Now that we know how to budget our income appropriately, it's time to start discussing what to do with the goals/money shovel piece of the budget. We have effectively handled our debts and have created some distance between us and Murphy's law with our emergency funds & necessary insurance products. It is now time to do fun stuff with money, investing it.
Side note: Murphy's law simply put, whatever can go wrong WILL go wrong.
In math terms, Murphy's law = sh*t happens.
It is very important at this stage to mention that you need to be very self aware before you do any investing. Investing, especially in paper assets can weigh on your emotions. Paper assets aren't as tangible as other investments like a business or real estate for example. All you have is a screen/paper with numbers that change at a moment's notice. Know what gets you to panic and prepare to stop yourself from panicking.
To explain what a stock also known as a share is, let's use an imaginary business as a case study.
So let's say I set up a company, let's call it aeromati solutions because goals. My company publishes books I author along with other educative material, it owns a radio station, a restaurant company and a web design firm. Now, let's say my company is valued at $100 million (to make the math simple). To represent each fractional piece of my company, I create what is called a share. For simple math, let's say I decide to create 10 million shares for my company. This means, each share/stock is worth $10.
Now say I want some extra cash to use in my business to expand. I decide I'd like to sell a piece of the equity in my business on the stock market (called an IPO, initial public offering). I decide it is okay to sell 10% of my company ($10 million worth of $10 shares = 1 million available shares)
This means, anyone can decide to buy as many of the available 1 million shares.
If you'd like, you could buy only 1 share, spending $10 to get it. You could also buy 10 shares, spending $100, 15 shares, 1000 shares, on and on etc. However, you can NEVER buy half a share. No such thing as $5 for 0.5 shares, no 1.5 shares. You either buy a full 1 share, 2, 3, 15, 100, 2000, full WHOLE numbers. That is how stocks/shares work.
Let's say my company now uses the newly acquired $10 million for more stuff. We publish two bestsellers back to back, the restaurant gets awesome reviews, and the design firm wins a large contract for a new project. wow! Business is booming! A year later, the company is now worth $200 million, your shares/stocks that you bought are now automatically worth $20 per share. At this point, you can sell your shares to get the growth of $10 per share on top of your initial investment.
Business is so good that we also made a massive profit (say $1 million) which we expect to keep happening every year. So say I decide I'd like to share this profit with my co-owners/investors. I would issue a dividend of $1 per share (because I have 1 million shares in my company). So on top of the growth of $10 per share, you have a dividend of $1 per share that you have in my company!
What if the investment doesn't work out and now the company is worth $50 million?
You would lose half of your investment reducing your stock to $5 per share because you now share the risk of ownership with me.
Even with all the movement in the value of your investments, you haven't YET lost or gained the money. Until you sell your investment, to get the real cash value of the stock, you still have the same number of stocks and own the same percentage of the company regardless of its value. You still have access to future earnings, rewards and consequences as before.
So now what?
Well that is the "intended" underlying behaviour of stocks. When you check out a stock, the share price essentially tells us what the stock market values the company at. It is not always accurate. In fact, a company's stock price is simply what we(the investors) agree to trade the stock at, irrespective of what the company is ACTUALLY doing.
What happens in real life is that people buy and sell stock willy nilly, the company may be performing very well in truth and thus the stock might be increasing. However, people might sell the stock just because investors got upset at the company behaviour, management or policy.
An example of this, TD Canada Trust posted its worst day on the market since 2009 (till March 2017) because of a news story. This also brought down the value of stocks of similar Banks (BMO, RBC, CIBC) in the process.
So why do people invest this way?
Well, compound interest is a tool that grows your wealth exponentially(a story for another day) and giving other people your money to produce better returns than you would by yourself is an effective wealth building strategy (usually said as, letting your money work for you).
So... The Market?
The stock market is the place where stocks get traded back and forth. Each country generally has it's own stock market where stocks of companies within their jurisdiction trade their stocks. The term "the market" really is a nickname for the average of the top companies in that stock market.
So say you invest in a stock market in the USA, you would beating the market if your investments on average beat the average performance of mega companies like Coca-Cola, Pepsi, Apple, Facebook, Amazon, Google(Now an Alphabet Company), Goldman Sachs, HP, MasterCard, Netflix, Verizon, Ford etc.
The stock market is a feedback loop.
When a stock starts going down and more people sell that stock, the value of that stock falls even further. When most of the stock market is trending this way, it is called a Bear Market.
When a stock is rising in value and more people buy that stock, the value rises even further as result.When most of the stock market is trending this way, it is called a Bull Market.
For now, let us stop here. See you next week.
As usual, I don't know what I don't know. If you know, please share your knowledge.