Benefits and Risks of Owning Stocks

Why do people invest in stocks? Is it because they like to take risks? What are investors looking for in return for investing in stocks? Historically, stocks yield the greatest returns over the long-run. The chart of historic stock market returns from 1986 through 2015 is shown below:

Historical S&P 500 Index Stock Market Returns
Year Return
1986 18.5%
1987 5.2%
1988 16.8%
1989 31.5%
1990 -3.2%
1991 30.5%
1992 7.7%
1993 10.0%
1994 1.3%
1995 37.4%
1996 23.1%
1997 33.4%
1998 28.6%
1999 21.0%
2000 -9.1%
2001 -11.90%
2002 -22.1%
2003 28.7%
2004 10.9%
2005 4.9%
2006 15.9%
2007 5.5%
2008 -37.0%
2009 26.5%
2010 15.1%
2011 2.1%
2012 16.0%
2013 32.4%
2014 11.74%
2015 1.4%

*Market return data from Dimensional’s Matrix Book 2016.

As you can see from the chart, the annual rates of return fluctuate from year to year. The average rate of return from the stock market from 1986 through 2015 is 11.76%. Most savings accounts today pay less than 1% interest annually. Can you see why people might be interested in investing in the stock market? One benefit of investing in stocks is the possibility of earning a higher rate of return than those of savings accounts. Another benefit of investing in stocks is the steady stream of dividend income which can offset the price changes.

If you take a look at the information in the chart, you will notice there were years with extremely high rates of return and years with extremely low or negative rates of return.   The trouble with investing in stocks is knowing exactly when to buy and when to sell. These are some of the risks of investing in stocks.

What comes in to play that causes stock prices to fluctuate? Often, investors’ emotions play a key role in stock prices. If an investor becomes anxious about the price of the stock dropping, that person may sell the stock at the point when the price is trending down which causes a risk for the investor. Instead of selling the stock based on emotion, the investor might be better off holding on to the stock until the price settles down. However, what if the stock price does not rebound? Then it might be the right time to sell before further losses are incurred. Economic and political conditions can also cause stock prices to change as well as defective products or other company issues.

An investor that is investing for the long term will not be as affected by price changes as much as a short-term investor might be affected. Those it in for the long haul realize there will be times of growth and decline and have chosen to ride out the changes. As I mentioned in a previous article, diversifying your portfolio can help alleviate some of the risks of investing in stocks alone. A portfolio with a mix of stocks, bonds, and mutual funds would be advisable.

One good learning tool for investing in stocks is How the Market Works virtual stock market game at http://www.howthemarketworks.com/. In the past, my students have played this game and have learned a great deal about how to invest in the stock market. If you are interested in practicing your investing skills, register for free and sign up for a contest. You might be surprised at how much you can learn about the Market!

 

The Basics of Stocks

When we talk about investing in stocks, what does it really mean and how does it all work? You’ve probably heard about the stock market and wondered how do I become an investor. Before investing in any type of product, I suggest you do your homework and understand how that investment works. Today’s post will cover some of the basics of stocks that will help you understand more about the stock market.

1) What is a share of stock? – A share of stock represents ownership in a company. Corporations that sell stock are selling part of the equity of the company. One reason a company may choose to issue stock is to raise large sums of capital that does not have to be repaid. By issuing stock (equity), the company will not have to repay a loan. Companies may use a stock issue to pay off another debt, expand their business, purchase another business, launch a new product or product line, etc.

2) What are the different types of stocks? Generally, there are two main types of stocks, common and preferred. Common stock has the benefit of allowing the owner to vote at shareholder or stockholder meetings and to receive dividends if the stock pays dividends.   Preferred stock usually has no voting rights, but will receive dividend payments before common stockholders will. For example, if a company pays dividends to preferred and common stockholders, but does not have enough to cover paying everyone, the preferred stockholders would be paid first and any remaining dividend amounts would be paid to common stockholders.

3) What are the categories of stocks that you can invest in?

  • Growth stock – Stocks whose earnings grow faster than the market average.   Growth stocks do not normally pay a dividend. Investors invest in growth stocks in hopes the stock price will appreciate or increase in value.
  • Income stock –Stocks that pay dividends to stockholders. Many people invest in income stocks for the dividend income. Dividends are generally paid quarterly. Companies can either send you a check for your dividends, deposit the dividend in your investment account, or can invest the dividend in purchasing more shares of the stock for you. The last option is called dividend reinvestment. Instead of receiving cash, you would receive a certain amount of stocks. To illustrate how dividend reinvestment works, we will assume that a stockholder will receive a $15 dividend. Under dividend reinvestment, the $15 would go towards purchasing stock. Let’s say the stock price is currently $9.25 per share. To calculate how many shares you would receive, take the $15 and divide it by $9.25 which would equal 1.622 shares of stock.
  • Value stock – Stocks that have a low Price to Earnings Ratio (P/E ratio). In this case, values stocks are less expensive than stocks with a higher P/E ratio. Some value stock investors buy the stock in anticipation that the stock price will go back up.
  • Blue-chip stock – These stocks are companies that have a solid growth history and they usually pay a dividend to stockholders.

To research information on stocks, go to finance.yahoo.com.  On the left-hand side of the page, you should see a box that says “Quote lookup.”  This is where you would type in the symbol of the company you want to view.  Just as an example, type in NKE for Nike and take a look at the stock information.  As of the time I checked NKE, the stock was trading for $54.36 per share.  Next week’s blog post will be a continuation of the discussion on stocks.

