Tag Archives: Investing

Market Jitters – Why the Chaos

 

market-jitters

Have you been reading the news lately? There has been a massive sell off of equities on the worlds largest stock exchanges. It seems to have started in China, but has spread like a virus.

There are a lot of factors involved in the sell off. Generally, when investors don’t have confidence in the market their money’s in, they sell their shares. How does this work if we’re supposed to be like Benjamin Graham and use a buy-and-hold investment strategy? Shouldn’t all investors be holding?

The thing to remember is that there are different kinds of investors. Most of the money that’s in stock exchanges doesn’t come from people like me or you, it comes from massive funds that need to constantly withdraw money from their investments and need to be sensitive to short term happenings.

Take pension funds for example. Massive pension funds worth billions of dollars exist in most states and provinces (Ontario Teachers Pension Plan has over $150 billion in assets). Pension funds are constantly withdrawing money and need to make sure they have enough money to see them through any slowdown without draining too many funds.

So though large institutional investors like pension funds will use a buy and hold strategy, they will also need to withdraw some money when they think the market might dip too much. What they are doing is basically guessing what the market will do.

Does that mean you should too? No, it is nearly impossible to accurately and consistently predict what stock markets are about to do, there are simple too many uncontrolled factors to take into consideration. For large funds, decisions are largely based on statistics. Institutional investors will attempt to time the market with mixed results, but the idea behind a buy and hold strategy is to buy into companies that will be resilient through a market downturn. In fact, if your favorite company’s share price goes down 20% because everything else has gone down 20%, what a great opportunity to buy more and watch it regain 20% almost as quickly as it shed it.

When the market has its bad days (and there will be plenty more bad days mixed with the good days), your best strategy is to take comfort in the fact that you’re in it for the long haul and to see momentary blips as opportunities to buy premium stocks at discounted prices, not reasons to panic and sell as a knee-jerk reaction.

As for the latest market shenanigans, it is largely a Chinese phenomenon that has reverberated around the world. In the years leading up to the current crisis, Chinese investors plowed money into the Shanghai Stock Exchange, inflating the value of many companies and effectively created a bubble. The Chinese government hasn’t helped by interfering in the market and introducing measures designed to keep the value of the stock market artificially high, rather than letting the market run its course and correct itself.

First Rule of Investing in Stock

first tip investing

If you had invested in Microsoft back in 1986, when they went public with their Initial Public Offering (IPO), you would have made 44,000% return on your investment (ROI). If you had invested $1000 in Microsoft then, it would be worth  $44 million today. This is why Bill Gates is still the richest man in the world, he owned the majority of Microsoft when it went public some 29 years ago.

Stories like this aren’t uncommon. Pretty much every publicly listed silicon valley company started off like Microsoft, and consequentially has amazingly wealthy founders. And thanks to stock markets, the ability to invest in other people’s good ideas and hard work is available to anyone.

There are many books, websites and careers based on investing in the stock market. So for this introductory post on the subject, I will simply say this: Invest in what you know.

To better illustrate this concept, consider this story that took place in the 1930’s. It was a party that a celebrated banker was throwing, he invited his business clients and colleagues. At the time, women weren’t involved in money matters much, especially the money matters of their extremely wealthy husbands. But the banker’s wife had inherited a small fortune from the death of a relative and wanted to grow the money herself.

She knew from listening to her husband and his friends talking about investing all the time that putting her money in the stock market was the best way to grow it. She saw one of her husband’s investment friends, Benjamin Graham, who at the time was a well respected investor (who later went on to define value investing, and teach other greats, like Warren Buffet).

The banker’s wife asked Benjamin, “What should I invest my money in?” to which Benjamin answered, “never invest your money into something you don’t understand. Invest your money in something you not only understand, but use every day.”

No one knew what the banker’s wife did with her money. Decades later, after her death, it was discovered that she had made a massive fortune, much more than her husband ever made, on the stock market. As it turned out, she followed Benjamin’s advice directly and invested in a revolutionary idea that she was uniquely positioned to appreciate, Tampax, the first makers of modern tampons.

