Back in the days when cars had fins and a household felt lucky to have one television, people invested mostly by buying individual stocks and bonds. The market swung up and down in the 1950's and 1960's, and then really dipped in the 1970's. After that, the benefits of diversification became much more apparent, and investors have gravitated toward mutual funds, and now their latest iteration, ETFs. But what about investing in individual stocks and bonds? Is it a workable way to invest? Is it a good idea? Here are a few thoughts.
1. It'll take a lot of research and analysis. You'll have to look into a number of potential investments before you find a good one. And you'll need a number of good ones to have a reasonably diversified portfolio. Don't invest based solely on someone's recommendation, especially if you got it in a social setting. Would you take financial advice from a financial planner who's had a couple of drinks? If not, why would you take financial advice from an acquaintance or neighbor who's had a couple of drinks? People will boast about their winners, but you won't hear much about their losers. So you'll get only half the story.
2. You'll have the problem of too much choice. There are thousands of mutual funds and ETFs to choose from. There are many, many more individual stocks and bonds. Knowing where to begin your research, and where to stop, will be a challenge. Sure, the Internet provides you a lot of information. But it provides everyone a lot of information. You'll have no informational advantage from using the Internet. You may be thinking that if you had been an early investor in Microsoft or Berkshire Hathaway, you'd be trading up to a bigger yacht today. But which of the many thousands of stocks available today is the next Microsoft or Berkshire Hathaway?
3. You need to keep a lot of records. In order to do your tax returns correctly, you'll have to have a detailed history of the stocks you own. Of course, you need a record of how much you paid for it--and it has to be a good record, like an account statement or a trade confirmation. Your personal notes or your entry in some computer software won't carry a lot of weight with the IRS. And that's just the beginning. You'll need to keep track of stock splits and stock swaps resulting from mergers or corporate recapitalizations. If you participate in a dividend reinvestment program, keeping track of the tax basis in your shares becomes more complex. And if you inherit stock, you need to know the "carry over" basis in the stock (i.e.., its value on the date of death of the person who bequeathed the stock to you). Get used to the idea of keeping some paper records for a very long time, because many computerized records often don't have much legal value as evidence. Further, as computer storage technology changes over time, the data on those floppy disks in the back of your desk will be inaccessible soon, if they aren't already.
4. You still have to diversify, but diversification is much harder with individual stocks and bonds. You need a fair amount of capital to have reasonable diversification, with stockholdings across a number of different industry groups, and in foreign as well as American companies. You'll also need to have some bonds, and the bond part of your portfolio should have a variety of maturities, ranging from at least two to ten years.
5. Unlike mutual fund investments, you'd have to pay commissions to purchase stocks, and also the "bid-ask spread." Stocks are quoted in two prices in the stock market: (a) the "ask" price, at which you buy; and (b) the "bid" price, at which you sell. The difference between these two prices, called the "bid-ask spread" is tantamount to an expense of investing. If you invest for the long term, buying and holding stocks for years or decades, these costs tend to amortize over a long time and become fairly minor. But if you trade stocks a lot, these costs can significantly reduce your returns.
6. You'll face the temptation to trade stocks and bonds on a short term basis, selling whenever you have a bit of a profit. This is a bad idea, because short term trading generally is less profitable than buying and holding. But your stock broker may encourage short term trading because it generates commission income for him or her.
7. At the same time, you have to monitor your portfolio and sell the investments that seem to be going downhill. The value of stocks can sometimes evaporate very quickly. Ask Enron shareholders about this.
8. If you see finance as a hobby or avocation, and are willing to put a lot of time into it, investing in individual stocks and bonds may be enjoyable and profitable. But if all this investing stuff is just work and more work for you, stick with mutual funds and ETFs. For more about investing in individual stocks and bonds, go to Uncle Leo's Den at http://www.uncleleosden.com/Step16aModelPlans.html.
Crime News: what some people will do to get their fruits and vegetables. http://www.wtop.com/?nid=456&sid=1170738.
Showing posts with label stocks. Show all posts
Showing posts with label stocks. Show all posts
Wednesday, June 20, 2007
Sunday, June 3, 2007
Stock Market Basics
For readers who are just starting out in the world of saving and investing, here are the basics of the U.S. stock and bond markets. (The financial markets of other nations can be quite different, so research them separately.) For more detail about the terminology, please look at our Glossary. There’s much more to learn if you want to become an active investor. But you can get an idea of the concepts here.
1. The corporation is an organization. It sells pieces of itself, called “stock,” in order to raise money to conduct business. (In other words, it takes money to make money, for corporations as well as people.) People who buy stock become owners (collectively with all the other stockholders) of the corporation.
2. Stock. When you buy a share of stock, you own a tiny portion of the corporation. The stock will increase in value if the corporation does well, and it will decrease in value if the corporation does poorly. Many people refer to stock as “shares” (as in shares of stock). If you want to invest in a particular stock, research it carefully.
