Today we are talking stocks, what they are, their benefits, their risks, and how you can invest in them. Stocks are also called shares or equities. When you own a stock, you are an owner. Yes, if you own one share of Amazon stock, you are an Amazon company owner. All owners participate in is sharing the profits. When a company like Amazon earns a profit, they may retain or keep some of that money to make improvements like buying new equipment or expanding operations. Or they may share some of profits with the owners by issuing dividends. Some companies may keep all the profits. And some regularly return profits to owners through dividends. That’s cash back, usually four times a year. The hope is that the overall value of the company grows and as an owner you own a share of that value. The value of your share has literally gone up, even if you don't receive dividends.
Unfortunately, even when a company keeps it’s profits to improve operations, it doesn’t always go up in value. In fact, it’s common for stock values to go up and down, sometimes a lot. And sometimes a company’s stock price never fully recover from a big drop. It may be because the company made poor choices or the overall economy of the country caused the problems. and it could go belly up.
Overall stocks in the US have averaged an annual return (that is the profit stock owners make) of 10% a year over the last 100 years. The risks are that stock prices go up and down like a roller coaster. And you might have to sell a stock for less than you paid for it.
The best way to minimize risks is to diversify by buying shares in many companies, including those in different lines of business. There are three ways of doing this with limited cash. Fractional shares, mutual funds, and exchange traded funds (ETF). Fractional shares, also called share slices, are just what they sound like. You work through a broker dealer like Charles Schwab, Fidelity, or Betterment and you can buy partial shares, or tiny slices of many different stocks. A basket with many different stocks is called a diversified portfolio. With share slices you can choose your stocks and build a diversified portfolio with less than $100.
You have plenty of things to do other than research hundreds of companies to try to build your own special portfolio? Me too. That brings us to mutual funds and ETFs. With both of these, they pool your money with many, many other people’s. The fund then goes and buys lots of stock in many different companies. These funds do the research and all the buying and selling for you, and will send you your share of any dividends or reinvest that money for you in the fund.
The value of a mutual fund goes up and down based on the value of all the company stock it bought with the pooled money. When you want to take money out of the mutual fund, you get the money from the fund based on the overall fund value at the end of the day. You can invest in a mutual fund directly with a fund like Vanguard. Or buy mutual fund shares from a broker dealer. Exchange traded funds also pool investor money and operate a lot like mutual funds, but ETF shares are traded on the stock exchange, so ETF prices fluctuate during the day based on supply and demand. The funds still can’t guarantee a certain returnor that you won’t lose money, but the risk is much lower than buying stock in just one company.
What if you have to sell when prices are down? The stock market can provide a very good return on your money over time. It is a good place to invest money you don't need for at least five years. For short term goals a savings account is a safer place save. Check out podcast Episode 39 Stash the Cash for more. For mid term goals or goals that will start soon but continue for a long time (like an upcoming retirement) a mix of stocks and bonds may be a good choice. Next week we’ll talk all about bonds, so stay tuned.