 

 

https://investor.gov/investing-basics/investment-products/stocks

A Few Basic Investing Tips for Beginning Investors

One of the myths I hear is that investing is just for people with a degree in finance or business, but many investors are just ordinary people. Today’s blog will introduce you to three tips that will help you understand more about investing.

Tip 1: Set your investing goals – Decide what your investing goals are and commit them to paper. A great free downloadable financial goals form to use for this step can be found at: http://www.financialliteracymonth.com/30Steps/Step12.aspx.

Remember to make those goals SMART goals: Specific, Measurable, Attainable, Realistic, and Time bound. The worksheet breaks your goals into short-term, mid-term and long-term. It allows you to set a target date to attain the goal, the cost-estimate, the amount already saved, and amount needed per month to reach the goal.

Tip 2: Determine the mix of investments – Once you have committed your goals to paper, plan the mix of investment vehicles that you will use to reach the goals. This step is different for everyone and your stage in life will play a key role in how long you have to reach that goal. What I mean by investment vehicles is what types of investments will you make. We also refer to this mix as the asset allocation for your portfolio. Will you use stocks, bonds, mutual funds, annuities, etc. to reach the goal? At this point, you may need to consult with a financial planner to help you determine which ones work best for your specific scenario.

There are 3 main asset classes: stocks, bonds, and cash & equivalents. Stocks, also called equities, represent ownership in a company. As an example, McDonald’s stock symbol is MCD on the stock exchange. We could place an order today and purchase shares of McDonalds’s stock (equities).

Bonds (debt) are a type of fixed income. An investor can purchase a bond and will receive interest payments until the bond matures. Once it reaches the maturity date, the principal of the bond will be repaid to the purchaser.

Cash is considered one of the safest investments, but the risks and returns are lower than with some other asset classes. It is wise to keep a certain amount of your investments in cash in case of emergencies.

Once you choose the mix of investments for your portfolio, you will need to consider diversification which means spreading the risk by investing in more than one specific investment instrument. It would probably not be a wise choice to just purchase one particular item such as McDonald’s stock. What would happen to your portfolio if all you had was McDonald’s stock and the price fell drastically? You would lose value in your portfolio. If on the other hand your portfolio included stock in McDonalds, Wal-Mart, GE, Apple, and Nike along with bonds and cash then we would say that your portfolio was more diversified. I don’t advise including only one type of investment. The risk needs to be spread around in order to minimize losses.

Lastly, identify how much risk you are willing to take in your portfolio. If you’re young, you would be able to bear more risk than a 68 year old could bear since you have longer to recover any losses you might incur. Each person’s risk tolerance is different, so decide how much works best for your situation.

Tip #3: Invest for the long haul – Investing is not a once and done activity. Your portfolio will need to be rebalanced from time to time. Strategies will need to be updated as retirement age approaches and when life’s activities occur. Investors are in it for the long haul, so don’t panic every time the market drops and sell everything in your portfolio. Many times this is when mistakes happen. Stay on task and stay focused on the end result!

http://www.schwab.com/public/schwab/investing/retirement_and_planning/how_to_invest/investing_basics/plan_your_mix

 

Getting your Budget Back on Track

Most of us start out with good intentions when budgeting. We make a plan called a budget and we put it on paper. We might even follow it for a few months but like most good habits, the excitement begins to fade. Don’t fall prey to the temptation to loosen up on the budget when things seem to be going well. That’s the time we really need to stay focused and committed to the budget.

I recently started watching a television show in which a personal trainer meets an overweight person whom they will train to become fit. The personal trainer will go from fit to fat and then back to fit in order to help the overweight person with their weight loss. The personal trainer usually gains a minimum of 40 pounds. At first, the trainer adjusts pretty well to the weight gain. But at a certain point, the trainer becomes lethargic and most become depressed. It is as much a mental battle as it is a physical battle. They finally get to go back to their prior healthy eating and exercising habits and back to their fit self again.

I want to relate this to a budgeting experience. We work hard to get a workable budget and to stick to it. Something usually happens along the way to get our budgets sidetracked. Maybe we need a new roof, our refrigerator needs repair, some unexpected medical event happens that causes debt, etc. You name it and it can probably happen. Then little by little, we begin to move away from using the budget. We really don’t notice it at first because it’s just a few dollars here and there. All of a sudden, we have completely stopped using the budget and our debt weight has increased tremendously! How did this happen? We didn’t go out and make any large purchase. What we didn’t realize at the time was how much the small purchases were adding up. We stopped looking for a discount here and there.   What we would once say no to, we were now saying yes to without hesitation. Has this ever happened to you? It’s just like weight gain. Most people don’t gain 40 pounds in one month. They slowly gain a pound here and there and before they know it they have packed on 40 pounds! Debt acts the same way. What might have begun as just a small step away from the budget leads us miles and miles away.

Financial independence does not come without some sacrifice just like a fit body does not happen for those who eat 5,000 calories a day and don’t exercise or workout.  There is a cost to becoming physically fit and financially fit. There is also a cost to becoming overweight and financially indebted.  You have to choose which you want.

Here is the action plan for today. Take the time to sit down with your budget if you still have one. If you don’t have one, commit to making one this week. Make the budget manageable so that you will be capable of sticking with it. Then commit to following the budget for the next few months. Just like weight loss goals, set a few small attainable goals that can be accomplished in the next six months. Here’s the “c” word again; commit to reaching the goals! You might find it difficult at times when little temptations arise, but keep the goal in focus. Don’t stray from the goal and commit to attaining it by a specific date.

Six months from today, take another look at your financial position.  Measure how well you met your financial goals. Then commit to meeting another set of goals.  You’re on your way to becoming a financially fit person!