3. Bonds. A bond is a way that corporations and governments borrow money. An investor lends them a fixed amount of money (e.g., $10,000), which is called the “principal.” They pay interest on the bond for a stated amount of time (e.g., 10 years), and then, if all goes well, they repay the principal (i.e., the money originally invested in the bond). Corporate bonds have “credit risk,” meaning the risk that the corporation might be unable to pay them. Government bonds are less likely to have this problem if they are issued by the governments of wealthy nations. But government bonds of less well-off nations can have significant credit risk. The riskier a bond, the higher the interest rate it will have. Be careful investing in bonds that offer a high return—the return reflects a higher risk that you won’t be repaid.
4. Mutual Funds. Mutual funds are a type of corporation used for investment purposes. Their business consists of investing in stocks and/or bonds. When you invest in a mutual fund, you are buying shares of the mutual fund. That gives you an interest in the fund’s holdings of stocks and/or bonds. The value of your mutual fund shares is based on the values of the fund’s holdings of stocks and/or bonds, and will increase or decrease as they increase or decrease in value. Most mutual fund shares are bought or sold at prices based on the values of their holdings of stocks and/or bonds at the close of the financial markets for the day. You usually buy or sell mutual fund shares by directly contacting the company that manages the fund.
Mutual funds can be index funds or actively managed funds. Index funds invest in a way that copies, or mimics, a financial market index, like the Standard & Poor’s 500 or the Nasdaq 100. Index funds have low costs and fees because they don’t have to pay professional money managers to strategize for them. Actively managed funds hire professional money managers to select stocks and/or bonds for them to invest in. These funds have higher costs and fees, because the professionals have to be paid to do the investment strategizing. Some actively managed funds are quite successful. But most do no better, or even worse, than index funds. An investor who is just starting out has relatively little, or nothing, to gain by investing in an actively managed mutual fund,
An exchange traded fund (ETF) is a special kind of mutual fund that can be bought or sold during the hours the stock market is open, at a price that normally reflects the most recent prices for its holdings of stocks and/or bonds. ETFs are bought or sold through stockbrokers.
5. The stock market and bond market are the principal financial markets for investors. They are open for normal trading from 9:30 a.m. to 4:00 p.m., East Coast Time. You can buy or sell stocks, bonds or exchange traded funds during these times. It is possible to buy or sell some U.S. stocks and bonds in other markets at other times. But the prices you get may be less favorable.
6. Stockbrokers are people and firms that serve as intermediaries in the process of buying and selling stocks. You can’t personally call or e-mail a stock market to buy or sell. You have to go through a stockbroker. (However, you can directly invest in or sell mutual funds--except ETFs--by contacting the company that manages the fund.) Stockbrokers charge commissions and/or other fees for their services.
7. Risks. You’ll probably have very little trouble getting information about the potential rewards offered by investments. You’ll probably have a harder time getting information about the risks (because people selling you investments tend not to emphasize their bad points). However, risk and reward walk hand-in-hand down Wall Street. The greater the potential reward, the greater the risk of loss. If you’re getting a glowing story about how great an investment is, but very little detail about the risk of loss, you will be at an informational disadvantage. You might be tempted to invest because you don’t know how bad the investment could be. Go back to cigarette ads from the early 1960’s. They’ll tell you that it’s enjoyable and sophisticated to smoke. But they’re rather short on information about heart disease, cancer and emphysema. Makes it tempting to light up—and that’s the idea. Make sure you know how an investment can go wrong before investing.
8. Investment Strategies. There are about eight and one-half zillion investment strategies. The large majority of them are (a) inconsequential (i.e., they won’t give you much of an advantage, or any, in the long term), (b) expensive (i.e., they require you to buy and sell investments often, which means large transaction costs that can significantly reduce your returns), (c) bunk (i.e., stupid, also referred to as dumb), or (d) fraudulent (i.e., a way to steal your money). Are there investment strategies that will prove superior in the future? Possibly, but you’ll have a hard time separating them from (a) through (d) above. Most professional money managers do not get returns higher than the stock markets as a whole and some do worse. That’s why investing for a return around stock market averages is a rational strategy. In general, most investors should stick to a simple strategy of investing on a diversified basis for the long term. See our recent blog on why the investor who does average is likely to do well. http://blogger.uncleleosden.com/2007/06/why-average-investor-does-well.html.
Also, take a look at the Investment Guidelines in Uncle Leo's Den at www.uncleleosden.com/Step11InvGuidelines.html.
New World Hot Dog Eating Record: You've been waiting for this. www.wtop.com/?nid=456&sid=1156698.
1. The corporation is an organization. It sells pieces of itself, called “stock,” in order to raise money to conduct business. (In other words, it takes money to make money, for corporations as well as people.) People who buy stock become owners (collectively with all the other stockholders) of the corporation.
