Taking Stock of Your Holdings

Photo by  jeff pineau

Welcome back intrepid reader.  As promised, today we are going to discuss ways to make your idle assets work harder for you.  As always don't construe anything I am saying as financial advice.  I highly recommend you talk to a licensed expert before making any investment decisions.

To understand anything about investing you're going to need to have at least a basic understanding of the stock market.


Each share of stock is a tiny piece of ownership in a company.  To determine how much of the company belongs to you take the number of shares you own and divide by the number of outstanding shares.  The individual who owns 51% of the shares of stock in a company owns the company; They out-vote the other 49% every time.  Shareholders get to vote on how they think the company should be run.  They usually do this by electing board members to operate on their behalf.  The board members get to choose who actually makes the day to day decisions for the company, the CEO.  The CEO then buys off both Democrats and Republicans so that they will make decisions favorable to the company.  Rock the vote, with your wallet.

I want to be clear that I am not talking about any particular company, rather making a comment on the American Political process in general.  The buzzword for changing how the current system works is Campaign Finance Reform.

The value of the stock is determined by supply and demand just like everything else.  A thing is worth exactly as much money as someone is willing to pay for the aforementioned thing.  People are willing to buy stocks based on how much money they think the stock will be worth in the future.  Therefor the value of stock is determined not by the actual value of the company but rather the perceived future value of said company.

There are only so many shares to go around so if you want to buy one, you have to find someone else who wants to sell one.  Negotiating this transaction is the function of a broker.  The more stocks people buy the harder and harder it gets to find another person who wants to sell the stock they own.  So the price goes up.  When the price goes up to the point that someone who owns the stock believes that the price of the stock is more than it's worth that aforementioned individual will sell the stock.  Conversely if a lot of people are trying to sell the stock all at once it becomes harder and harder to find someone who wants to buy it.  So the prices go down until someone feels that the price of the stock is now less than it's worth.  And round and round we go.

Historically the data shows that in the short term prices go up and down, but in the long term prices go up.  You're playing with a yo-yo, but you're also ascending an escalator.  The longer of a time frame you look at the more predictable the growth becomes.  This is why many investors determine the risk in their portfolio by how long they intend to invest.  If want to retire tomorrow you don't want your current holdings to drop a dime.  If you have 30+ years until you plan on retiring you can afford to wait out a bad market.  Even if the numerical value of your investment account is going down you haven't lost any shares until you sell.  Hodl (Hold on for dear life) until that upswing comes back around and sell when prices are high again.  You're young, you have the luxury of time.

No one can guaranty you a specific rate of return because 100% of the people that claim to tell the future are frauds.  If Ms. Kleo (sic) really could have seen the future she would have been picking stocks so that she didn't have to talk to the general public on the phone.  Have you ever talked to the general public on the phone?  They can just be the worst sometimes.

Although no stock is a sure thing, there are certainly stocks that are more risky than others.  A start up business for example has more risk of failure than an established corporation.  Generally speaking large cap stock tends to be less volatile than small cap stock.  On the other hand stocks that have a higher chance of catastrophic failure also have a high potential gain if they pay off.  At a certain point picking high risk stocks can feel a lot less like investing and a lot more like gambling.

Companies can choose to pay dividends to their share holders.  This means you can make money off of your stock portfolio without selling any existing shares.  Most long term investors choose to reinvest the dividends by immediately buying more shares with the proceeds.  Some investors plan their stock choices around companies that have consistently paid high dividends over time.

There are a lot of complicated ways that very smart people use to calculate the future value of stock.  It's mostly a bunch of crap.  Every time somebody says they have a fool proof plan they end up getting out picked by a cat or a monkey or something.  No, not an anthropomorphic money monkey, just a regular animal who is picking at random.  That being said I'm still going to explain some calculations on the subject to help you have a better understanding of how the market works...but it will be a topic for another day.

Conventional wisdom states that diversifying your portfolio is less risky.  Lets say that there were only two companies in the world.  The red store and the blue store.  When the red store is doing poorly all of their customers are going to the blue store and vice versa.  So if I only owned red stock I might lose big when blue is doing well.  If I instead owned both stocks the upswing on one end would offset the downturn on the other end.  I have less of a chance of winning big, but I have a very small chance of losing big.

Now that we understand diversification we are ready to tackle our next financial instrument.  The Mutual Fund.  More on this topic when we return on Tuesday.