Never forget these two axioms:
Money frees us, but its pursuit may enslave us.
It’s not about how much you have at the end; it’s how much you could have made.
ASSET CLASSES
OK! Now we will leave all the argy-bargy philosophical talk behind and start the nuts and bolts discussion of investing to preserve and grow your money.
First, some lingo…
In the good ol’ US of America, any kind of tradable financial asset is known as a security.
Securities are broadly grouped into the following:
Equity securities or equities (e.g., common stocks, mutual funds, exchange traded funds)
Debt securities (e.g., banknotes, bonds, and debentures)
Derivatives (e.g., forwards, futures, options and swaps)
Equities are what you’re most likely familiar with—stocks and mutual funds +/- exchange trade funds (ETFs).
You’re possibly familiar with bonds. But, banknotes may make you frown in puzzlement whereas the mere mention of debentures makes you squint in frustration.
And then we get to the wonderful world of derivatives….where the less said, the better for now.
Much, much more on all of this in a later post.
Stocks
Mutual Funds/ETFs
Bonds
These are your three basic building blocks—this is the backbone of your investment portfolio/mechanism of your retirement/conduit through which The Plan is executed.
Yes, you may buy a fast food franchise, commodities, do puts and calls and the obscenely named naked straddle option (much more on all of these and much more in future posts), but the above is the foundation—if not the entire sum of your investment portfolio.
Master these three and you will retire on Easy Street.
So let’s try to understand them better.
STOCKS:
You hear about them all the time in one form or another including DJIA, NYSE, NASDAQ, “the market”, blue chips, and foreign “markets”.
Let’s start with the basics of stocks and then build upward.
Owning stock means that you are actually an owner (possibly owning an infinitesimal amount) of the company you have decided to buy into. You can walk around the mall, stroll by an Apple store, and point to it exclaiming “Yeah, I own a piece of that.” and you’d be a 100% correct.
Like many people I know from school and even work today: Stupid, but definitely still technically correct.
Companies issues tiny pieces of themselves (called shares or stock) for sale in order to raise money which they will employ in order to expand operations (e.g., build factories, expand a work force, etc.) which will then (hopefully) make them far more profitable which will then make the stock price of the company higher.
Easy peasy lemon squeezy.
Companies however will not put up 100% of themselves for sale or some billionaire can suddenly own a majority of that company. In addition, with how much a company can be valued, millions or even billions of shares are offered for sale for any interested party (mutual funds, hedge funds, college endowment funds, etc. [known as institutional investors] or what are known as retail investors—guys and gals like you, me, and the guy in the tree—OK, not so much, the tree guy, but you and me anyway) to buy.
Let’s stick with Apple as an ongoing example through the stock section here.
Apple has issued a total of 5.13 billion shares for purchase. So…when you see someone walking through the mall and is humble bragging that they own a piece of Apple…well, they’re an idiot.
You could own 1,000 shares of Apple (approximately $174,000 currently—Woo hoo!! Now we’re talking real money; those of you scrambling to figure out when this written need not worry; it’s Thanksgiving Day 2017—yes, I care about you unknown people so much that I’m writing posts on Turkey Day as my wife cooks—she’s a saint!) and not even own one millionth of the company. (This shouldn’t make you feel small or insignificant [I mean…hey, $174,000 is nothing to sneeze at no matter who you are; if you think so, that’s a you problem, not a “that’s just not much money” problem], but rather give you an appreciation of how massive some of these companies are.)
Companies often want more stock issued for a variety of reasons (often because the shares are so highly priced that the company is concerned that mob psychology is inhibiting the buying and selling of shares thus causing the stock to plateau and not budge any further upward), so do to that but not give up the entirety of the company, they “split the stock” to issue more shares without giving up more of the company.
For example, if Company X is at $100/share and the company decides to “split the stock” in order to issue more shares, then the company must decide what the split will be. In other words, how many total shares do they want floating out in the world (known as “outstanding shares”)/what price are they shooting for to make it attractive to be bought and move the stock price with upward pressure of massive buying alone?
So, in what is known as a 2:1 stock split, in the $100 stock example above, if you owe 100 shares (total value=$10,000), then the stock goes from $100 to $50.
Dr. Scared: What?!?! I just got ripped off!! Isn’t this illegal?? For the love of all that is holy, somebody do something!
But then your shares are increased by 2:1 thus you would now have 200 shares at $50 each (new total value still=$10,000)
Dr. Scared: Oh, well. Why didn’t you just say that in the first place? Scare a guy, why don’t you?
Companies can split it in any way they so desire.
Apple and Netflix each split their stocks 7:1!
Companies can even do more exotic splits if they only want a slight increase in their outstanding shares such as 3:2 or 5:4 splits.
