BASICS OF INVESTING AND THE STOCK MARKET

Saving and Investing: Financial System- allows the transfer of money b/t savers and borrowers Financial Intermediaries- institutions that help channel funds from savers to borrowers; they are b/t savers and investors ex: banks, credit unions, finance companies, etc.

3 advantages to financial interm: 1. sharing risk- diversification allows you to spread out investments to reduce risk 2. providing information- they collect info about borrowers; this is passed on to investors which encourages us to invest our money in those companies 3. providing liquidity- ease with which people can convert assets into cash

What do I look for? Liquidity- the ease with which savings or investments can be turned into cash Risk- the chance of losing some or all of the money invested. Return- earnings from an investment Remember: risk = rate of return

Investment Options: Savings Accounts- provides a small but steady return; offered at any financial institution Certificates of Deposit- like a savings account, but it pays a slightly higher return; the trade off is that it is less liquid -available at any financial institution also Real Estate- less liquid and comes with risk of being a landlord, however, the values tend to appreciate and provides a steady cash flow

Stock- Provides the greatest return to investors; long run investment Bonds- IOUs or long-term loans to the issuer who promises to pay you a specified rate of interest during the life of the bond and to repay the original loan when it matures; less risky than stock **Mutual Funds- a pool of stocks and/ or bonds in which the investor owns many shares instead of just one company

Compound Interest It is interest that is paid on your original investment and the interest earned Don’t withdraw the interest earned along the way- this stunts the growth of your earnings It is money that your money makes for you that you didn’t have to work for The Rule: pay yourself first! spend less, use credit wisely, and search for the best options among financial institutions

What is the Stock Market? The exchanging between buyers and sellers of stocks and bonds which is done by stockbrokers (defn) It isn’t necessarily a physical location, but a set of arrangements and transactions that make it possible for stocks to be traded Includes all forms of investment, not just stocks of companies It is composed of several different exchanges: NYSE, AMEX, and NASDAQ

New York Stock Exchange Oldest, has about 2,800 listings No small corporations, only large volume Includes some major indexes used to measure the activity of the stock market as a whole such as the Dow Jones Industrial Average and the Standard & Poors 500

American Stock Exchange NASDAQ Not a physical location but an electronic network Over 3,700 listings most technology-based companies are traded here The US mkt for Over the Counter trading The companies listed here are smaller than those on the NYSE Lists about 800 companies

Measuring Stock Performance: Bull and Bear Markets: bulls are mkts that are rising and bears are mkts that are declining DJIA- an average composed of 30 stocks that are representative of the whole mkt and reported in points, not dollars S&P 500- stock prices of 500 companies in leading industries; considered the most accurate reflection of US stock market

What is a stock? A piece of ownership in a corporation; aka equity Advantages to stock ownership: investment opportunity to make money, some pay dividends (defn), has the potential to grow at a higher rate of return than other forms of investment Disadvantages of stock ownership: Very risky, no guarantees

Bonds: Issued by the government and/ or corporations for investment purposes Government bonds are the safest form of investment and not taxable by state or local governments/ used to finance the national debt Corporate bonds are somewhat riskier than government bonds but still safer than stock, and the rate of return is higher than on government bonds Pays interest to investors at set intervals

Mutual Funds: More Americans invest through mutual funds than any other method Some are just bonds, just stock, or combinations of both Factors to consider: performance, cost, convenience Advantages- professional management, diversification, liquidity, and investment objective

How do I buy or sell? Brokers- professional managers who give expert advice and facilitate the exchanges between sellers and buyers; they are usually paid either a commission or a fee - commission is a percentage of the total transaction - fee is paid for services of a financial advisor to minimize your risks and maximize your profits; this is paid regardless of making a profit or loss

Banks- many banks offer investment services, such as Trustmark Internet- it is very easy and cost efficient to do it yourself online; helpful sites include ETRADE.com, TDAMERITRADE.com, and fidelity.com

Researching Companies: Select a few to research Monitor their progress/ review their history Don’t just look for “good” companies, but ones that may generate surprises, however, surprises are very difficult to predict (you are looking for potential) Review their financial information- look for changes in sales, changes in earnings, demand for their goods or services, get recommendations from professionals Positive or negative publicity

Helpful Websites: www.marketwatch.com www.bloomberg.com www.hoovers.com www.finance.yahoo.com www.nyse.com www.amex.com www.nasdaq.com www.schwab.com www.cnnmoney.com

Stock-selection Criteria: Share price- determined by supply/ demand of stock and profits of company Price/ earnings ratio- the recent stock price divided by 12 months of earnings per share; it measures how much the investor will pay for a dollar of earnings or profits high P/E = young, fast-growing company that may be more risky low P/E= less risky, more stable company

Annual revenue or sales- this reflects how well the company may be doing; rising sales/ revenue means profits are increasing, therefore, stocks will be more valuable (demand will increase pushing up the stock price) Earnings per share- this measures how a company’s profits compare to the number of shares; rising earnings per share suggests that a company is well managed

What determines stock prices? Supply/demand Law of Demand- at lower prices, people choose to buy more and vice versa Law of Supply- at higher prices, people choose to produce more and vice versa As the company becomes more profitable, people will purchase more stock which will drive its price upward. As the price goes up, the incentive to sell stock will increase. If the stock is available in excess, then the price will come back down. As it falls, people will be motivated to buy more.

Expectations are Everything Demand: people buy stock when their expectations for a company are positive because they believe the share price will increase and they may see an improved dividend payment Supply: people sell stock if they have negative expectations for a company’s future because they fear stock prices will drop, dividends will decrease, and they don’t want to miss a better opportunity to purchase other stocks

Expectations can cause a huge upset in the Stock Market!!

Stock Market Summary (2007): From 1926 to 2003 there was a 72% chance that the year experienced a positive stock market growth and a 28% negative chance Out of the 72%: 40% was at a growth rate of 20% or more Out of the 28%: 16.7% was between 0 and -10 In other words, when it was positive, it was really positive; when it was negative, it was a small loss and not the huge losses most people associate with the stock market Over the last 80 years, the market has averaged a growth of 12% including losses as well as gains

How are things now? The Dow has been making new records hitting over 14000 points recently (Oct 07) The S & P 500 has also been making gains The economy has been growing, but it is slowing and inflation remains in check Analysts believe we are due for a negative year soon (2008 or 2009) but this is where having a balanced mutual fund is attractive-when the stocks go down, the bonds tend to go up washing the losses

Suggested Readings: Start Late, Finish Rich by David Bach Wall Street Journal’s -Understanding Markets -Understanding Stocks -Understanding Bonds Dave Ramsey’s materials are oriented more for getting out of debt rather than building wealth