Library of Smart Investments: The Stock Drawer, Riding the Investment Waves: Picking A Stock, Choosing a Mutual Fund
Historically stocks have outperformed other investments, including bonds and real estate. So the stock drawer is a must understanding for a thriving Money Machine. The stock drawer includes individual stocks, mutual funds, which are simply a ‘basket’ of stocks and
ETFs (Exchange Traded Funds) which are the best of both worlds—an ETF trades like a stock and looks like a mutual fund (and works well in your Money Machine).
Let’s Take a Deeper Look at Stocks
What is a stock? It represents a share of ownership in a company. When you own a stock, you own a piece of the ownership of the company — and all of the shareholders together own the whole of the company.
When you buy a stock, you buy it through a purchasing agent (known as a broker) and it is purchased through a trade in a market that represents the stock. Normally, stocks are traded on one of the following exchanges: the New York Stock Exchange (NYSE), the American Stock Exchange (ASE), the National Association of Securities Dealers Automated Quotations system (NASDAQ), the Paciﬁc Stock Exchange (PSE), or the over-the-counter market (OTC). (You can tell when a stock is traded on the OTC, because it is listed by a symbol with four characters. For example, Apple, the computer company, on the OTC, has the symbol AAPL, whereas IBM, which is traded on the New York Stock Exchange, has the symbol IBM.)
These various exchanges are like fraternities: Some guys decide to sign up with one, while others decide to sign up with another. If a stock is traded on an exchange, it means it must abide by the exchange’s rules of public disclosure of information and generally accepted accounting guidelines.
Since a share of stock represents part ownership of a company, the prices of stock shares rise and fall depending on the earnings picture for the company. Traditionally, investors looked in The Wall Street Journal, The New York Times, or their local newspaper, and stocks and their current prices were listed by initials or by combined parts of their names—not by their formal trading symbols. If you already know the abbreviation or listing name of your stock or mutual fund, it’s merely a matter of looking it up. If you don’t know the abbreviation, it’s not too difficult to figure it out. For example in the papers, General Electric is listed as GenEl and Home Depot is listed as HmeDep.
Typically today, investors go to Yahoo Finance, the Motley Fool or other websites to get their stock information. These sites will help you look up the symbols assigned to the stock you are seeking and also give you gobs of information about the stock.
Check to see if the quoted prices are from the preceding day’s trade, and if the listing will also give you the stock’s high and low prices over the past fifty-two weeks; the high and low prices for the day’s trade; the dividend yield (that is, profits paid out to investors); the number of shares sold that day; and the P/E ratio, which is the price of a stock divided by the company’s profits or earnings per share. These are all important indicators of the stock that you are researching for its historical performance.
A stock’s P/E ratio is an important measure of how much investors are willing to pay for a dollar of a particular company’s earnings, and is thus a strong indicator of the stock’s currently perceived value—its popularity among investors.
As an example, let’s look at Yahoo. The symbol of the stock is YHOO, so we know that it is traded on the NASDAQ. On December 8, 2015, Yahoo closed at $34.85 up slightly from the previous day of $34.68. If you wanted to buy a share of this stock today, you would have placed your order with the broker and you order would have been filled in the trading range which was $34.03 to $34.97. When you place your order, you can say exactly what price you will pay for the stock, or you can ask that your order be filled at the market and it will depend on the exact price at the time that your order is filled. In this case, you would have paid more or less by 94 cents.
Yahoo does not pay a dividend, and it’s PE ratio was estimated at 139.40. This is very significant because you will pay $138.40 to $1 of revenues. Some stocks have P/E ratios which are more than this, and some less than this; as you will learn, this should guide your investment choice.
The 52 week high and low: 27.20 and 51.68. If you purchased the stock at $27. 20 and rode it to $51.68, you are a happy camper. However, we can see that the price of Yahoo stock has fallen because it closed on December 8th at a price that is near the low end of the price range that it had attained throughout the previous year. We’ll talk about how to protect your stock investments in another article on this website.
