With Stocks: the sure bet for wealth, we will be looking into what exactly is a stock, why they make such terrific investments, and how we can make better use of these to meet our investment goals. It has been said that Real Estate has made more millionaires than any other asset class or investment vehicle. While this might be true, stocks have made more billionaires than all other asset classes combined. While we may not end up billionaires by simply investing in stocks, by hitching our bets on the asset class that can deliver such tremendous results, we almost assured to get into the millionaires club very easily.
Article Goals
My goal with this post is to bring to light some of the common bad practices with stock market investing, and simultaneously address the concerns that I commonly face from well intentioned, would-be investors. Let’s get into those two points after we review what stocks are and then afterwards we will finish with some helpful tips to stay on track.
What is a Stock?
First and foremost, stock is an ownership share in a company. Take any and all companies that exist in the world, including those that are private, and inspect the corporate structure on which it is formed. If this company is incorporated, this will mean the ownership stake is divided up into shares and private citizens will hold these as proof of ownership. As the company operates and generates profits the equity portion of the company will grow and thereby the wealth of the shareholders who own this equity will grow too. This is why stocks are often referred to as equity based investments.
Stockbrokers
Suppose you are a shareholder of a company you started years ago with some friends and now you wish to sell half your shares. If you can find a buyer, you can literally sell them your half for cash and sign over the paperwork. Now they own this equity portion and are entitled to the profits just like you were before. When you sell or buy an entire company, the transaction is for all of the outstanding shares. Shares are to companies what land title is to real estate.
Centuries ago, there were places where you could go and easily find a buyer for your shares. Likewise if you wanted to buy shares, you could go to the same place and put in an order. People that helped facilitate these transactions were known as Stockbrokers and the places they did business came to be known as Stock Exchanges.
New York Stock Exchange
The NYSE was founded in 1792 when 24 stockbrokers signed the Buttonwood Agreement on Wall Street. They formed a centralized exchanged for the growing securities market in the United States. The organization made the Tontine Coffee House its headquarters and focused on first on government bonds. Throughout the early 1800s, the NYSE expanded beyond bonds and began trading in bank stocks. The telephone was introduced and now would-be investors could put orders in by phone directly with the brokers and buy a portion of corporate America.
Buy a Piece of a Wonderful Company
So when you buy a stock, or shares in a company, you are literally buying a small ownership portion from someone willing to sell their share of the same company. To facilitate the ability to buy and sell shares of companies, the shares have been listed onto a stock market exchange where they can be bought and sold all day long. As a shareholder you are entitled to all the rights and privileges that come with such ownership with one caveat. Your ownership, in percentage terms, is almost certainly close to 0.001% and so they will never contact you or ask your opinion on important items; you just don’t have enough skin in the game. The game changes once you own more than 5% of the company.
Profits and Earnings
As a shareholder, what you are interested in from an investment perspective, is current earnings (another word for profits), what the prospects of future earnings are, and what the current price per share are for the shares. Businesses for profit will always generate the most returns for investors and there is an economic reason for this.
The Economies of Why Business is Best
Businesses must generate more profits and revenue than the underlying endeavor that supports it. If the business cannot generate more money than the utility company that supplies the electricity for it to operate, then it would not make sense to do more than the utility company. If it would be more profitable to run and manage the building where the business is located, then the business should close down and endeavor to build more real estate. This is why bonds, real estate, utilities, and gold MUST return less than a business who takes the risk to earn more. Otherwise why would you do it?
Stock is the Apex Asset
Take one of my favorite companies, Disney for example. Take into account all of the input costs that they use to operate their business. They sum this together and strive to sell a product for more than the constituent parts.
In the last 12 months they had the following financial results across the entire company and also per share.
| Company (Billions) | Per Share (Dollar) | |
| Revenue | $75,100 | $45.35 |
| Cost of Revenue | $46,033 | $27.80 |
| Gross Profit | $29,092 | $17.57 |
| Operating Expense | $17,818 | $10.76 |
| Marketing | $12,369 | $7.47 |
| Depreciation | $4,445 | $2.68 |
| Operating Income | $11,274 | $6.81 |
| Income Expense | $(2,845) | $(1.72) |
| Pretax Income | $13,145 | $7.94 |
| Income Tax | $2,845 | $1.72 |
| Net Income Available to Common Shares | $10,373 | $6.26 |
| Enterprise Market Cap (Dollars) | $324,765,000,000 | $179.75 |
These are impressive numbers. That revenue means they are bringing in $205.8 million dollars of revenue each and everyday, close to $10M an hour! People all over the globe WANT to own this company. So you divide up the ownership, issues shares, and viola, you have yourself an investible product that investors, as of writing this post, are paying $179.75 a share to own one billionth of a piece of Disney!
