Before you invest, take some time to understand all of your options beginning with the different types of investments and the characteristics of each. There are three basic categories of investments — cash, stocks, and bonds. All other investments represent a variation of one or more of these basic types.
Stocks
When you invest in stock, you buy ownership shares in a company — also known as equity shares. Your return on investment, or what you get back in relation to what you put in, depends on the success or failure of that company. If the company does well and makes money from the products or services it sells, you generally benefit from that success and your investment will grow. However if the company does poorly and experiences losses, you may also lose a part or all of your investment.
There are two main ways to make money with stocks:
Dividends: When publicly owned companies are profitable, they can choose to distribute some of those earnings to shareholders by paying a dividend. You can either take the dividends in cash or reinvest them to purchase more shares in the company.
Capital gains: When you sell a stock at a price higher than what you paid to buy it, you sell your shares at a profit. These profits are known as capital gains. In contrast, if you sell your stock for a lower price than you paid to buy it, you will have a capital loss.
Both dividends and capital gains depend on the success of the company — dividends as a result of the company’s earnings and capital gains based on investor demand for the stock. Demand normally reflects the prospects for the company’s future performance. Strong demand
(good for you as an owner) means that many investors want to buy the stock you own and this tends to result in an increase in the stock’s share price. On the other hand, low or negative demand (bad for you as an owner) results when more investors want to sell rather than buy the stock and your shares may be worth less than you paid for them.But demand is not the only thing that affects a stocks price. It is also affected by what’s happening in the stock market in general, which is in turn affected by the economy as a whole. For example, if interest rates go up and investors think they can make more money with something else like bonds for example, they might sell off their stock and the stock market as a whole is likely to drop in
value, which in turn may affect the value of the investments you hold. Other factors, such as political uncertainty at home or abroad, energy or weather problems, or soaring corporate profits, also influence market performance.The stock market runs in a cyclical pattern and as prices drop, at some point they will be low enough to attract investors again who believe they can make money when the market turns around. An influx of investors tends to make the market rise. Sometimes, the market moves from strength to weakness and back to strength in only a few months. Other times, this movement, which is known as a full market cycle can take years.
Remember, at the same time that the stock market is experiencing ups and downs, the bond market is fluctuating as well but usually in the opposite direction. That’s why asset allocation, or including different types of investments in your portfolio, is such an important strategy. Therefore, be sure to invest in several types of investments at the same time, so that some of your money will be in the category that’s doing well at any given time.
Up next, learn to speak the language of stocks.
P.S. Missed a segment? This info and so much more about investing can be found in my ebook Investing 101: Everything You Always Wanted to Know About Investing But Didn’t Know How to Ask, which is available in August. Visit the MYM store at www.MindingYourMoney.net/store.htm to order your copy or for more info.
Patricia Stallworth, CFP is the president of PS Worth, a financial planning and adviory firm, the founder of Wise, Wealthy Women, and the author of Minding Your Money. Visit www.psworth.com and download a free series on investing.