Sarcastic Reader (now and forever to be known as SR): Uuh…No one said they’d be math on this blog.
The key is to always to understand that the price of the stock goes down as much as the number of outstanding shares go up with your total value and the company’s total value not changing one cent.
There also is the dreaded “reverse split” which always signal a major (usually) company in major (always) trouble. This practice occurs when a company has fallen into such major financial trouble that their stock is in the < $1 range or is threatening to do so (not always, but often something like this) and they want to increase the price while consequently decreasing the number of outstanding shares.
So, a company with a stock with $1 dollar shares may undergo a 1:10 reverse split meaning that afterward, the stock will be $10/share with one tenth of the outstanding shares as before the reverse split. Realize even successful companies like Priceline (1:15), Citibank (1:10), and Nestle (1:10 multiple times, more on them later*) have done reverse splits over the years.
Realize that as an owner of a company’s stock (also known as a shareholder) has all of the rights and responsibilities as any owner of the company.
If your company gets acquired for a huge amount by an even larger company, congratulations!, you’ve made a nice bundle of money (proportionately of course).
If it goes bankrupt instead, congratulations again!, you’ve lost all of your money!!
Believe it or not, as a shareholder of even one measly share (come on, man, seriously, one share, that’s no way to live), you will get invited to the annual shareholders’ meeting in such exotic places like Omaha, Nebraska or Fort Worth, Texas or wherever the company is headquartered and are asked to vote on all company issues that are left to shareholders. (
Realize that many regular Joe investors like you and me—i.e., retail investors—never vote and, if so inclined, the company’s board of directors recommends voting in a certain way. This can all be done by mail rather than attending the meeting where the vote actually takes place/is counted. Also realize, this is not the time or place to be a contrarian or “stick it to the Man” as in this case, you are “the Man”. Say whatever else you want about the company’s board of directors, but they have the best interest of the company in mind and your interests align with theirs unless you have some bizarre revenge plot enacted against yourself. Ultimately, if you don’t have an understanding of the issue at hand, either vote as the board recommends or simply don’t vote at all.)
This also holds true for the absolutely wonderful feature of dividends.
Some blessed companies (very mature companies with excellently consistent earnings and seemingly little competition) reward you as a shareholder by paying you every quarter (i.e., every three months—usually), monthly (far less common), biannual (really rare), or even annually (rarer than Martin Landau Pez dispensers—thanks a lot, stupid Nestle!*). These payments, known as dividends, are paid by number of cents or dollars per share you own.
Therefore, let’s consider Apple again. Apple is paying 63 cents per share per quarter. If you own 100 shares, then Apple cuts you a check for $63 every three months just for being an owner and will continue to do so until one of four things happen that will influence the dividend being paid out to you.
1.) Apple (in this case, but it could be any company obviously) decides to raise the dividend to their shareholders (Yay!!) because business is going so great.
2.) Apple decides to decrease the dividend to their shareholders (Booo!) because business isn’t going so great or they need more money for product development
SR: Yeah, instead of iPhone 96, make something new, damn it!!
3.) Apple decides to cancel the dividend to their shareholders (Major booo!!) because business is brutal right now…or they’re just being pricks.
4.) Apple goes bankrupt. (Don’t laugh. There were rumors of this as late as 2002 when Apple stock was selling at [AKA trading for] $8 a share—yes, $8/share. Three months earlier, the iPod had come out in October 2001. Five years later, the iPhone came out and…well, the rest is/was history.)
(Much much more on dividend investing, dividend taxes, etc. on a later post.)
About companies (i.e., stocks), you never know. You think you may know, but you never really know, especially in the long term.
The one single thing to remember about stocks is simply this:
Think of companies and not stocks.
Think of the company, what it does, is what it’s doing important or useful, are you familiar with their area of business or is anyone you know familiar with it to give you insights, who are its competitors, and then do a SWOT (Strength, Weaknesses, Opportunities, and Threats) analysis on it. Then and only then, you have at least the start of a good understanding of said company.
Never ever think of it as a stock alone that is “hot” or that everyone is talking about. Think of the actual company and your error rate will be greatly reduced (but never eliminated).
Future posts will discuss how to better evaluate individual stocks, how to actually buy stock, how to build a stock portfolio, and much more.
I think that’s enough for one day/one post for all of us.
I’d love to hear from any and all of you about your thoughts, so we can all learn from one another.
Talk to you soon.
*Nestle has been paying dividends since 1873 and annually since at least 1959 with few exceptions. Despite my earlier whining, it’s a fantastic company that has its fingers on many, many things. It’s not just a candy company any more. Seven of the top ten bestselling bottled waters in the US is owned by Nestle. Goes down nice with their candy making for a nice fat (pun intended) dividend each spring.