Risk: The Price of Admission to Hold the Apex Asset
What’s the price of capturing this superior performance? High price shares? NO! It’s actually risk and volatility. This is the one and only reason investors shy away from stocks. Even more than the the price for the asset itself! If investors knew their investment principle would not decline they would pay the required price regardless of what is asked. However, despite this risk, to many investors, this price is worth the price of admission because historically speaking, the returns have been terrific. The formula for investment returns goes like this.
Time Invested
As you increase your time in the market and how long you can let your investments compound and grow, you can expect a larger and more substantial return from your investments.
Risk Exposure
As you increase the risk your capital or investment principle is exposed to you can expect a higher eventual return. However the caveat is that when you need to access this capital it stands to reason that the value of the investment might be lower than where you needed it to be. The more variance you will permit your capital to be exposed to the higher the chance that the eventual value will be higher. Think of it like the casino, however the odds are in your favor.
Risk of Absolute Collapse
Is it possible that your original investment could go to zero? Yes, this is entirely possible when you hold any individual stock on its own. Especially young companies in unproven industries. However, this risk can be very easily diversified away buy owning a basket of stocks across various parts of the economy. Is it possible that Oil and Gas will no longer be needed? Yes, its entirely possible, but not likely. Is it possible that Business in America will stop? Well if it did, we would have an entirely different set of problems and perhaps your investment portfolio is not at the top of your concerns any longer! The point is that you can diversify away the risk of a single stock going under by owning the entire asset class, or index, instead of just buying one. This practice is highly recommended!
Total Returns
Total returns is the result of time multiplied by risk.
- Want to increase your returns but keep the same time frame? Then you will need to increase your risk exposure.
- Need to lower your risk but keep the same returns? Then you will need to lengthen your time invested.
- Need to invest for a short period with low risk? Then you will need to lower your expected returns
But Wait! I Know Some Who Lost it All!
I could promote the virtues of investing in stocks all day long, and at the end someone will say, “Yes, but I know someone who lost it all in the Stock Market.” Yes this happens from time to time. However we need to realize this happens with all asset classes. It happens with Real Estate where investors over leverage themselves, buy too many properties, or buy at the market top. It happens in the bond market when the borrowing company or country defaults and the principle is lost. However there are some common traits among these investors that lost it all.
Leverage
Borrowing to invest increases the risk profile substantially. Leverage will magnify all returns and losses by the amount you’ve borrowed. Remember how I said investing in the stock market is like the casino, except the odds are in your favor? Leverage tends to tilt the odds away from your favor because of the interest rate you pay to borrow the capital. This raises the minimum performance requirement to break even and skews the parameters away from you.
But more importantly this raises the probability that you could lose money and because you’ve magnified the risk, the magnitude of the loss is greater too. This is how you can lose everything in the stock market: That 50% loss is now 100% because you doubled down with leverage.
Buying at the All Time High
When everything in the news is about how this stock or that investment is doing extremely well, compounding at rates never before seen, this is a sign to SELL, not buy. When an asset, such as stocks, makes all time high prices, this is a good sign to at least be careful and not be buying. There could still be some upside potential, but in cases where people “Lost it all” they are likely buying at market tops once everyone else is convinced the investment is terrific. Please at least, never buy on margin or leverage when the asset is hitting an all-time high. Again the odds are stacking against you.
Unrealistic Time Period
Stocks do best when you give them 10 or more years to grow and compound. Investors who are stepping in with borrowed money to buy a stock at an all-time high, with the goal of making quick money will often be disappointed and lose everything they had. It’s ironic, that extreme efforts to make money and get ahead, will often result in getting set back by a decade.
Evaluate Those Who Lost it All!
So the next time you hear of someone losing everything in the stock market. Ask them these questions: Did you borrow money to invest? Did you buy near the top? Just how long did you stay invested before selling out and locking in the loss? Chances are good you’ll see an emerging pattern. Non leveraged, broad based stock market investing for time periods of 10 or more years will not cause you to lose everything and take your house away.
Tips to Successfully Invest in Stocks
Here are 4 tips every investor should use when investing in Stocks. I can personally attest to their effectiveness having used them over the last 17 years.
