Stock Investing Basics

Stock Investing Basics - Part I

The Investment Process

What is investing? Any time you invest, you are putting something of yours into something else in order to achieve something greater. You can invest your weekends in a good cause, you can invest your intelligence in your job, or you can invest your time in a relationship. Just as you do each of these with the expectation that something good will come of it, when you invest your savings in a stock, bond, or mutual fund, you do so because you think its value will appreciate over time.

Investing money is putting that money into some form of "security" - a fancy word for anything that is "secured" by some assets. Stocks, bonds, mutual funds, certificates of deposit - all of these are types of securities. As with anything else, there are many different approaches to investing. Some of these you've probably seen on late-night TV. A well-dressed, wildly positive (though somewhat whiny) young man sits lazily waving palm fronds and shakes his head over how incredibly easy it is to amass vast wealth - in no time at all! Well, hey! That sounds fine! However, discerning minds will wonder: If it were so easy, wouldn't everyone who saw the same pitch be rich? Then, too, you always have to send some money to learn the secrets. So we suggest you take the $25 you'd spend on the hardcover EZ Secrets to Untold Billions book and the $500 you would shell out for the EZ Seminar, and invest it yourself - after you've learned the basics here.

Time Value of Money

Is a dollar always worth a dollar? OK, you sly fox - you caught us, it's a trick question! And you guessed it - a dollar is not always worth a dollar. Sometimes a dollar is only worth 80 cents, and sometimes it is worth $1.20. (Say! You give us your dollars worth $1.20, and we'll give you ours worth $0.80, in an even trade! Have we got a deal?)

But let's think about this. How can it be? The value of a dollar changes dramatically depending on when you can take control of the dollar and invest it. The critical variable in the exact value of a dollar is time.

If someone owes you a dollar, do you want him to pay you today or next year? (Yes! Another trick question! The answer is, "Today.") With inflation consistently destroying the purchasing power of a dollar, a year from now a dollar will be worth slightly less than it is today. "Inflation" is an economic term used to describe the gradual tendency of prices to rise over time. If inflation is 2% per year, that means that prices, on average, will rise 2% over the next year, which in turn means that your dollar can purchase 2 cents less in a year than it can today. That's right, all you mathematicians out there - with 2% inflation, a dollar today is worth only 98 cents in a year.

However, if you got the dollar back today, you could invest it. If you invested it (along with a few of its cousins, we hope) in the stock market, and your investment returned 10% over the course of the year (which is somewhat less than the market average has historically returned), then you'd have $1.10 at the end of the year. So your money would be growing instead of shrinking, and you'd be staving off the negative effects of inflation.

The Miracle of Compounding

In fact, if you leave this dollar invested, its value will mushroom over time through the miracle of compounding. As you earn investment returns, your returns begin to gain returns as well, allowing you to turn a measly dollar into thousands of dollars if you leave it invested long enough.

The more money you save and invest today, the more you'll have in the future. Real wealth, the stuff of dreams, is in fact created almost magically through the most mundane and commonplace principles: patience, time, and the power of compounding. To heck with your lousy odds in the lottery or with someone's "Wealth in Nanoseconds!" pitch.

Look at it another way -- if you were to take a mere $20 a week and put it into an index fund, then at the end of 40 years, assuming a modest 12% return, you would have just over a million bucks. In short, you would basically have won the lottery -- for $20 a week, or a total of $40,800 out-of-pocket along the way.

We like those odds.