Early on, we covered the need for insurance and emergency funds before investing. A brief history of the stock market and the role your broker plays when you buy or sell set the stage for our various investment choices. Nearly everything roots back to stocks so it’s here we begin.
Stocks by themselves are far too risky. It’s so easy to diversify your portfolio with mutual funds and ETFs that we should only buy individual stock under special circumstances and in limited quantities.
Buying stock means you’re buying a piece of a company. The stock price is determined by supply and demand. If there is demand for shares, the price will go up. If sellers start dumping shares and there aren’t enough buyers, the stock price will fall.
The number of shares issued during the IPO is basically what trades every day. If you take that number and multiply it by the price per share, you get that companies’ total market capitalization. In the future, we’ll talk about large cap, medium and small cap stocks. It’s simply a fancy way to describe big, medium or small companies.
The price of a stock is based on future earnings expectations. If a company is coming out with new products that are big sellers, their stock price should be on the rise. If a company makes replacement parts for 8 track players well…you know.
Comparing a companies stock price to its earnings gives us a P/E ratio. Don’t be overly concerned with the math but the lower the P/E ratio, the better. It’s a good way to compare companies in similar industries. It wouldn’t make sense to compare a computer maker to a restaurant chain. The P/E ratio is only for companies with earnings. If a company loses money every year, they won’t have one.
Last month, we established a starting point which included insurance and emergency funds before investing. Excessive debt should also be eliminated.
Monthly payments feel like you’re running in sand. Nearly impossible to get ahead of them, no? Assuming you can stay current on all payments, consider this easy way out. Arrange your debts by size. Focus on the debt with the smallest balance, pay more than the minimum due and pay it off first. Next, use the money used to pay on that loan and apply it to the next smallest balance and work your way up. If possible, stop buying on credit. Consider how much more you could buy if you didn’t have to pay the interest charges. That’s enough math for one day.
When you pay anything above your normal payments on a loan, clarify if you’re making extra payments or paying down the balance. The lender will lean towards counting it as extra payments. Your loan should pay off faster if you apply it to the balance.
So, what are stocks and where do they come from? Imagine the following scenario: Joe and Mary make the best widgets in the world. Demand is strong but they can only make them so fast. They need to expand production but have already exhausted their life savings to get this far. They are willing to sell a portion of their company to raise funds so they can grow. Fast forward past all the regulatory crap (you’re welcome) and investment banks will bring their company public with an IPO or Initial Public Offering
Normally, investment bankers reserve the shares for their biggest customers. When those customers sell them, they are sold on a secondary market like the NYSE or Nasdaq. That’s where we can buy them.
The New York Stock Exchange was founded in 1792. Regional exchanges opened later and in 1971 Nasdaq opened. What does this mean? When we buy or sell securities, we place an order through our broker and they present that order to the market. It’s an efficient ongoing auction driven by supply and demand.
Next up, stock.
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This is the first in a series to discuss money: How to make, save, invest, whatever. Many times we’ll merely scratch the surface of a topic and that’s OK. Feel free to dig deeper on your own. No topic is off the table and I’ll try to answer questions as they come. I’ve seen people make the same avoidable mistakes over and over. My aim is to break that cycle.
I have no intention of offering advice. Rather, I hope to introduce some ideas and mindsets to help build and maximize your nest egg for retirement. My first finance professor at UCF used to say “Money isn’t everything but it’s way ahead of anything else in second place”. While this might be disturbing on several levels, it makes a point. Money makes life easier (and sometimes more complicated). Either way, let’s get started.
Before investing, most planners will tell you that we should all have life insurance and three months’ salary saved for emergency purposes. Anything less assumes some risk and that becomes a personal decision based on your own risk tolerance and personal situation. The younger you are, the more important this next part is…invest in your future by contributing to a 401k plan at work or IRA. Check with your tax preparer for eligibility. It takes a lot of discipline but pay yourself first. Thank me later.
Final thought, when going to the beach, protect your valuables. Manage your keys, money and jewelry. The people with metal detectors scanning beach are not looking for stuff they lost. They’re looking for stuff we lost.
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