When it comes to money, making more is always a desirable goal. Investing your money is a valuable means to achieving your financial goals that puts your money to work. The stock market is one such way to invest and, with the right tools, knowledge, and patience, an informed investor can become a money-making investor.
WHAT IS A STOCK?
A stock is a basic unit of ownership of a company. Also referred to as shares or equity, it represents your investment into a business or corporation. Companies offer up shares of their company in return for capital, leaving investors, or shareholders, to acquire a portion of that company which can include voting rights and profit distribution.
Stocks aren't only found in individual accounts; they are also in mutual funds and Canadian pension plans.
Stocks are a financial tool. Money can be made if stocks increase in value after you've invested or if companies you've invested in pay out dividends to their stockholders. Stocks provide options for making money or building wealth but only if they are understood and used correctly.
Shares can be purchased by individual investors, via financial institutions, or through stockbrokers or investment advisors, as they are known in Canada. These regulated professionals buy and sell stocks for clients in return for a fee.
WHAT IS THE STOCK MARKET?
The stock market is the collection of buyers and sellers of both public and private stocks. Not a physical location, it is a network of economic transactions.
A stock exchange is an organized service provided to facilitate the buying and selling of tradable financials. An exchange usually operates within a central location where brokers and advisors complete sales and trades under strict regulations governing the industry. Several exchanges are active within Canada including Toronto Stock Exchange, Montreal Exchange, Canadian Securities Exchange and NASDAQ Canada operating out of New York City.
The market is influenced by outside factors including global events, cultural situations and even weather phenomenons - all beyond the control of brokers, bankers and investors – making ups and downs difficult to predict and even harder to profit from.
BEFORE YOU INVEST
While you might think 'buy low, sell high' is all you need to know before you throw your next paycheck towards a low cost stock option, there are certain fundamentals that will save you from unnecessary losses.
Understanding risk is essential to understanding the stock market. Risk is the amount of uncertainty associated with an investment and your tolerance of risk determines the level which you are comfortable. While not always the case, it is important to consider that the higher the potential for a good return, the higher the risk may be.
“Novice investors should think about how much tolerance they have for risk. Investing in the stock market is quite a bit more risky than putting money into a term deposit, Canada Savings Bonds, or Guaranteed Investment Certificate. There will be ups and downs in the stock market, and [investors] need to be able to cope with those fluctuations without getting anxious about it on a daily basis,” explains Kin Lo, professor of accounting with the Sauder School of Business at the University of British Columbia.
These days, information about stocks is abundant and, for both the beginner investor and the expert, it is necessary. Searching out the available resources that provide insight into the stocks you're interested in, related industries, and the economy is essential to making informed decisions.
Lo offers two pieces of advice for getting into the market directly. “One: buy stocks in companies that you understand. If you are thinking about, say, Lululemon, do you go to their stores and do you know their products? If you don’t understand what the company does or where it operates, don’t invest in it.”
Lo's second piece of advice is to try before you buy. Most financial institutions offer free practice portfolios allowing customers to familiarize themselves with investing without the risk of a real account.
“It’s a risk-free way to learn, to see if you would have made money, and to see how much the stock prices fluctuate from day to day, week to week,” explains Lo. “You might find that you don’t have the stomach for the ups and downs—and that is perfectly fine.”
HOW TO MAKE MONEY
Investing in stocks takes effort, education, and experience. And even the most experienced investor is likely to experience a loss. Understanding the wins and the losses will allow you to continue on an upward trend, avoid costly mistakes and consider yourself a successful stock investor.
“The stock market is far from a surefire way to make money. This is especially true if someone wants to make a quick buck,” cautions Lo. “Over a short period of time, it’s very easy to lose 10%, 20%, or even 50%. Just ask anyone who bought in the summer of 2008 before the financial crisis. Over the long-term, the investor is much more assured of making a decent return.”
The long-term, adds Lo, is at least five years, but ideally ten to twenty. “Because of the ups and downs, the focus has to be on the long-term,” he says.
Analyze industries before investing in individual stocks. While it is important to understand the companies you intend to invest in, the bigger picture may tell a different story. Watching industry trends, profit potential, competitor moves and inherent risks will provide valuable insight into your investment's potential to rise or fall.
Lo stresses the importance of diversification. By having a mix of investments, you're able to reduce your risk and the likelihood they will all experience losses concurrently.
“Don’t put all your eggs in one basket,” Lo says. “Expecting to earn a profit from buying a single stock is like playing roulette. Anyone who put all their money in Blackberry in 2004 or 2005, and sold in 2007, he/she would have doubled his/her money. However, if he/she bought in 2007 or 2008 and held on, he/she would have lost about 80% of their money
by now.”
While diversification is more time consuming, it lessens the chances of a large loss – and Lo cautions against doing anything but.
“The risk is not worth it,” he says. “It is much better to spread out the investment over many stocks. This might seem difficult to do for a beginner with a small amount of money—you have to buy shares in multiples of 100. That is why mutual funds are a good way to get into the stock market. When you buy into a mutual fund, you buy into the basket of stocks in which the fund has invested. Mutual funds do charge fees, so it is important to find a fund that has low fees.”
There is an overwhelming amount of variables influencing a stock's ability to perform in relation to your financial goals. Evidently, buying low and selling high is not the advice a beginner investor needs to succeed.
“The difficulty is in knowing when a price is low or when it is high. With the benefit of hindsight, it is very easy, but of course, we don’t have that—we have to make investment decisions in real time,” says Lo, adding that more experienced investors succeed for a reason. “I’m not saying it is impossible for a novice to buy stocks that are 'priced low' and then sell at a higher price later, but that is likely just a matter of being lucky. And you don’t want to count on luck over the long-term.”
The stock market can be a complicated – and costly – place without the knowledge to understand how it works and how it can work for you. While a basic understanding doesn't scratch the surface of what occurs globally on a daily basis within the market, becoming invested in understanding your investments will increase your chances of
long-term gains.
