Client Investments: Basics of Playing the Stock Marketby
Once upon a time, investors came to financial advisors who worked at brokerage firms back in the days of fixed commissions. Because research and information wasn’t widely available, these firms had a pretty good deal. In those days, these folks were known as stockbrokers or “customers’ men.”
Jump ahead to today. Investing has become a spectator sport. Cable TV has stations dedicated to financial news. Commentators narrate the action like sportscasters. They create a sense of urgency. Meanwhile, online trading has brought the cost of transactions close to zero.
About half of all Americans have money invested in the stock market. But many don’t know what they are doing.
Basic Lessons to Pass Along
As their accountant, you might be able to educate them – at least just a little bit. Here are some basic stock market lessons you can give to your clients:
1. Leading indicator. The stock market is widely considered a leading indicator for the economy. If it rises, this implies the overall economy will be in better shape six-plus months down the road.
2. What is a share of stock? It’s a proportional share of ownership in a company. You buy it because you think the company will do well in the future. You want to share in its success. Common stock also has voting rights.
3.How much is a company worth? A good measure is market value. The price of a share of stock multiplied by the number of shares outstanding gives the market value of the company.
4. Why do the shares of two companies in the same industry sell for different prices? Broadly speaking, the company is a pie cut into tiny slices. The slices are different sizes between one pie and another. If the market value is higher and the number of shares lower, those shares sell for a different price than another company in the same business.
5. Why do stocks go up? Lots of reasons, but the primary one is based on earnings per share. The money a company makes is proportionately divided by the number of shares outstanding to show how much of those earnings is attributed to each share. The company also has another number: the price/earnings ratio. Theoretically, this number is pretty stable. If the per-share earnings go up, the price of the stock should rise proportionately.
Another important reason is the availability of other investment choices. Suppose a pension fund, thinking long-term, wanted a return of 9 percent. Your client might invest in the stock market because during the 20th century, the stock market averaged about 10.4 percent a year. However, if long-term Treasury bonds yielded 9 percent, a pension fund might consider that as an attractive alternative because you invest your money, hold it to maturity, get it back, and collect interest in the meantime.
6. What are dividends? You buy companies you hope will make money. Some companies plow all their earnings back into the firm in an attempt to grow the company even faster. These are usually “newer growth” companies. Other companies hand back a portion of the earnings to shareholders. These payments are called cash dividends. These firms might be more established, also called “value” companies.
7. The market hasn’t gone anywhere.Do people still make money? Some do. The stock market indexes get all the attention, but they are actually made of sectors containing a basket of stocks. Schwab produces a nice report on sector analysis.
For example, as of Aug. 30, 2016, the S&P 500 was up about 5.71 percent. Meanwhile, the telecom sector was up 16.64 percent, and the energy sector was up 14.39 percent. But the healthcare sector was only up 0.22 percent, or under 1 percent. Investors can buy exchange-traded funds representing different sectors.
8. Why do stocks go down? Many reasons, but a basic one is “the market doesn’t like surprises.” When lots of economists predict the health of the economy will be good and it’s bad instead, the market often declines.
9. Why does the state of the European economy matter to US investors? Investors might think they own American companies, but many are actually multinationals. They make money by selling products in several countries. If those economies slow or local currencies move against them, it hurts their profits.
Buying stocks and daytrading without understanding them is very similar to gambling. Investing involves owning a diversified portfolio of good stocks (or good managers) and leaving them alone. If certain companies with sound management have been in business for a hundred years, you can be pretty confident they can navigate different economic cycles.
But you still need to “watch your stuff.” Unfortunately, “buy and hold” isn’t often in favor when it costs almost nothing to trade online.
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Bryce Sanders is president of Perceptive Business Solutions Inc. in New Hope, Pennsylvania. He provides high-net-worth client acquisition training for the financial services industry. His book, Captivating the Wealthy Investor, can be found on Amazon.com.