Dollar Cost Average
Buying a small amount of stock on a set interval over time ensures you never buy in at the top and spreads your entry cost basis over time. Setup a preapproved contribution plan with your investment service and they will take $50 or $100 from your paycheck and buy stocks with it. I personally do this every Tuesday and use the WealthSimple service to do this. I never have to think about it as its done automatically for me. They buy diversified low cost index funds on my behalf and charge me no trading commissions.
Always have Cash on Hand / Never Go All In
Hand in hand with not borrowing to invest, is also never going all in, and never having all your cash invested in the market at once. Have some cushion so if the market tanks, crashes or corrects, you can actually step in with cash and buy extra shares at steep discounts. The time to be buying is when stocks are crashing and selling at a discount. I always have at least 10% of my portfolio balance in cash. This lets me sleep sound at night, keeps me looking for opportunities, and also acts as my emergency fund in case its needed; protecting my stocks from being sold at a bad time.
Diversify
One way to get great returns from the stock market is to buy the entire stock market instead of just individual stocks. This helps so if any one particular company goes under you’re not left holding the bag. One of the best ways to do this is to simply buy the S&P 500 stock market index. This provides a terrific diversified portfolio of stocks, 505 of them actually.
Check out the following returns for the S&P 500 if you had bought it in 1942 with $10,000 and held until 2020:
Yes, you are reading that right. Your investment of $10,000 turns into $51,651,605.58 at the start of 2020. In 2020, the market returned another 18.37% so its actually now worth $61,140,005.53 at the start of 2021.
Now, there are further ways to diversify your portfolio than just buying 500 companies. If you read my article on how I’m investing through 2021 you’ll see what other assets I’m recommending for this calendar year. How to Invest 100K for 2021. Stocks are a critical core holding of any portfolio but they are not the only asset we need to buy and hold. Read that article.
Give it Time
The next tip is building on the last chart we just looked at – we need to give this thing time. Recall the investment formula above. To get absolutely mind numbing returns in a short period, we will need to take extraordinary risks – risk that could prove fool hearty and result in disaster. However to get the same return with normalized risk, we just need to give it time. Let your portfolio grow over a 30 year time period and you will be amazed at how much it can grow.
How to Get Started
Robo-Automatic
Solution with More Control
Another solution to get started with is to use All-In-One ETF portfolios. Here the investment is listed on the stock market and you buy it at regular intervals through a discount brokerage. The advantage here is your costs will be lower. Many of these ETFs carry fees below 0.20% which can make a difference over time when your account balance is higher. The disadvantage here is there is less automation which can lead to less overall results if you don’t keep to your plan and approach. I use this approach within my corporate business account. If this interests you or you want to learn more you can read my article: Get Rich Keeping it Super Simple.
Even more Control Please
After this, the next level is to further control the precise ETF’s in your portfolio and the dollar values of each. This of course will require much more hands-on involvement from your part and you will need to control all the buying, selling, and rebalancing on your own. To be honest there isn’t much more advantage to this over the previous solution. You might be able to shave a few percentage points off on fees but its likely not enough to justify your efforts unless you have a massive account balance. If this does interest you then read my article on How to invest 100K for 2021. In the article, I break down all the ETF’s you need to create a terrific investment portfolio.
Please. I Want all the Control – No Indexes
I don’t recommended you get started with investing in stocks by picking individual stocks on your own. Not even if you do it under the guidance of a professional stock picker. At least not when you’re starting. Please resist this urge and instead start with a foundation or a core investment established on the solid footing of broad based diversified indexes or funds. This approach is too risky and can lead to disastrous results.
Summary
Today we covered the basics and fundamentals of stocks: the sure bet for wealth!
What is a Stock? – Stock represent an investible ownership share in a corporation whose objective it is to generate returns for their shareholders. It literally means you own a piece of the company!
But Wait! I know Someone Who Lost it All! – They likely used leverage or borrowed against their home and bought in at the market top when market hype was rampant. When all the news is about how terrific the market is doing, never borrow to invest with the goal of making it big in a short timeframe. This is not how the formula works.
Tips to Successfully Invest in Stocks – Get diversified, buy small amounts of stock over time and let the magic of compounding work in your favor over 10, 20, or 30 years. You will be amazed at the results!
How to Get Started – I highly recommend investors start with an automated Robo-Advisor like WealthSimple which will handle all of the guess work for you. They do it for an absolutely minimal cost and give you incredible returns over time. It’s really this simple!
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