Mutual funds, which are baskets of from twenty to fifty stocks or more, are also priced daily at the close of the day. You can look up their prices in financial papers or on the web. Listings for mutual funds give slightly different information. The listing will tell you the net asset value (NAV) of the mutual fund’s shares. The NAV is the combined daily price of all the stocks in the mutual fund’s portfolio, so you are seeing the ‘basket’ price of the fund. Other information that you will find about the mutual fund is the year-to-date total return and the net change from the day before. Like individual stocks, mutual funds are also abbreviated Vanguard Prime Capital Core Fund is listed under the Vanguard fund family.
Mutual funds are sold for all kinds of groupings of stocks—the mutual fund basket may be for health care stocks, Asian stocks, energy stocks, or an endless list of other choices that may be what you are looking for in a basket of mutual fund stocks.
There are lots of buyers and sellers of stocks on the various exchanges, which establish the daily pricing for each stock. The sizable mutual funds also have many buyers and sellers. The most important reason to buy a stock or a mutual fund for your Money Machine is the expectation that its price will rise. And the key factor in whether the price of a stock will rise is whether the company in which you own a share will make more money—more money this year than it did the last and more money next year. If this happens, the price of your stock will probably rise. As the company becomes more valuable, the value of your share of the company increases.
Another factor that drives market prices is demand. Demand is how much money is coming into the market and looking to purchase stocks. While supply (investible stocks) does change, its change is very small relative to the demand (amount of money looking to invest in the market). So as more money goes into the market, the market goes up. If money is coming out of the market, then the market goes down. It is basically that simple. This is also true for individual stocks: as more money is attracted to the purchase of shares of a particular company, the price of the shares will go up. And a new product, service—something that many people want will attract demand to the stock.
A current rage has been the new Apple iPhone 6, and people rushed worldwide to buy this product. Let’s look at a few of the statistics that showed the inevitability that the introduction of the iPhone into the marketplace would be a wiz bang success. This demonstrates that company earnings and a rise in stock prices are often simply about consumer demand by seeing the need that people have for products and services.
Research showed that a huge proportion of iPhone users were making their calls on iPhones that were three generations old. There was a glut load of pent up demand for the eventual sales of the new model phone, and sure enough, consumers rushed out to buy the new version.
Verizon, AT&T and Sprint all estimated that on average 50% of iPhone users had an iPhone 4s model or older. If you were thinking about buying Apple stock, the key was to confirm these basic ownership statistics as evidence of a coming cascade of sales for the new iPhone 6. And, the basic understanding that iPhone users have fierce loyalty to the Apple brand. This scenario is going on every day in the stock market.
Ultimately, the value of a stock depends on smart management of a company. If the managers develop great products or services and sell them brilliantly, as leading companies like Microsoft and Apple have done, the company’s shares will grow in value. If they produce poor products or fail to build their markets for whatever reason—like being overtaken by the competition—the value of the company’s shares will likely fall.
Mutual Funds: Collections of Stocks
A mutual fund is a collection of stocks chosen by a fund manager who has developed a skill at buying and selling stocks. Mutual funds allow you to invest in the stock market without having to make individual buy-and-sell decisions; the fund manager does that for you.
Mutual funds are a way for a beginning investor to tap into the opportunities offered by the stock market. Here’s why. Too many people invest in a stock solely because it was recommended by someone else. As a result, they often lose their investment. Many quit the stock market because of that one negative experience. By giving up, however, they miss an opportunity to grow their money. With a mutual fund investment, you’ll be more secure. After all, the fund is composed of many stocks that each perform differently. Some of the stocks will do better than others, but overall, the fund’s objective will be to increase in value and grow your investment. So investing in a good mutual fund is a solid opportunity to broaden your investment prospects and to beneﬁt from the market performance of various companies. This opportunity to invest in many stocks, not just one, diversifies the dollars that you invest and is one of the major advantages of mutual funds.
Many people choose to be in mutual funds because they’re not interested in mastering the nuances of trading—the buying and selling of stocks. In this fashion, they don’t actively manage their stock portfolios; they leave monitoring tasks to the mutual fund manager. The fund manager keeps a watchful eye on the appropriateness of stocks in the fund. So mutual funds are custom designed for investors who have little time and energy—and, perhaps, inclination—to constantly make quick buy-and-sell decisions.
