When you a buy stock you are buying a piece of ownership in a company. What does it mean to be a partial owner? What, besides getting the right to brag to your friends that you own a piece of a company, do you have—or get, depending on your attitude—to do?
Well since you are a shareholder, you own a right to everything the company owns. The more shares of stock you own, the more of the company you own. You actually own a slice of all the company’s assets. An asset is anything the company owns that has commercial value. Think of an asset this way: Your personal assets include anything you own which you can sell on eBay. A company’s assets include things like desks, chairs, computers, contracts for business, sometimes the building they are in. Obviously, some things a company owns have more value than others.
As a shareholder (a person who owns stock), you also have the right to your share—hence the name—of the company’s earnings (the money the company makes, its profits), as well as the right to vote at the company’s annual meeting on the board of directors. Once a year, companies hold meetings to review their performance over the previous year, discuss the upcoming year and to elect the people who run the company. One share of stock equals one vote. What you don’t have is the right to run the company, at least day-to-day. Instead, you get to help decide—along with all of the other shareholders—who will run it on a daily basis.
The importance of stock ownership is that you own a portion of the company’s assets and are entitled to a share of the company’s profit, the money left over after the company subtracts all of its bills (its debt) from all of the money it took in. As you learned in previous blogs, bonds pay interest in the form of a coupon. Well, when companies do well they pay a version of interest in the form of dividends, that is, they pay their shareholders some of the profits, usually on a regular basis. Sometimes dividends are paid quarterly; other times, annually. Unlike coupon payments on bonds, dividend payments are not a given. If the company is doing well, the management of the company may decide to pay a dividend. But, they do not have to do so. They can do well and decide not to pay a dividend. If they do pay a dividend, they also get to decide how they are going to pay it. Dividends are most often paid in two ways: Cash or in additional shares of stock.
Fashionista Fact:
In the 16th century, Catherine de Medici was engaged to the powerful Duke of Orleans, who later became the King of France. She was petite (not quite five feet) and felt insecure compared to the Duke’s taller and favorite mistress, Diane de Poitiers (who wouldn’t? Diane was considered exceptionally beautiful). So for her wedding, she asked the shoe maker to add two inches to her shoes which gave her both height and a captivating walk. Needless to say, the shoes were a huge success. Given her status as the Queen of France, high heels quickly became associated with privilege and power. Needless to say, her risk paid dividends (not punny – sorry!).
August 25th, 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.
August 21st, 2009
When you buy a bond, the elements I mentioned in my last post create a language which might sound/read like this: This bond has a face value of 1,000 dollars, a coupon of 6 percent, and a maturity of 10 years. The total principal of the bonds to be issued is $10,000,000.
If you bought this bond when the company originally issued it, you would pay 1,000 dollars to the company, receive a total of 60 dollars (1,000 dollars times six percent) of interest per year for the next 10 years, by check, from the company. When the bond matures, after the ten years are over, the company will send you back your 1,000 dollars. So the total amount of money you stand to earn on this bond is 600 dollars (the interest the company paid you over 10 years.) Plus, you will get your original principal back as well.
Remember how I have written about opportunity costs ? (See May 5, 2009.) Understanding the difference in the risk/reward profile between treasuries, and bonds is an example of just how important this concept is. Let’s assume you have 1,000 dollars to invest. Which should you choose: A CD, a US treasury or a corporate bond? Since the amount of money you have available to invest is finite, you have to make your decision based upon your risk tolerance and the interest rate, and therefore the return you can expect to receive. The CD will pay the lowest interest rate, but is federally insured so you do not run any risk of losing your 1,000 dollars. The US treasury will pay more interest than the CD and is an obligation of the federal government, but it is not insured or guaranteed by anyone. So it is possible, although highly unlikely, that you could lose some of your principal if the US government decided it couldn’t pay all its debts.
The corporate bond will pay more interest than either the CD or the treasury, but is neither insured nor backed by the federal government. Instead, it is backed by an individual company, and depending upon the financial health of that company, the bond might not repaid in full when it matures. As we’ve discussed, you will get paid more interest for loaning to a borrower who is less likely to pay back the loan. The less likely the borrower is to pay you back, the riskier the loan and the higher the interest rate. So while choosing a safe low paying investment is fine, it also means you will miss out on the opportunity to earn more if you can learn to pick healthy borrowers who pay a higher interest rate.
For now, know that bonds, whether from the US government or a company, are a sensible and versatile alternative for the beginning investor. Like flats, they can make almost any outfit look good and ensure comfortable feet!
