putting money in a savings account is a form of investing Interest earned is low Little or no risk of losing money in your account if amount is less than $250,000
Risk Risk is something we encounter every day With investments, understanding the relationship between risk and reward is very important. All investors want to maximize their potential returns, while minimizing risk.
Risk vs. Reward "If no one ever took risks, Michelangelo would have painted the Sistine floor." - Neil Simon
We can't expect to get anywhere if we avoid taking risk. History shows that great accomplishments have always involved taking significant calculated risks in one form or another. Great artists, investors, and entrepreneurs alike are willing to take risk because they see it as opportunity.
Risk can hold tremendous opportunities for those who know how to manage it. Some investments are certainly less "risky" than others, but no investment is risk free. With investing, you should carefully consider your overall financial situation.
Always bear in mind your ability to tolerate and assume risk, then choose a comfortable level of risk for yourself and select the appropriate investments
Some investors are comfortable with risks that make another's stomach churn. How would you feel if your portfolio lost 21% in a single day? That's how much the S&P 500 fell on Black Monday in October 1987
Risk Profile So what's the right amount of risk to take? First, consider your risk preference. After all, what good is a profitable investment if it costs a heart attack along the way.
It is said: The higher the risk, the greater the potential for a higher reward
Blue-Chip Stocks Are stocks of large, well-established companies that have a good track record of profitability and success Are said to be the safest IBM GM
Speculative Stocks Stocks of relatively new firms that do not have an established track record of success Often small firms that are developing new types of goods and services Riskier investments
Day Trading Very big during late 1990s and early 2000 when the Internet stocks took off. People buy and sell stock based on minute-by-minute changes in the price of a stock Extremely risky