Many mutual funds are part of “fund families” run by large investment companies. Fund families offer different types of funds for investors with different objectives and interests. You’ve probably heard of some of the largest mutual fund families, like Fidelity and Vanguard. A fund family can be composed of anywhere from two to two hundred funds. TheVanguard family, for example, contains the Health Care fund, the Growth and Income fund, the Large Cap Index Fund, and the Mid-Cap Growth fund.. . If you have enough money, you can buy more than one mutual fund — for example you can buy shares in both the ‘Large’ Cap fund, the ‘Mid’ Cap fund and the ‘Small Cap fund — and thus further diversity your investments. Let’s talk about these different types of funds..
Some types of funds have historically performed better than others. Mutual funds composed of smaller companies that are poised to grow into much bigger companies generally outperform mutual funds composed of large, established corporations. These small-company funds are known as “small capitalization,” or “small cap,” funds and typically represent companies that are energetically developing new technologies. These would have included the microchip manufacturers and software developers beginning back in the 1970s. There usually will be more volatility in the price of a small cap fund than in the price of a fund composed of larger, established companies because the small caps are youngsters growing up.
By contrast, the “value” funds—often composed mainly of “large capitalization,” or “large cap,” stocks—typically include larger, established companies that are mature, like , Exon Mobile, Johnson & Johnson, Facebook, Procter & Gamble, and AT&T. These companies have proven, established markets, but their stock value generally rises more slowly than that of successful, smaller, upstart ﬁrms. Value funds include medium and large companies that the fund manager believes are “values”— that is, bargains—because their shares are priced low in the market.
If the small cap funds have been the best performers among mutual funds, the “international” funds—those composed of companies represented on worldwide, not just American, stock markets—have been the second best. I’ll talk more about the international marketplace for stocks and mutual funds elsewhere.
When you’re selecting a mutual fund, ask to see what kind of stocks and what particular companies are in its portfolio so you can get a feel for the fund’s objective and the stock-picking style of its manager. (Ask for a prospectus, a document that includes this information.) This will allow you to discover what themes or trends determine the composition of the fund and what types of industries go into consumer products, cyclical goods, technology. Is the fund composed of stocks of industries that specialize in health care or something else? For example, a technology fund might include Microsoft, Apple, Intel, IBM, and other technology-driven stocks.
Exchanged Traded Funds: The Best Way To Invest
An ETF (Exchange Traded Fund) is the best of both worlds—the trading flexibility of a stock and the diversification strengths of a mutual fund. ETFs experience price changes throughout the day like a stock as they trade on the stock exchanges (unlike a mutual fund that is only priced at the end of each trading day) — and they are made up of a basket of assets, including stocks. ETFs typically trade more often in the stock market (higher liquidity), and importantly, have lower fees than mutual funds. Mutual funds depend upon a professional manager to actively buy and sell stocks, picking investments, on your behalf. An ETF, though, is designed to track an index of the market—for instance the S&P 500—and therefore does not have the expense of a manager because the ETF is a predetermined ‘basket’ that is aligned with the index and therefore maintains a consistent ‘basket’ of stocks without the expense of a fund manager.
Let’s just say—that you get more bang for your buck!
It’s as easy to buy an ETF as a stock or a mutual fund in your brokerage account, but an ETF has distinct advantages over both an individual stock or a mutual fund.
Mutual funds were birthed on the notion that a fund manager could ‘beat the markets’. Over the course of history, it has been shown that most mutual funds do not beat the overall market. In 1976, the investment firm Vanguard Group launched the first mutual fund to restrict its investments to the S&P 500 index. It was known as ‘Bogle’s Folly’ for John Bogle who was the founder of the company. “Yet Bogle knew that most active managers can’t do it (beat the market), and even less so after subtracting their fees.. Bogle believed that it was far more important to stay invested than to trade in and out. The Vanguard 500 was designed to keep up with the broad index of stocks at a rock-bottom cost, and it still does.” (Forbes June 2013).
This was the birth of the evolution of the exchange traded fund, which has grown over the last decade to offer many options for your Money Machine. In addition to trading actively like a stock —ETFs have a lower cost (and sometimes are commission free), they are more tax efficient for you, and you can buy an ETF for as low as the cost of one share—a small dollar amount that gets you a diversified investment.
