So Many Shoes, So Little Money – Blog

Stocks

August 21st, 2009

Just as you need different shoes for different outfits, you need to invest your money in different ways for different reasons. As you have seen, when you put your money in the bank, whether you put it in a checking or savings account, you are keeping it as cash. But, as you have also seen, your money can work harder for you. You could buy US treasuries or corporate bonds. Buying treasuries and bonds is riskier than leaving your money in cash. However, thanks to their higher interest rates and coupon payments, your money is still relatively safe and earns you a better return than you would get from a checking or savings account.

There is yet another kind of investment that is riskier than either cash or bonds but which can earn a higher return. The name for this type of investment is a stock. Buying a stock is buying ownership in an individual company (business); how much ownership depends on how much stock you buy.

For example, if a stock is selling for 110 dollars per share and you ask your stockbroker to purchase 110 dollars worth, you now own one share of the company. If the company has one hundred thousand total shares outstanding, you just bought .00001 percent of the company. If you want to buy stock in shoes, for example, you could purchase stock in Crocs, Heelys, and Nike. Or, perhaps you prefer to own a piece of a shoe store such as Shoe Carnival. When you buy a share of stock, you are buying a small piece of everything the company owns and owes. (You are literally buying a piece of a company.) Ownership in a company, and therefore stocks, are also referred to as equity. Equity means ownership and you now have equity in the company. Remember, bonds are debt—they are a loan to a government or company. With stock, you can not only own a piece of these companies, but you can show your brand loyalty by wearing them.

If a company does well, your stock goes up and you share in their good fortune. Unfortunately, if a company does poorly, your stock goes down and you share in their misfortune. There are few limits on how well or how poorly a company might do. As a result, there are few limits on how well or poorly a share of stock might do and therefore how much money you might make or lose.

This is an important point: Remember, bonds pay a fixed interest rate. You basically know what return you are going to get when you buy a bond. While it is true that interest rates rise and fall and that bond prices rise and fall accordingly, bond prices are not nearly as volatile as stocks are. They do not rise and fall nearly as much as much as shares of stock in a company can.

There are lots of reasons companies do well and lots of reasons they do poorly. Let’s use the company Apple Computers as an example. In 2003, Apple introduced the iPod which was a smashing success. In 2007, they introduced the iPhone which was also a smashing success—two very popular products in a row. People bought lots of both. As a result, between 2003 and the end of 2007, the price of Apple’s stock increased approximately 700%! (It depends on which exact days in those two years you use to figure it out.) So, one dollar invested in Apple stock in 2003 would be return seven dollars in 2007. (The more money you invested, the more money you could make: 1,000 dollars invested in Apple stock in 2003 would return 7,000 dollars in 2007). Cha Ching. Apple made good products, sold a lot of them, and their stock increased. But then, Steve Jobs, Apples’ founder and CEO, became ill and took a leave of absence. The company’s future was in doubt and its stock went down. So a company’s stock can go up or down for a variety of reasons.

Sometimes companies come out with un-popular products and their stock goes down. For example, in 2006, Revlon developed a line of cosmetics called Vital Radiance, was aimed at women over 50 and did not sell well, at all. Revlon continued to launch other new products some of which also did not do so well. If you had purchased one share of Revlon stock in the middle of 2006, at the end of 2008, just two and half years later, you would have lost approximately 44 percent of your money. One dollar invested in Revlon stock in 2006 would have returned only fifty six cents in 2008. (The more money invested, the more money you would have lost: 1,000 dollars invested in Revlon in 2006 would return 560 dollars in 2008). Cha No-Ching.

So, companies that issue stocks can earn and lose money for lots of reasons. As their fortunes go, so does their stock price. And, by owning their stock, you make or lose money right along with them. It is because of this relatively un-limitless ability of companies to earn or lose money that stocks are considered less safe than bonds.

Filed under: Investing

Tags: stock