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Investing in securities What is a stock Most investors buy a stock with the idea of selling it for a profit at a later date (or, in the case of day traders, in a few
hours). The result is that common stock prices
rise and fall primarily on investor confidence about future stock prices. A share of common stock represents partial ownership of a corporation (usually a very, very small part). You can calculate the percentage of the company you own by dividing your number of shares by the total number of shares of common stock issued by the company.
There are other kinds of stock other than common; preferred, convertible, restricted, but who cares! The important thing to remember is that you are buying into a company not just swapping paper. Buy companies that you are comfortable with, are willing to hold for a long period, and not stay awake nights worrying about your investments. How you make money owning stock You can make money two ways: an investor may receive dividends and or profit from an increase in the stocks price. A dividend is a payout to the investor a share of the corporations profit. Some companies and industries have a high dividend payout, utilities and tobacco companies to name two. Some companies do not pay dividends but use all of its profits to reinvest and grow the company, or use a share of the profits to repurchase its own stock. By repurchasing its own stock a company is making its remaining publicly traded stock more valuable and increasing the percentage of ownership of the company among its stockholders. Dividends are taxed at your normal marginal rate. Share price growth is a capital gain. If a company is seen by investors as having an a bright future they will bid the price up. Stock prices follow over time the investors perception of the companies long term earning prospects. Stock prices are not fixed and fluctuates according to the laws of supply and demand. If you hold a stock longer than six months and you sell at a profit, you will receive favorable capital gains treatment. Long term capital gains are taxed at a very favorable rate.
What is a bond Bonds have been and will remain disappointing investments. Barron's Allen Ableson once remarked "What distinguishes bonds from all other investments is that they are a fool proof hedge against capital gains." Bonds represent corporate or institutional (government) debt. They are essentially IOU's . Companies can raise needed capital by selling stock ( shares of ownership) but also by selling IOU's. Long term IOU's are called bonds short term IOU's are called paper , notes. The issuing party promises to repay these instruments, with interest, by a certain time. Bonds are seen as less risky than stocks because they pay interest and at a pre determined date promise to return the face value of a bond. Less risk for investors does not mean no risk — the possibility that an issuing company will be unable to meet its payments to bondholders always exists. To assist investors in assessing the risk of default — or not being paid back — several independent agencies list debt ratings for various companies and their bonds. The lower the rating, the riskier the bond — and the riskier the bond, the higher the yield tends to be to investors. Bond yield can be stated as current yield or yield to maturity. Current yield - This is the yield you will see in the newspaper. This is the dividend rate adjusted for the current price of the bond. Yield to maturity - factors in the gain or loss you will receive when the bond matures and you are paid the face value of the bond adjusted for the amount of time remaining on the bond. The value of bonds is largely dependent upon the market level of interest rates. As interest rates rise the face value of the bonds fall. This is necessary in order to increase the relative bond yield to competitive market levels. If interest rates, fall the face value of the bonds rises as the income stream the bond represents becomes more valuable. There are pocket calculators that readily adjust price and yield of a bond under different scenarios. My personal favorite is the Hewlett Packard model 12C. Bonds are usually issued for periods of ten to forty years. In general the longer the term of the bond the higher the interest rate should be to reward the holder for the increased time risk. Risk is measured by commercial rating services that issue a risk rating of AAA which is the highest rating issued to the most credit worthy borrowers. The lowest rated borrowers are given a D. these companies are in default on their financial obligations and/or in bankruptcy with debt service in jeopardy. Investors should avoid bonds where the issuer has the right to call the bonds on a basis favorable to the issuer. This stacks the deck in the favor of the issuer and deprives the investor of possible market rate gains associated with the risk they have taken.. The investor commits for a twenty to forty year period and accepts the risks (company and market) and if the market turns in the investors favor the investor the issuer simply buys the bonds back at a small premium. Bonds with an unattractive call feature sell at virtually the same yield as bonds that do not have this feature.
What is a mutual fund Mutual funds are pools of money that are invested is the various markets. the
Funds are professionally managed by a
portfolio manager or a management team. Purchasing shares of a mutual fund
can be an excellent savings vehicle for beginning investors. Many funds
allow you to invest with as little as fifty dollars with a automatic investment
plan. Mutual funds are traded much like
stocks and closed-end funds are even traded on the major exchanges. Mutual
funds can be good for the beginning investor because they can provide instant
diversification among many stocks and industries that the beginning investor may
not be able to afford. There are additional expenses associated with
funds, load, fees, and often commissions on top of the fees. Because there
are more funds than stocks on the New York Exchange, there is a lot of different
types with various investment goals i.e. growth, income, International, bond,
and even real estate funds some even further divided between mortgage
participation, and asset participation. I am not overly enthusiastic about
mutual funds comprising the majority of an experienced and knowledgeable
investor, because I do not like to turn my investment decisions
over to others. This is not to say that I do not invest in funds. I
find them very useful for diversification. I also find funds especially useful to invest in industry specific funds where I can invest in say
for example bio-technology or the communication industry, and let the managers who follow the
industry make the specific stock purchases while I trade the industry.
Remember that one of the most important strategic decisions investors need to
make is to be in the right industry at
the right time, and with funds I can diversify the company specific risk from
the industry risk for a small fee to the fund. Following mutual fund purchases and sales is a useful source of information to gain insight as to where professional fund managers (the smart money) are placing their money. What industries and specific companies are the successful managers buying and selling. The funds are now so large that their purchases and sales can have major impact on individual stocks and markets in general. Much information can be gained from financial newspapers and from popular web sites such as Morningstar and Microsoft Investor. The following table gives an average return for the major averages for the past seventy years
The most important advice I can give an investor here is: Think for yourself. Learn, research and invest . Do not let anyone sell you something, learn to make your own decisions. Set realistic goals. Get started NOW.
How to Make Money in Stocks - William J. O'Neil Intelligent Investor - Benjamin Graham
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