There are ETFs for all sorts of things. You can buy an ETF for a particular country, which invests in the top stocks of that country; an emerging markets ETF, which invests in a group of countries and the top stock in those countries; you can invest in a ‘value’ or ‘growth’ ETF—a ‘small’, ‘mid-cap’ or ‘large-cap’ ETF; a type of industry ETF such as oil and gas, health care, communications and consumer products; and many other cross sections of both world and domestic economies.
The Dow Jones Industrial Average
When I entered the financial industry in 1975, the Dow Jones Industrial Average, widely known as the “Dow,” was hovering around the 800 mark. Wow and yippee. Look what it has done! The Dow ranged to above the 18,000 mark by 2015. You would happily have seen your investments grow through this market.
Now, what do these numbers mean? The Dow is a way to measure the growth of the price of stocks in the United States by examining the prices of the same thirty stocks each day. The Dow plots the rise and fall of these stocks as they are bought and sold, using them as a mirror of the stock market. It is a weather vane of sorts, as it heralds the ups and downs of Wall Street.
The Dow, which celebrated its centennial in 1996, has an interesting history. It was the brainchild of Charles Henry Dow, a newspaperman who founded a financial news service with another reporter, Edward Jones. The two men issued a newsletter called the Customers’ Afternoon Letter, which began recording the average price for nine railroad and two industrial stocks in 1884. Then, on July 8, 1889, Dow Jones & Company started The Wall Street Journal, which is still the preeminent business newspaper in the United States.
Dow continued to hone his stock index, and in 1896 he finally launched the first of what we know as the Dow Jones averages. The first one measured a dozen stocks, including U.S. Leather, American Sugar, American Tobacco, Chicago Gas, and General Electric. How many of these stocks do you recognize? Of the twelve original stocks, only General Electric remains on the index today. The other companies that were on the original Dow have closed, merged with others, or lost their place on the index as their importance in the U.S. economy diminished. The current makeup of the Dow reflects the changing American society: Disney, American Express, IBM, Microsoft, Home Depot, Pfizer, Walmart , Nike, Verizon, Cisco Systems, Visa, Caterpillar, Chevron, Coca-Cola and McDonald’s are among the stocks listed now.
The Dow reached its first milestone in 1906, when it closed above 100 points. It continued its steady rise over the years. On October 28, 1929, the Dow took its deepest plunge. It fell 38.33 points, closing at 260.64. This was the great 1929 crash and the beginning of the Depression. The Dow didn’t reach 500 until 1956. It exceeded 1,000 in 1972. Since then, it’s had several dips, but it has always recovered to rise higher than before.
There are other indexes of stock market growth, some of which are probably more accurate barometers. For example, the Standard & Poor’s 500 Index (often simply called the S&P 500) is based on the value of five hundred companies. Because this is a much larger cross section of the stock market (it includes many mid-sized firms as well as the American giants), the S&P is a good indicator of the direction of the market and the U.S. economy. However, the Dow is still the most commonly followed index, and the current Dow level is the number most people have in mind when they ask, “How did the market do today?”
How Stock Prices Rise
Most women—and most men—aren’t used to buying things that grow in value. Your car, your clothes, your appliances all decline in value from the minute you buy them until, eventually, they’re worth nothing and have to be thrown away. Investing in stocks is a different matter and requires a very different psychology.
Let me tell you a story that will illustrate how the stock market works.
Years ago, my companion and I ﬂew to Aspen for a ski vacation. He was flipping through a flight magazine when he suddenly stopped and blurted out, “Joanie, look. These are your earrings!” I leaned over, looked at the picture, and read the description, and sure enough, they were my earrings—a beautiful and distinctive set of Mobe pearls with a gold shield and a few small diamonds. I read further and saw that they had been designed by the same artist as mine.
Both of us were amazed to see the earrings because I had purchased the lovely pair a decade earlier from my favorite jeweler, Sacks, in Philadelphia for $260. Now here they were for sale at a jewelry story in Aspen—the ski resort where we were headed.
Naturally, we were curious. When we landed in Aspen, we visited the jewelry store selling them and found out the new price, $2,200—for the same earrings by the same artist!