Fashionista Fact:
In the United States, women spend approximately two billion a year to make their feet more comfortable from surgery correcting problems generated by tight-fitting shoes and bunions. There is even a treatment to help make high heels more comfortable which combats pain by injecting collagen or DermaFiller into the fat pad in the ball of the foot.
Generally, the higher the heel, the higher the risk for future foot problems. Comfort offers a lower return, while the return from style is much higher. But remember there is an opportunity cost!
August 14th, 2009
Why do companies issue bonds? If they need money, why don’t they just go to a bank and borrow it? There are a few reasons, but the main reasons are that borrowing from a bank can be very restrictive and very expensive—more expensive than selling a bond to the general public. In other words, banks are usually more conservative when it comes to investing than people are. (Unfortunately, this is not always true—I wish they had been more conservative before making all those home loans that could never be repaid.)
So it costs a company more to borrow from a bank than it costs them to borrow from you. Plus, when a company borrows money from a bank, the bank often tells them what they can and can’t do with their money. The banks give the company lots of rules, which are called covenants. For example, a bank might tell a company that the money can only be spent on one thing, like operations and not on expansion. Or the bank might say that if the present head of the company leaves the company, all of the money is due back to the bank immediately. Or the bank might tell a company how much cash it must keep on hand at all times. Sometimes the bank requires the company pay back the loan too quickly for the purposes the company is raising money for, like building a new plant.
Companies can find these rules stifling. So, instead of going to a bank for a loan, a company will issue a bond through the bond market. (Think of a bond market as a huge shoe store—where you can buy all different kinds of shoes. In the bond market, you can buy all different kinds of bonds.)
Company bonds are typically issued in 1,000 or 5,000 dollar increments. These increments are called the face value. Face Value really refers to your principal—the amount of money you paid for the bond. The face value has to be paid back to you within a set time frame, called a maturity. The time period in which the face value must be paid can vary from as little as 30 days to as long as 30 years and anywhere in between—there are bonds with even longer maturity dates than 30 years, but they are rare. But typically a bond’s maturity is seven to ten to fifteen years in the future.
Generally in exchange for borrowing your money and issuing you a bond (which is the piece of paper or contract that describes the terms of the loan), a company will periodically pay you interest. Interest is the fee the company pays you for borrowing your money and is no different from the interest the bank pays you. When interest is paid from a bond rather than from a bank, it is called a coupon. To reiterate, a coupon payment is conceptually no different from the interest the bank pays you for leaving your money in a savings account. And, just like with a treasury, the longer the company borrows your money, the higher the interest rate because the longer you are agreeing to tie up your money.
So, when a bond is issued, the bond issuer (the company borrowing the money) determines how much money they need to borrow, the total value of each individual bond (principal), how long they need to borrow the money for (maturity), and the fee they are willing to pay to borrow the money (interest rate or coupon).
August 7th, 2009
Just as flats are a sensible and versatile shoe for women, corporate bonds can a sensible and versatile investment for the beginning investor. A corporate bond is a loan to a company for a set period of time. If you have been reading this blog then you already know all about them – they are pretty much the same as US Treasuries. The exact same explanations and logic apply except that corporate bonds (or “Corporates”) aren’t guaranteed by the US Government. Rather, they’re guaranteed by the particular corporation from whom the bond is purchased. Therefore, they are a bit riskier than treasuries but, as a result, pay a bit more in interest (a “higher return”). (Remember, the lower the risk, the lower the return; the higher the risk, the higher the return.)
When you buy a corporate bond, you agree to loan your money to a particular company, rather than the US government, in exchange for interest payments that the company will make to you. You can buy corporate bonds from a lot of different companies (lots of different types of companies sell bonds), for example Microsoft or AT&T. Buying a corporate bond is considered riskier (less safe) than buying a treasury or savings bond. Why? Because treasuries and savings bonds are backed by the US government while a corporate bond is backed only by the particular company from whom the bond is purchased. And, unlike to government, a company can’t print more money or raise taxes to pay its debts.
Just like with treasuries, the company that issues the bonds you buy will return your money (your initial investment) plus the interest you’ve earned (the company selling the bond sets the interest rate at the time they issue their bond) once the bond has run its course at a later set date (maturity).
Usually you receive your interest rate payments in the form of checks, sent out within a set time frame, often semi-annually. Then, when the loan matures, you receive the full amount of your original loan back. The original amount you loan the company is called the “Principal”.
