With investing, as with almost everything else in financial planning, there is a tendency to get to tactics before the strategic questions are clear. If you are young and find yourself with a little extra money at the end of the school year, what should you do with it.
- Buy Stock in a marijuana producer?
- Buy an index fund?
- Buy 10 shares of 10 companies?
- Keep it in a savings account and earn nothing?
Questions to know the answers:
- When do you want the money back?
Not sure. Probably would need some of it in September, but if I get a good job for the summer, maybe not.
- What is the purpose of the investment? Income or appreciation?
I would like it to get worth a lot more in 90 days. I have heard the stock market makes 10%.
- How much does it cost to do two trades, or in the case of the 10 stocks idea, twenty trades. Have to buy and sell both.
Not much. I checked. Less than $10 each.
- How would you feel if you lost 25% of the money in the next 90 days?
That would be awful, but that has only happened in 1929. (Showed him a graph of how the market works really.) Surprising.
- You know that buying 10 stocks almost guarantees some of them will lose?
I would only buy ones I thought would go up. 🙂
Where to start so this makes sense and is actionable?
There are always two values for a stock. The real value and what the market says it’s worth.
The market assigns value at a point in time by an auction. People on both sides of the deal.
When you buy a stock you no longer have money. You have the stock and probably you can sell it someone, some other day. For how much is unknown. Some people buy paintings, antiques and rare books on the same conditions. They might be able to sell them when they need the money. The stock market at least, is more available and has more participants. No one knows the future price because that depends on how the other participants are feeling that day.
Sometimes when you want to sell, all of the other buyers are cranky and won’t give you much for your stock. Other times they are euphoric and will pay whatever you ask. You cannot know ahead of time which will appear.
The stock market assigns prices, but has little to do with the value of the underlying business. That depends on people and if you must have the money for you stock, you must deal with whoever is available and how they feel that day.
The fundamental value of a business is strangely easier to determine, even though it looks harder than music theory.
A stock is ownership of a business. Its intrinsic value depends on its future and the many things that affect that. Most of them are objective. You must have at least a hint of how the business behaves.
- Is to growing market share?
- Is the industry growing or shrinking?
- Does it make net cash flow now or will it soon?
- What debt has it incurred and how well can it deal with it?
- How talented and stable is its management?
- How strong are its competitors?
- Can it control its own prices for its products?
- How is it affected by the economic and political environment? Taxes particularly.
Eventually you ask yourself a question. “What would I have to believe to make this my best choice for my money for X months?”
Usually people answer in several ways.
- This is the only stock I have looked at, but a taxi driver told me it was a good one. I have heard its name before.
- I know something about this industry and I have looked at the five largest companies in the business and three of the newer entrants. I think this one has the best prospects.
- I use their products and they are well made, well supported and priced well. I looked at their financial statements and they are growing and making cash flow.
- I don’t know anything, but I am afraid. I think I will by gold coins.
And all places in between.
Buying investments is like buying a computer. You cannot know which one to buy and what price to pay until you know what you want it to do for you. Amazon buys computers based upon different factors than I do. Both are computers but theirs won’t work for me within my budget and mine won’t work for them.
Know what the investment must do and know when it must do it. Investing is purposeful and time sensitive and those two conditions will limit what is available for you to buy. If you would suffer from the loss of capital, time becomes more crucial.
Everything is context. Own investments whose behaviors that your needs.
For the speculator types, who need success in the short run remember this.
The long run only matters if you are there for the whole time. It does not matter how the long term works if you cannot survive the short term.
Don Shaughnessy arranges life insurance for people who understand the value of a life insured estate. He can be reached at The Protectors Group, a large insurance, employee benefits, and investment agency in Peterborough, Ontario. In previous careers, he has been a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business.
Please be in touch if I can help you. firstname.lastname@example.org 866-285-7772