2. Stock. When you buy a share of stock, you own a tiny portion of the corporation. The stock will increase in value if the corporation does well, and it will decrease in value if the corporation does poorly. Many people refer to stock as “shares” (as in shares of stock). If you want to invest in a particular stock, research it carefully.
3. Bonds. A bond is a way that corporations and governments borrow money. An investor lends them a fixed amount of money (e.g., $10,000), which is called the “principal.” They pay interest on the bond for a stated amount of time (e.g., 10 years), and then, if all goes well, they repay the principal (i.e., the money originally invested in the bond). Corporate bonds have “credit risk,” meaning the risk that the corporation might be unable to pay them. Government bonds are less likely to have this problem if they are issued by the governments of wealthy nations. But government bonds of less well-off nations can have significant credit risk. The riskier a bond, the higher the interest rate it will have. Be careful investing in bonds that offer a high return—the return reflects a higher risk that you won’t be repaid.
4. Mutual Funds. Mutual funds are a type of corporation used for investment purposes. Their business consists of investing in stocks and/or bonds. When you invest in a mutual fund, you are buying shares of the mutual fund. That gives you an interest in the fund’s holdings of stocks and/or bonds. The value of your mutual fund shares is based on the values of the fund’s holdings of stocks and/or bonds, and will increase or decrease as they increase or decrease in value. Most mutual fund shares are bought or sold at prices based on the values of their holdings of stocks and/or bonds at the close of the financial markets for the day. You usually buy or sell mutual fund shares by directly contacting the company that manages the fund.
Mutual funds can be index funds or actively managed funds. Index funds invest in a way that copies, or mimics, a financial market index, like the Standard & Poor’s 500 or the Nasdaq 100. Index funds have low costs and fees because they don’t have to pay professional money managers to strategize for them. Actively managed funds hire professional money managers to select stocks and/or bonds for them to invest in. These funds have higher costs and fees, because the professionals have to be paid to do the investment strategizing. Some actively managed funds are quite successful. But most do no better, or even worse, than index funds. An investor who is just starting out has relatively little, or nothing, to gain by investing in an actively managed mutual fund,
An exchange traded fund (ETF) is a special kind of mutual fund that can be bought or sold during the hours the stock market is open, at a price that normally reflects the most recent prices for its holdings of stocks and/or bonds. ETFs are bought or sold through stockbrokers.
5. The stock market and bond market are the principal financial markets for investors. They are open for normal trading from 9:30 a.m. to 4:00 p.m., East Coast Time. You can buy or sell stocks, bonds or exchange traded funds during these times. It is possible to buy or sell some U.S. stocks and bonds in other markets at other times. But the prices you get may be less favorable.
6. Stockbrokers are people and firms that serve as intermediaries in the process of buying and selling stocks. You can’t personally call or e-mail a stock market to buy or sell. You have to go through a stockbroker. (However, you can directly invest in or sell mutual funds--except ETFs--by contacting the company that manages the fund.) Stockbrokers charge commissions and/or other fees for their services.
7. Risks. You’ll probably have very little trouble getting information about the potential rewards offered by investments. You’ll probably have a harder time getting information about the risks (because people selling you investments tend not to emphasize their bad points). However, risk and reward walk hand-in-hand down Wall Street. The greater the potential reward, the greater the risk of loss. If you’re getting a glowing story about how great an investment is, but very little detail about the risk of loss, you will be at an informational disadvantage. You might be tempted to invest because you don’t know how bad the investment could be. Go back to cigarette ads from the early 1960’s. They’ll tell you that it’s enjoyable and sophisticated to smoke. But they’re rather short on information about heart disease, cancer and emphysema. Makes it tempting to light up—and that’s the idea. Make sure you know how an investment can go wrong before investing.
8. Investment Strategies. There are about eight and one-half zillion investment strategies. The large majority of them are (a) inconsequential (i.e., they won’t give you much of an advantage, or any, in the long term), (b) expensive (i.e., they require you to buy and sell investments often, which means large transaction costs that can significantly reduce your returns), (c) bunk (i.e., stupid, also referred to as dumb), or (d) fraudulent (i.e., a way to steal your money). Are there investment strategies that will prove superior in the future? Possibly, but you’ll have a hard time separating them from (a) through (d) above. Most professional money managers do not get returns higher than the stock markets as a whole and some do worse. That’s why investing for a return around stock market averages is a rational strategy. In general, most investors should stick to a simple strategy of investing on a diversified basis for the long term. See our recent blog on why the investor who does average is likely to do well. http://blogger.uncleleosden.com/2007/06/why-average-investor-does-well.html.
Also, take a look at the Investment Guidelines in Uncle Leo's Den at www.uncleleosden.com/Step11InvGuidelines.html.
New World Hot Dog Eating Record: You've been waiting for this. www.wtop.com/?nid=456&sid=1156698.
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