Principles of Investing: Chapter 2
The Power of Investing
Saving and Investing
- Saving: putting money aside for a rainy day or when needed
- Investing: not just putting money aside for a rainy day, taking measures to make your money grow
o Buying Stocks
o Anything you think will increase in value over a period in time
o Putting your money to work for you!!!
Rewards of Investing
1. Investing is a great way of making money.
2. Rewards of investing can last a lifetime.
3. With investing, time is on your side.
4. Investing can help you beat inflation.
5. Investing is a way of owning a piece of corporate America.
6. Investing is fun.
Growing Importance of Investing
- Not everyone has a pension
- Long-term security resides in your own hands.
Magic of Compounding
- Investing is so profitable over a long period of time because your earnings are compounded.
- Compound Interest: When you earn interest on your initial investment, then interest on the interest
Ie: Invest $100 make 6% interest a year = $106 at the end of the year
The next year your $106 makes 6% = $112.36
- Money in the stock market is made through two basic ways
o Dividends: money that companies pay to their stockholders
o Increase in the prices of stocks that you own.
- Key: Reinvest your dividends
Rule of 72
- If an asset grows x% a year, its value will double in 72 ¸ x years
- ie: 72 ¸ x = number of years it will take an investment to double in value
10% : 72 ¸ 10 = 7.2 years
3%: 72 ¸ 3 = 24 years
5%: 72 ¸ 5 = 14.4 years
Four Basic Rules for Investors
1. Invest on a regular basis over a long period of time.
2. Reinvest all earnings (dividend, interest, capital gains).
3. Invest in the common stocks or mutual funds of good quality growth companies.
4. Diversify your portfolio to reduce overall risk.
Organizing a Business
- Labor: those people who will do the work.
- Capital: money to buy real estate, equipment, raw materials and underwrite other start-up costs.
- Lenders: people who lend money to the business in return for a contracted rate of interest or return for their investment.
- Stockholders: people who buy shares of stock in the company and, in effect become part owners.
- Sole Proprietorships: One owner is liable for company’s losses and lawsuits
- Partnerships: Partners are liable for company’s losses and lawsuits
- Corporations: Shareholders have only a limited liability for losses incurred by their company. They can only lose what they have invested.
o Private Corporations: shares sold privately, only purchased from current stockholders.
o Public Corporation: shares sold on the open market. Can be purchased from dealers, shareholders and traded openly.
How Businesses Raise Money
- Primary Capital Market: Process of raising new money and selling stock directly to the public.
o IPO: Initial Public Offering – when a company goes public for the first time.
- Secondary Capital Market: when stockholders buy and sell shares from one another on a stock market with the help of brokers. (None of the proceeds of these sales go back to the corporation.
The Stock Markets:
o NYSE and AMEX: Auction markets where buyers and sellers come together to do business.
- Over-the-Counter (OTC)
o NASDAQ: dealer market where securities dealers buy or sell from their own accounts (for themselves)
§ Mostly smaller and newer firms, but some well established firms and a number of technology companies
- Stockbrokers: a person who assists you in purchasing stocks and bonds.
o Full Service Broker: provides more customer service and investment advice, charges a high-end fee
o Discount Broker: just assists you in purchasing stocks you selected
- SEC: Securities and Exchange Comission
o The “policeman” of the securities (stocks and bonds) industry
- Prospectus: Discloses financial information about the company and filed with the SEC
- Accounting: Publicly traded corporations required to have annual financial statements