In planning for your future, you have probably thought about investing in the stock market. Whether you are in your twenties or in your fifties, the stock market can be a valuable tool in increasing your wealth and making your future more secure. Successful investing can fund your retirement, help pay for your children's college education and make you financially independent. It's important to remember, however, that investing in the stock market involves risks that could be devastating to your plans.
Each share of stock represents a unit of ownership in that company
Investing in the stock market is not a game for the faint-hearted, the unprepared or the lazy.
So, what are stocks?
Once a company decides to "go public," they provide stocks that investors can purchase. Each share of stock represents a unit of ownership in that company.
Owning shares of stock comes with certain rights. As a shareowner, you have the right to vote for various members of the board of directors. If the company with whom you have purchased shares distributes its profits, you will receive a specific amount concurrent with the number of shares of stock that you own.
Another right you will enjoy is that of "limited liability." This means that if the company goes bankrupt or loses a lawsuit, your stock might become worthless, but no one will ever come after you to garnish your assets. Privately owned companies cannot make this claim.
You may hear about two different types of stock, preferred and common. Common stock is the type that is usually purchased and owned by the public at large. Preferred stock does not enjoy the same rights as common stock, but it does take first call over common stock when it comes to dividends. Companies that provide preferred stock generally pay regular dividends and that is why some investors collect them.
Common stocks are generally easy to trade on a day-by-day basis. The stock market allows us to buy or sell our shares of stock on any business day of the week.
There are different types of stock shares. Before jumping into the investment fray, you should do all you can to understand what is meant when these terms are used. We've defined a few terms for you.
the total number of stock shares that were authorized when the company was started. To increase this number, shareholders must vote on the number of issue. The company may not necessarily issue all of their authorized shares to the public.
Restricted stock shares:
those held in reserve for employee incentive and compensations.
the number of stock shares a company keeps in its "treasury." These shares are not issued to the public or to employees.
the stock shares that are available to the public for buying and selling.
all the stock shares issued by the company. These include the restricted shares and the float shares.
In your studies and education of stock investing, you will learn how to gauge a company's health and growth through a comparison of these types of shares. This will help you analyze the companies with whom you might want to invest.
Investing in stock versus other types of saving
Simply put, stock investing has the potential of earning you a lot more money than a run-of-the-mill savings account ever could. However, you must decide for yourself how willing you are to risk your money. Savings accounts are generally much safer than stock investing, but they offer a lower return.
There are different levels of risk even in stocks. You can invest conservatively or aggressively. You can make more money by investing aggressively, but there is generally more risk involved, and you can lose everything.
Investing in stocks gives you ownership in a specific company. When you put your money into a savings account at a bank, you will never own any part of that bank. If you purchase stocks in a growing company and it excels, your profits will rise. With a savings account, even if the bank does well, this won't happen.
The risk of stock investment
People invest in stocks because of the potential returns they can make, and they can sometimes be enormous. Those who invested right at the beginning with Microsoft are millionaires now. Even if you invest conservatively, you can still generally make more money than you can by purchasing a CD or keeping your money in a savings account.
If you can't afford to lose anything, investing in stocks may not be worthwhile for you. You should, instead, invest in more modest ventures and allow yourself to be happy with more modest returns. U.S. Treasury bonds, certificates of deposit and perhaps a few mutual funds might be the right choice for you.
Many people lose a lot of money when they invest in stocks. Those who make substantial sums of money generally get to that point by first losing money or by taking the time to thoroughly learn every facet of investment before risking a single dollar. One of the biggest mistakes we can make is to leap into stock investment without taking the time first to learn all we can about the process.
The general rule that most advisors give is this: if you are young, you can usually afford to take more risk because if you lose money, you have time to regroup and recover. If you are older, say, within five years of retirement, you should be more careful and perhaps invest in conservative stocks or mutual funds.
Diversification and asset allocation
These are the words associated with two ways to lessen your risks. Diversification simply means that you diversify your investments into different stocks carrying different levels of risk. That way, if one of your stock investments goes under, you won't have lost everything. Maybe two or three other investments will do well.
