Welcome to the World of Stocks

The world of owning portions of good businesses; the world of being rewarded for taking risks.

To recap quickly, the last post covered keeping your money safe, lending it to banks and large companies and letting them take the risk. Not all stories are like the one I told you with a spread of 11%, but in most cases, these companies are mostly rewarded for the risk. Basically, when you decide to buy shares in companies, you are removing the middle man, taking the risk yourself and being rewarded for it. Just a reminder though, you need time on your side to make this work for you.

THE STOCK MARKET

“Whew, I’m sure happy I wasn’t invested in the stock market . . . . . I would have lost all of my money”

If I had a dollar for every time I heard that . . . .

First of all, I learned that most people who said that had NO MONEY ANYWHERE! It reminds me of one young client who had done a very good job of investing in mutual funds. The market was down about 20%, so his portfolio which had been sitting at $10,000 was now $8,000. He was a bit nervous and was told by his friends that he should get his money out before he lost it all.

Keep in mind that when you own mutual fund shares or individual shares, the market price can change from day to day, hour to hour. What can’t change is the number of shares you own. If he had 100 shares priced at $100 each and the market is down 20%, he still had 100 shares; the price is now $80 per share.

As it turned out, his “friends” had nothing saved or invested. A drop in the market didn’t affect them at all. They had ZERO and after a 20% decline, they still had ZERO. He, on the other hand, still had all his shares, currently worth $8,000. Who would you rather be? His money was long-term money and not needed any time soon. He did not cash out and his investment grew back to $10,000 and continued to grow.

I think the phrase “stock market” is a bit confusing to people. First of all, you can NOT invest your money in the stock market; you can only invest in individual stocks/shares. The stock market is the exchange where buyers and sellers meet.

Think about a “farmers market” – no one is buying a farmer. The farmers bring their produce to sell and people come to buy what they are selling. If you are familiar with the farming community, we also have “auction marts”. Where I live, the auction mart sells cattle; lots of cattle! Ranchers bring their cattle here to be sold to interested buyers.

In all markets, the price you pay and the value of the purchase is not necessarily the same. The price is largely dependent on what the seller is willing to sell for and what the buyer is willing to pay. And the more interested buyers you have, the better the chances of getting a better price for what you are selling.

The stocks/shares of any company have a VALUE that is determined by a number of things; their cash balance; their debt; their annual profit; their growth expectations, etc. Their price, on the other hand, is what someone is willing to pay for that share. If you really think about that, you’ll realize that you CAN NOT sell something if no one is willing to buy it. If you pay attention to stock prices, you will notice when certain things happen (aka “the problem de jour”), fear sets in and you will see lots of people selling off their shares (lots of sellers and not as many buyers) thereby driving the prices down. Guess what? SOMEONE is buying the shares they are selling. Who do you think that might be?

It is most likely the financial institutions, fund companies and portfolio managers who realize the bargain they are getting during these times (ie price is falling but the value is still there) OR, the RICH – the people who can afford to buy and hold on until the price recovers. My best advice here is “don’t let fear drive you – make sure you are running with the rich”. If you sell during these times, you ARE taking a loss. Hang on and let your stocks bounce back and continue to grow.

“the stock market is a device for transferring money from

the impatient to the patient”

- WARREN BUFFETT

NEXT POST – Businesses big and small – understanding what you own!