If you don’t know what you’re investing in, you are literally relying on luck. It is possible that some solar panel company that just started up is going to go somewhere, but unless you know about solar technology, or how that industry works, all you can do is hope to get lucky, because you don’t understand what needs to happen for a company to be successful in the solar energy market.

I can’t tell you how much the concept of investing in what you know has changed my money outlook. I have invested in Google, and Visa because I use their products almost every day and I understand how their business models work. I love Netflix, and am very happy that I invested in them 5 years ago, before everyone had a subscription.*

In fact, all my dud investments (and there are a lot of them) have all been in companies I didn’t use or understand.

If you have some extra money you want to play with, and a couple good investment ideas that you personally use daily, then there is no shortage of companies for you to invest in. This means that if you love comic books and video games, invest in Disney (as they own Marvel now, and Star Wars, and have bankrolled all the big superhero movies in recent years). Like playing video games? Put your money where your mouth is, EA and Activision are on the Nasdaq, so is Sony and Xbox. Making lots of money with your home made goods business on Etsy or eBay? Maybe your unique experience makes investing in those companies a good idea to you.

A little more grown up than games and comics, and short of ideas? You should pay for an annual subscription to a publication that analyses individual companies for you. I have subscribed to the Motley Fool before, and indeed, that’s where I first read about investing in Netflix or Marvel. It is a great way to read about what other investors have to say about a lot of popular, and up and coming companies.

* As a full disclosure, I currently own shares in Disney, Google, Netflix and Visa. Though they have been a good investment for me over the years, they might treat you differently tomorrow.

Stock Exchanges – The First Sharing Economy Market

exchange

A stock exchange is really a large auction, like ebay, but for company shares. Stock exchanges allow anyone with a bank account to buy shares in companies and Exchange Traded Funds (ETFs). Companies sell small amounts of themselves to the public in exchange for ownership shares in an Initial Public Offering (IPO).

For example, Acme Inc might try and sell 1,000,000 shares of itself for $50 per share in order to raise $50,000,000, or more if investors think Acme Inc is going places. If things go well for Acme Inc, they will have traded tiny slices of ownership for at least $50,000,000. This would be called Acme Inc’s IPO, they can then use the new money to invest in their business (maybe acquire a rival, update their factories, etc).

IPOs also allow founding shareholders the chance to sell some of their shares to the public for what can be a small fortune.

For Acme Inc, raising money on a stock exchange might be better than borrowing money from a bank, or raising $50,000,000 from one person or small group of people who would then be able to exert control over the inner workings of a company.

Companies that have shares on a public exchange, like the TSE or the New York Stock Exchange (NYSE), are called ‘public companies‘ because any member of the public can own a part of these companies by buying shares on a stock exchange. Companies on exchanges are subject to various rules and restrictions though. For example, they have to publicly announce the status of their operations and finances every 3 months (quarterly reports), they have to publicly declare who is on their board of directors, which typically represents the biggest share holders of a company. Also, their finances have to be in good shape, or they will kicked off the exchange.

Most of the time, when you buy shares on a stock exchange, you are not buying them from the company you wish to invest in, but from another investor. You are only buying shares from a company directly if it has an IPO, or secondary public offering, or third, etc. Otherwise, you are buying from another investor. It is important to know that people will sell shares for many reasons, but will generally only buy shares in a company if they feel that the worth of the company will go up.

And the worth of the company is often described as its market capitalization: the number of available shares it has, multiplied by the value of each share. So Apple, the largest company in the world currently, has a market capitalization of $740 billion, and a current share price of $127.09, making the number of Apple shares available at 5.8 billion. Market capitalization is generally considered how much it would cost to buy a publicly traded company, if you wanted to completely buy Apple, the company, that would cost you $740 billion today.

But we’re not looking to buy a company, only the S&P 500. Our next step is setting up a self directed investment account.

In order to invest your money with the S&P 500 you need to open a special kind of bank account, a self directed investment account. Because the specific S&P 500 investment we want to make takes the form of an ETF, we need access to the Toronto Stock Exchange (TSE).

The S&P 500 itself is an index, an index that can be easily duplicated with a basic formula. Other financial companies have created funds using this simple formula, and made these funds available on the TSE, Canada’s main stock exchange.