Company bonds usually refer to loans that are longer than one year, but like the US government, corporations can also issue shorter term loans. These shorter term company loans are called “Commercial Paper”.
More corporate bonds tomorrow.
August 5th, 2009
According to In Style Magazine, in 2008, women spent more than 5 billion dollars on heels!
The breakdown by inches:
- 0 – 1 inch: 1 billion dollars
- 1 – 2 inches: 1 billion dollars
- 2 – 3 inches: 1.6 billion dollars
- 3+ inches: 1.5 billion dollars
By anyone’s measure, that’s a lot of shoes!
August 3rd, 2009
Jimmy Choo will bring its international glamour and covetable shoes and bags to selected H&M stores. Woo Hoo – talk about style on a budget!
The collection will be available from November 14 in around 200 stores across the world.
http://online.wsj.com/article/SB124522785484222715.html
July 28th, 2009
No more excuses! A new iPhone app from Quicken connects you with your bank and also let’s you enter your cash purchases.
You know…the money that seems to leave your wallet without your knowing it… and which you can never figure out where it went…
It even tells you what’s left – how much money you have in your account. What, no iPhone? You can still use their simplified version at m.quicken.com.
http://blog.quicken.intuit.com/2009/04/30/introducing-our-first-iphone-app-quicken-online-mobile/
July 27th, 2009
Lace is so last year. In 2008, one of the big fashion trends was lace. In 2009, apparently it’s see-though. Now, I know there is a recession and that times are tough for a lot of folks. However, might I suggest that rather than forgoing a shirt, shop your closet and wear last year’s.
You don’t want to wear something you might really regret…and then have pictures to prove it:
http://www.huffingtonpost.com/2009/07/21/sheer-genius-2009-is-the_n_242275.html
On the other hand, you’ll certainly get your drinks paid for!
July 23rd, 2009
In addition to treasury bills, treasury notes and treasury bonds, the US government also issues savings bonds. There are two kinds of savings bonds: “I” savings bonds and “EE/E” savings bonds.
I savings bonds can be purchased for as little as 25 dollars up to a maximum of 5,000 dollars. They pay an annual interest rate which is adjusted twice a year based on the consumer price index. The consumer price index is a measure the government uses to calculate inflation. As the index changes, your interest rate rises or falls during the time period of your bond. This is how the amount of money your money earns for you keeps up with the rate of inflation: when inflation is high, you earn more interest; when inflation is low, you earn less interest.
Note: Inflation is the reason keeping your money in a shoe box or under the bed is a bad idea. A dollar today will buy more than that same dollar tomorrow. If you put your money in a shoe box, and decide to spend it ten years later, the amount of money you put in will be worth less (you will be able to buy less with it) than you would have at the time you tucked it up in your closet.
Note #2: Fashionista Fact:
Manolo Blahnik’s first shoe collection appeared in 1972, when after presenting the legendary Vogue editor Diana Vreeland with some theater design sketches, she advised him to “go with the shoes”. Today, a pair of his fabulous shoes (known to Fashionista’s everywhere simply as Manolo’s) start at 500 dollars. In 1972, they would have cost 102 dollars—102 dollars in 1972 is the same as 500 dollars today. That’s inflation at work.
The interest paid is added to the value of the bond each month and is paid to you when you cash the bond I savings bonds must be held for one year but can be held as long as thirty years. There are some penalties if you hold them less than five years, but the maximum penalty is the forfeiture of three months interest.
EE/E savings bonds have many of the same characteristics as I savings bonds: they, too, can also be purchased for as little as 25 dollars up to a maximum of 5,000 dollars. They also must be held for one year but can be held for as long as thirty years. They have the same penalties as I bonds, forfeiting three months interest, if you hold them less than five years. However, unlike I savings bonds, EE/E savings bonds pay a fixed interest rate. Instead of calculating the interest rate based on the consumer price index as Series I bonds do, the interest rate is a combination of a fixed rate, which applies for the life of the bond, and a semiannual inflation rate which is calculated on an average six-month rate of interest on US government treasuries.
So the biggest difference between the two kinds of savings bonds is how the interest is calculated. And how the interest is calculated determines the interest rate you receive and, of course, reflects how hard your money is working for you.
You can buy savings bonds or treasuries, learn what interest each type of savings bond is paying, and otherwise get additional information at www.treasurydirect.gov. This website is managed by the Department of the Treasury. Reviewing this site is a good way to determine which of the two Series are best for you.
July 21st, 2009
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