Investments 101: Stocks
Now that we have touched on the foundation of investments namely; COMPUND INTEREST, INFLATION and TIME, I hope that you have a better understanding of why it’s so important to start investing. Today we will have a brief look at some investment options and over the next few weeks I am going to tackle one investment vehicle / opportunity at a time. The reason for this is not to overwhelm you with too much information in one very long post that 99% of people will not ever bother to read (let’s be honest), but also to highlight each option on its own for what it is. I like to call this investments 101, so you can get a very broad overview of investing and hopefully start to understand how things work.
Please keep in mind that the posts over the next few weeks are going to give you the basics of each investment vehicle, and in later posts I will take each investment vehicle and describe it in more detail. But for now we just want to get everyone comfortable with the different options.
I found that I didn’t really appreciate wine as much as I do now, until I helped out with a harvest at Rust en Vrede Wine Estate in Stellenbosch a few years ago. After going through the harvest process, not only did I appreciate the wine, but I also understood it far better and appreciated the development process of coming out with such an amazing end product. So I am hoping that these next few posts, will begin to bring everything together for you and give you much more confidence when approaching investments and selecting the right investment vehicle.
Let’s start from the top of the investment spectrum and work our way down.
The first place to start off would be the stock market or as we know it in South Africa as the JSE (Johannesburg Stock Exchange). This investment option is not for the faint hearted, and in my opinion has the highest risk when it comes to investing. This market is intimidating, but hopefully once we walk through the information, it won’t be too difficult to understand.
What are stocks/ shares?
Shares on the stock market are literally buying a share of ownership in a specific company… It’s as simple as that. The reason why somebody would want to buy shares in a company, is so that they will be entitled to ownership of the assets in the company and possible earnings or income that might arise within the company if the company makes a profit. The assets of the company are everything that the company owns and the earnings are the income that comes in from selling services or products of the company, the profits of the company.
So I am guessing that your next question is why would companies want to share their assets and income with the public like you and I?
The answer is that every company needs money to get the business up and running or to grow bigger. A company has mainly two ways that it can generate capital to cover start-up costs or expand.
Number 1 is to borrow money from banks or other channels, or number 2 is to sell stocks or shares of the company to the public. The disadvantage of borrowing money is that they would have to pay interest on the borrowed money and this can sometimes not make it worthwhile. But if the company sells stocks to the public, there is less strings attached to the funds that are generated for the company. There is no interest that needs to be paid and the company is not even obligated to ever pay the money back to the stock holder. The other advantage of selling stocks, is to distribute the risk of the company over many stock holders /shareholders, so if the company goes under the founders don’t lose all of their money, but rather split the risk over many people’s money.
The reason why this can be a very risky exercise, is because not many people have hundreds of thousands of rands on hand to play the stock markets and get the proper diversification that you would need in an investment portfolio. So what you land up doing is buying a bunch of stocks, but they are all in one company and the problem with that is if that company doesn’t do well, your stocks can lose great value.
Warren Buffet once said: “unless you can watch your stock holding decline by 50% without becoming panic stricken, you should not be in the stock market”.
So if you don’t have the risk appetite for the buying of stocks and the stock price fluctuating on a daily basis, the next best thing for you is to invest into UNIT TRUST.
What are unit trusts? This you will have to wait to read all about in the next post.
But for now, I hope that this helps you to understand the stock market a little better!
I might also add, that if you don’t feel comfortable with any of this, and it’s just not something you would not like to get involved in by yourself, then approach a CERTIFIED FINANCIAL PLANNER® (make sure he/she has the CFP® professional designation) to assist you with making the right choices. However please do take the time to get the basics under your belt, so that you can be part of the process when making the decision where your hard earned money goes.
Let me know if you have any questions, by sending me an email or writing in the comment box below.
August 18, 2014
Grant van Zyl