Finance at Fingertips by Moses Ayiku, Jr. MBA OP/ED
Last week, we started discussing investments. Once we have laid the foundation of our finances with sound budgets, planning, and saving, we need to go to the next step and determine the types of investment we would want to make from our savings. Savings accounts provide very little by way of return. In the U.S., the average savings account has an interest rate of 0.04%. This is according to data from the FDIC. The return is low, to say the least.
Ultimately savings accounts can be used to build up finds but they are not a way to grow one’s money at a meaningful rate. Investments in stocks for example allow a person to expose themselves to the possibility of a return on their money. It is possible to make sizeable returns on stocks.
However, take note that stocks do not guarantee a high rate of return. There is a risk in investing in stocks and it is possible for prices to fall as well as rise. Stated more clearly, one could make money in the stock market or lose money. There is always a risk.
Stocks are shareholdings in a company. When you buy the stock of a company you become a part owner of that business. While you may not own enough stock to sit on the Board of the company, you would have an opportunity to vote at Annual Shareholders meetings. The stock market brings together buyers and sellers of stocks. The market provides an option for individuals to either buy or sell stocks in the companies listed on the exchange.
When we buy stocks, we are typically trying to get a return through the following means:
a. Dividends: companies declare the portion of their net profit that should be given out to shareholders. A company may announce for example that they are giving each shareholder $1 in dividends. Assuming you had 100 shares of stock in that company, you would receive a check for $100, being your dividend payment.
b. Capital gains: Stock prices change over time. This price change provides stockholders with the potential to sell their stock at a profit. If for example, you bought stock at $10 each and after a year the stock price is $15, this means you have had a capital gain of roughly 50%. You could sell your $10 stock for $15 and have a capital gain of 15-10= $5. This represents a 50% return on investment which is quite high.
In terms of return in the long term, the average annual stock market return is about 10%. This is one key reason why many people are advised to buy stocks and hold them for a long period of time. However, take note that when we are calculating returns on investments, it is appropriate to adjust for inflation. Inflation refers to when price levels of goods and services increase.
If for example a stock provides a 10% return in a particular year, then we subtract the rate of inflation to obtain the real rate of return. With a 3% rate of inflation, then the real rate of return on that stock would be 10-3=7%.
One method of tracking the performance of stocks is to monitor the performance of the S and P 500. The S and P 500 is a collection of the 500 largest publicly traded companies in the U.S. The average performance of the companies is calculated daily and changes as the stock prices change. On average the S and P 500 increases by about 8-12 % annually.
This is perhaps one of the most important Investment Principles; do not put all your eggs in one basket. It emphasizes the point that we need to diversify our portfolio by buying stocks of firms in different industries for example. That way when one sector has a poor performance, the other stocks may have fared better and could lift your overall portfolio. An investment portfolio is simply all the stocks you own grouped together. This is a way of tracking your investments and their performance.
These days stocks are easier to buy than ever. There are various apps available on the market that can assist you in purchasing stocks. Remember, you are buying stocks for the possible return you could get, either dividends or capital gains. Apps available on the market to buy/sell stocks include RobinHood, SoFi and Stash. It is important to do your homework and research the different apps to determine which one would be best for your investment needs.
Before buying any stocks, it is important to conduct a certain level of research on the companies. Through annual reports and other SEC filings, one can learn a great deal about a company. This can assist you in deciding whether to invest in that company or not. One can learn things such as the past financial performance, the management of the business, dividend payment track record, legal battles, future financial obligations, and a host of other pieces of information.
Based on all your research the next question should be; how will this company perform in the future? Not scientific but the research can assist you in making an informed opinion. For example, if you want to invest in a food company, you may gauge that the business should do well in the future as you expect the demand for the product to grow with time, as the population increases. In other words, more and more people may end up buying that food product.
As I did last week, I will end with this note of caution; stocks do not rise every year! Typically, the S&P 500 falls three out of every 10 years. At times, the market can be quite volatile. A key step is to make sure that you understand the stock market quite well before beginning to invest. There are some pillars of knowledge that one should learn before taking the plunge to invest in stocks. Next week we shall continue our discussion on investing in the stock market.
This week we discussed one key pillar of Investing; “Do not put all your eggs in one basket.” In other words, it is safer to diversify your stock holdings than to have only one type of stock. This is a method of protecting your investment. If you diversify, a fall in one stock in your portfolio could be counteracted by a rise in other stocks in your portfolio.
Please feel free to share with me your questions and experiences on stocks and investments. I will do my best to respond, and, in some cases, I will write on some of these questions. Your questions and comments can be sent to localtalknews@gmail.com.