Some people think that asset allocation is the same thing as diversifying. It is, to some extent, but it goes deeper. With asset allocation, you not only diversify your investment money into a mix of areas, such as stocks, bonds, mutual funds and cash, but you determine exactly the optimum amount to put into each area. To learn the identification of the proper percentages to invest will take study and effort on your part. When determining your asset allocation, consider the answers to these questions:
- In how long are you planning to retire?
- What are your investment goals?
- What is your comfort level when it comes to risk?
- How much money do you earn?
- How much money do you have in savings?
A wisely balanced investment portfolio can help shield you from the ups and downs of the stock market. Once you have figured out all the particulars, don't forget to keep track of your investment strategy, and change it if needed.
The Stock Market
Nearly every successful company, from Microsoft to Wal-Mart, began as a small business. In order to expand and grow, these companies, and many more like them, went public and began selling shares of stock. This allowed them to raise money, which they used to gradually become the giants they are today. They might have been able to acquire loans from a bank instead, but that money has to be paid back, with interest, and sometimes small businesses don't qualify for loans. Going public and selling shares becomes an attractive alternative.
"Trading stocks" is the language used to describe buying and selling stocks in the stock market. The two ways of doing this are electronically and on the stock exchange floor at the New York Stock Exchange, or NYSE.
When you decide you want to buy or sell shares of stock, you contact your broker, either a traditional broker or a discount broker, and put in your order. The broker finds the buyer or seller for you and the deal is done.
The stock broker
At some point in your investment adventure, you will probably have to choose a broker. This is the person who will access the exchange network and finalize the deal you want to make. There are a few exceptions to this rule, which are explained below, but generally, most stock investing is done with some type of broker.
A traditional broker is a full-service broker. He or she will work with you closely, one-on-one, every time you want to buy or sell stock. This person will give you advice and ideas and will prepare and give you reports concerning your portfolio. He or she will inform you on a regular basis how your stocks are doing and make recommendations. The commission you pay will be higher for this type of service.
A discount broker is designed to be of assistance to investors who wish to delve more deeply into the adventure of investing and do much of the work on their own. Here you will get no investment advice or reports. These people simply perform the orders you give them concerning what you want to buy or sell. You will probably speak to a different person each time you call. The commissions you pay will be significantly less. Be sure to find out what the commission is before you open an account.
Many brokerage firms require that you open your account with a certain amount of money. Make sure you understand all the potential fees that may be attached, like maintenance fees and charges if you fall below a certain balance in the account.
One way to determine what brokerage firm you would like to open an account with is to research them on the Internet. The big ones all have websites. If you go with a discount broker, you should feel comfortable on their website, since you will be doing a lot of trading there.
Brokerage firms will offer you the option of setting up automatic monthly withdrawals that will transfer a specific amount from your savings or checking account into your brokerage account.
Investing without a broker
There are ways to invest without a broker.
- Some companies offer a direct stock purchase plan. You can set up automatic withdrawals so that stock is purchased for you on a monthly basis.
- Sometimes, if a company does not offer a direct stock purchase plan, they may have a DRIP plan, or dividend reinvestment plan. With these, you can mail a check to the program administrator, who will purchase additional shares for you. Even fractional shares are invested, which helps your money grow faster. You will need to acquire one share of stock before you can take advantage of this.
- There are companies who offer the option of purchasing one share of stock. If enrolling in a DRIP plan is the way you want to invest, you will need to own one share of stock first. Once you own that single share, you can fill out the enrollment forms and begin investing while sidestepping any brokerage commissions.
Don't forget the other financial areas of your life
Investing in stocks is only one area you should consider when planning a healthy financial life.
It is always good advice to determine exactly how much you are worth. What do you own? Cars, a home, certificates of deposit, savings bonds? Now list your debts: credit cards, automobile loans, your mortgage, and any other type of debt you have. Knowing these amounts will help you gauge what you need to do differently.
Many financial experts say that you will be financially healthy when you have fully-funded all available retirement accounts, you are debt-free, you have six months of emergency funds available, and you have diversified investments. If you work for a company that offers a 401K plan, you should contribute the maximum amount that your employer matches. Additionally, set up and fund a Roth IRA. Save and prepare for your children's college education, own your own home and pay off high-interest debts. Don't assume that investing in the stock market will bail you out of your mistakes.