What happened to my jewelry is what happened to stock when the Dow rose from 800 to upward of 18,000: The price rose when more people wanted to buy it. The market rewards the patient investor who buys something of value and holds it until more people recognize its worth.
Furthermore, the stock market is a more powerful and reliable source of value growth than the jewelry market for several reasons. The value of a share of stock is based on the value of the company it represents. If the company is well run, its sales and profits will grow, and the value of its shares will rise. The continued growth of the U.S. and world economies is an engine that helps drive companies. Think about it: If you own shares of Disney, every baby born represents a potential new consumer of Disney products—movies, toys, videos, vacations. And each new customer has a positive impact on Disney’s bottom line—and on the value of your stock.
I have a saying ”Put your canoe in the river and float.” That means, invest your money and you’ll move along just fine with the currents of the stock market. Certainly, the market has ups and downs, but the downs are minuscule compared to its historic pattern of growth. The Dow has climbed steadily and relentlessly—it’s the economic event of our lifetime. It’s never approached zero, as a few doomsayers would have us believe. It hiccups once in a while. That’s when many people run scared, tip their canoes, and swim to shore. Just remember the most significant characteristic of the stock market: Its history is a remarkable, insatiable, proven climb. You don’t have to outsmart it—you just need to go with it. You have to get into the stream, though, to feel the momentum of the currents.
But what about those market “dips,” when the Dow drops 50 or 100 points in a day and the price of your favorite stock is off by as much as a few dollars a share? What do you do when this happens? Don’t run scared. Instead, love those dips!
Think of it this way. If you walk into a department store and see a dress you’ve wanted on sale, you don’t look at it and say, “Yech! That’s junk now because they’ve reduced the price. I wouldn’t think of buying it!” No. A huge smile would probably wrap around your face as you reach for your wallet and think, “Wow! How great. What a terrific value. My favorite dress is half price. I probably should get two!” Well, the same is true of the stock market. If you believed a stock or mutual fund was a value before its price dropped, it’s still a value; only now, it’s a better one. In fact, when the market drops, I call it a “half-year liquidation sale.” After you buy these “sale” stocks, keep them until they become popular again. Sometime later, you might sell them and realize a nice proﬁt from your shopping spree.
Do you recall October 19, 1987? It was the day the media blurted out that the stock market “crashed.” The Dow plunged more than 508 points as nervous investors sold their stocks. Well, I don’t believe in “crashes.” These market adjustments are wonderful “liquidation sales,” and history proves that when you buy during a time when others are fearful, and hold on until investors are no longer panicky, you will eventually harvest rewards. If you purchased stocks at the great sale of October 19th of 1987 you’re extremely happy because the Dow has more than recovered and has gained enormous strength since then. Following this day, the Dow steadily climbed, setting a new record on January 2, 1990, when it closed at 2,810.15. A year later, the Dow closed at over 3,000. By 1996, it reached a high of over 6,000 and by 1997, it climbed to 8,000 and now at the opening of 2015 the Dow is topping 18,000. So the next time you hear “crash,” just smile and say, “Great. I’m going shopping!”
Words like “crash”—words that grab headlines—can swing you into that “fear and greed” mentality of Wall Street. Remember, selling when the market declines should be a rational choice that depends upon your personal risk tolerance. That’s sensible investing. When the market is down, the wealth-building strategy is to buy more or evaluate your tolerance. Historically, the market has always bounced back from its falls to even higher heights if you can withstand the fluctuation.
Over the last 10 years, the rate of return of the market (which is defined as the S&P 500) has been 9.5 percent. The average annual growth of the stock market since the very beginning of the U.S. market, including all of its dips, is 10.4 percent per year (including dividends). Just $1000 invested in 1900 would be worth over $19.8million by the end of 1999.
In a given year, returns can run as high as 35 percent, as did the returns from many mutual funds in 1995. You won’t expect every year to produce a return as high as those in 1995, but statistically, there is a one-out-of-two chance that you will receive better than a 15 percent return in the market in any given year.
Few things in life are as reliable as the growth of the stock market. That’s why stocks have been such an essential part of building a Money Machine.