A novice's guide to the stock market
By Peter Andrew
I did it. I finally did it! Last fall, very late in life for such things, I finally lost my stock market virginity. I'm now the proud owner of shares in not one but two companies. And things are going really well. I invested $3,900 back then, and my holdings are now worth $4,900. On the night after Warren Buffet sees this article -- and who could doubt he will? -- sleep may well elude him.
Cash currently king
Of course, I'm more than pleased with how my investment has grown. And you might assume that those who have deposits today in savings accounts would be green with envy. But no. Many people make an informed choice to keep their money in cash (sometimes literally, but usually in bank accounts) rather than invest it in equities, stocks and shares. By the way, although there are distinctions in the meanings of those three words, there are also large overlaps, and for our purposes today we can use them interchangeably.
In May, the State Street Center for Applied Research found that 36 percent of Americans' assets were held in cash. Extraordinarily, that was up from 26 percent in 2012, just two years earlier. And this rise -- which occurred across all age groups and wealth levels -- was in spite of the fact that, by the end of 2013, all the three main U.S. stock indices were up at least 26 percent from the start of that year. So what is it that makes so many settle for one-twentieth the return, which is common among even the most generous high-interest savings accounts? You can sum it up in a word: fear.
Risk, return and retention
This is no imagined or irrational phobia. Stock markets really can be scary. Look at the period from 2008 to 2009, and imagine you invested $10,000 in a wide range of shares at the height of the market, when the Dow Jones Industrial Average (DJIA) index was up above 14,000. Assuming your pick of shares shadowed the average, in less than two years, when the index bottomed out at 6,626, your investment would be worth less than half: $4,733. Think how pleased you'd have felt in 2009 if you'd instead kept your money in the bank: At least you'd still have your $10K, even if the yield you'd earned was derisory.
Of course, things are more complicated than that. For many, that stock market loss would have been only on paper. They'd actually be down at all only if they'd cashed in their holdings during the market slump. If they'd left them there until today, they'd be well up on the deal. At the time of writing, the DJIA stands at 16,781, meaning that $10,000 invested when it stood at about 14,000 in 2008 would be worth $11,986 -- much better than the return from a savings account.
But imagine you'd invested in 2009 at the bottom of the market, when the DJIA stood at 6,626. Your $10,000 would now be worth $25,326. Smart investors (so not I) aim, if they can afford it, to buy during market slumps, ride out lows and sell at market peaks. The first key skill -- which often involves a bit of luck -- comes in recognizing when those lows and highs have been reached. The second is in selecting the companies you invest in. Pick badly and your losses would be greater and your gains smaller than the average reflected by the DJIA. If you choose well, the opposite would be the case.
Making money in markets
If you're tempted to invest in stocks, you can do what I did, and make your choices by following tips in the financial pages of newspapers. But, as in most things, the more you know, the more successful you're likely to be -- though in this game there are no guarantees. So I'd suggest you take the following steps:
- Keep up with developments. Start to make daily visits to financial websites that cover the stock market: Businessweek, MSN Money, Fox Business, MarketWatch ... there's a long list of excellent and free sources of financial information. Many of these also provide informative articles that provide beginners with the essentials they need to get started.
- Take an investment class. There are many online courses on offer, and most offer a fantasy portfolio resource, which allows you to safely test how you'd have done if you'd actually made the investments you'd liked.
- Lay down some ground rules. It's easy to get carried away when you seem to be making mega-bucks. But those gains are often only on paper, and such periods can turn out to be pre-burst bubbles. Decide on the proportion of your wealth you're prepared to risk and stick to your limits. Borrowing to invest can be seriously disastrous.
- Consider your strategy. We've so far explored relatively safe "blue chip" stocks. But there are other sorts. So-called penny stocks tend to be cheap, and can sometimes provide dazzlingly high returns. But they also come laden with risk, and usually appeal to nature's gamblers. Choose a strategy with which you're comfortable.
The 25 percent or so I've earned over the last eight or nine months is mostly down to sheer dumb luck. I picked my companies because the risk was low, and I could afford any losses I incur. You may be able to do much -- maybe much, much -- better. In the meantime, sweet dreams, Mr. Buffet.
Peter Andrew has over 25 years of experience writing about marketing, advertising and management. He regularly covers consumer credit card topics for IndexCreditCards.com and other personal finance publications including Fox Business, TheStreet and MSN Money. He also writes frequently about mortgages and auto loans. Peter has spent extended periods living overseas, in the UK, France and Africa. He lives with his partner of 20+ years, and wastes too much of his time on cryptic crosswords.