This is the fifth post in our Retirement Investing 101 series written by Amanda Smith, Client Services Specialist at CESI. Check out Part 1 or continue on to Part 6.
Investing. Some people feel excited by this word while others fear it. Investing can be very confusing, especially for those who have no idea what a stock or bond is and why they should buy these things. Honestly, it took me awhile to have investing down and truly understand how exciting it can be. But then again, I like to gamble, which basically is what investing is. You are gambling your money in hopes of getting more money back when you need it. So let me explain investing, starting with the basics – stocks, bonds, and mutual funds. (We’ll only cover stocks in this post, but we’ll get to bonds and mutual funds next.)
Stocks are part ownership of a company. Yes, if you purchase just one share of stock in a company, you are part owner of that company. Why would a company allow Joe Schmo to own part of the company without working there? That is a great question. Companies need a lot of money to run operations and produce materials or provide a service. To maintain these costs, companies need to raise money. Therefore, they go public by selling portions of the business, allowing for ordinary people to invest in the company’s success.
Here’s an example. Disney has a lot of overhead costs and is constantly expanding with new products and/or experiences. (Did you know they bought the rights to Star Wars? I wonder what would happen if Snow White met Darth Vader? Would she ask him to whistle while he works on getting Luke to join the dark side? Can Darth Vader actually whistle? But I digress…It’s hard to keep the nerdy girl at bay when thinking Star Wars!) Anyway, to cover these expenditures, Disney has given the public the opportunity to be a part of the Star Wars experience. No, you won’t get to use a lightsaber but you will have a part in financing the production by purchasing Disney stock. So how do you make money investing in stocks? Here’s an example. Don’t worry, I’ll do the math for you and keep it easy.
Disney share price: $50
You have $1000 to purchase shares of the company stock.
$1000 ÷ $50 = 20 shares of Disney stock
You now own 20 shares of Disney stock and/or the company (only hypothetically, don’t get too excited).
Twenty shares won’t give you a seat as CEO but those 20 shares can be a big deal. Here’s why: Ten years from now you’re ready to sell your Disney stock. The stock price at the time of sale is $99.
$99 x 20 shares = $1,920
That means you’ve gained $920 for doing absolutely nothing.
Obviously, the more shares of stock you own, the more money you’ll make. Additionally, the higher the price of the stock when you sell, the more you’ll gain.
What drives the stock price up? More people buying the stock as people sell the stock at higher prices. The price of stock fluctuates up and down. Therefore, the reverse can also be true – let’s see an example of that, using the same example of 20 shares of Disney:
Suppose the stock price at the time you decide to sell your shares has dropped to $40.
$40 x 20 shares = $800
You have lost $200 from the purchase of the Disney stock.
As you can see, investing in stocks is a gamble. You have no way of knowing if the price will go up or down but the potential to make money is great, especially over time. The stock market is unpredictable, but doing research about the company and reviewing the company’s financial history can sometimes provide you with an indication of whether a company will be a good investment.
Historically, people make more money purchasing stocks than saving money in a savings account. While investing in stocks can be risky, the earnings potential makes this a valid savings vehicle. When investing in stocks, it is best to purchase stocks from different companies in different fields rather than purchase too many shares of only one company in the event the stock price goes down.
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