Introduction to stock market investing

Stocks, bonds, cryptocurrency,… Investing is such an interesting topic! To see it this way, you have to get through the first barrier, learning basics. This article will guide your first steps in the investment world, but I invite you to do your own research. No one serves you better than yourself.

One essential aspect for financial freedom is obviously making money. Stock investing is not only an excellent way to make money. It has the advantage to generate money passively.

Imagine, you are waiting for a friend in your favorite bar. The waiter brings you the white beer that you ordered. Your friend, as usual, is late, so you check your broker, and BIM, you made 100CHF, while doing nothing.

Of course, as we will discuss, life does not only have a bright side. Investing implies risk management, strategy, emotion control and a bit of study before diving in. I am convinced that investing in stocks can be done by everyone, and can require less than an hour a month. You just have to study the topic before.

I will never say it enough. I encourage you strongly to study this topic and cross-check different sources! Search for serious sources of information, don’t read only this blog, dive into literature, forums videos.

But you have to keep in mind one thing. Quick, easy, safe and big wins don’t exist! I will say it again to be sure “Quick, easy, safe and big wins don’t exist!”

Yes, this advertisement, besides “Congratulation! You won an Iphone 12!”, that ensures you that you can win 10'000 chf in just 2 minutes is a lie. In fact, both advertisements are probably fake. So sad.

So please, to avoid that, consult many sources and make up your point of view. 🙂

The purpose of this first post is to explains different tools to invest. It is primary to have a good understanding of these concepts before digging more in detail. Advanced investors, brace yourself, we have tons of articles planned.

images/stock-graphs.jpg The stock market can be frightening. But with a little study, everyone can handle it.

What is a stock, bonds or indexes?

The first step in your investor career is to understand how you can invest! This article will go through the main aspects of stocks, bonds and indexes. With that, you’ll be able to understand better the overall working of stock market related investing.

Stocks

A stock, share or equity represents the ownership part of the assets and profits of a company. You buy a part of a company, just by buying a share! The price of your share will grow or decrease according to the company results and the enthusiasm of other investors. In addition to this price fluctuation, some shares are paying you dividends, which can provide an side income.

That is beautiful, you can own a part of your favorite company! Huh yes, but no… Keep in mind that you own a share issued by a corporation, you cannot walk in their office and take the coffee machine because it is “yours”.

This share is a part of the company shares. With this, you can gain access to company shareholder meetings and voting power, and dividends, if any.

Stocks are an excellent way of investing. However, it can become quite complex to pick the right one, at the right time. You can place part of your savings on a company that seems to have a bright future, and a virus comes. After one week, the stock price has decreased by 50%, you sell it and swear to never approach stocks again.

One year later, you become even more disappointed when while reading your newspaper, you see that the price has recovered. You would have doubled your initial amount. You could have even gain more if you would have wait that the share was underpriced. You will never touch stocks again.

Many strategies will help you avoid being in this situation. Keep in mind that stock investing is a highly psychological task. You have to be prepared. You have to have a plan. Following a plan is way easier and probably thousands of time more efficient than following your emotions. Your emotions can lead you to your worst investing choices.

These plans will be briefly described in future articles. For the moment, let us stick with stocks and questions that can come to your mind.

How can I gain money with stocks?

You want your part of the company profits, and you are right. You place your trust in them by investing in the company, you deserve part of the cake.

The first gain that can come to you is an increase in the stock price, resulting in a capital gain. A corporation having its revenue growth will attract investors, then increasing your share price.

The second one is dividends, the company is giving you direct money, corresponding to a percentage of the value of your share.

Who would say no to an income source? No one, right. Dividends are wonderful, free money coming every once in a while.

However, you have to keep in mind that in many countries, like Switzerland, this is considered and taxed as an income. You will pay taxes on your dividends.

Companies have an interesting alternative to redistribute company profits: Buying stocks back. The corporation will buy a determined amount of its stock back which will increase the value of your equities. Indirectly, you earn money.

Why do corporations sell stocks?

Companies are selling stocks to raise funds. By selling part of the company, new money arrives, which they can then use to increase growth. Everyone is winning, they get your money, you get a part of their profit, and you can then get your money back by selling the stock.

That sounds quite easy, so why don’t companies sell an unlimited number of stocks?

This is quite simple. Every time that the company sells a new stock, increasing the supply, it decreases the already issued stocks value. The supply increases, but the demand remains the same. That is the supply-demand law. You can find a good and visual explanation of this principle here.

Bonds

A bond is a loan between you and a borrower. That could be governments, cities or companies. Bonds are composed of an amount loaned to the borrower called face value, and interests called a coupon, which can be fixed or variable.

To understand this, we will take the example of a bond with a face value of 100 CHF, a coupon of 5% and a maturity of 10 years. After paying 100 CHF to get the bond, you will get 5% of its value per year, which are usually paid semiannually. Your bond will arrive at maturity 10 years later, you will then receive back the face value, 100 CHF. This will generate a passive income for ten years.

This is an excellent way to secure money. Some bonds, like government-backed ones, are considered extremely safe. No one can imagine countries like Switzerland or the United States not being able to reimburse the face value. These bonds safety can be compared to cash or gold.

The quality of a bond is often rated by private services, such as Standard & Poor. For the S&P, rating goes from AAA to BBB-. AAA bonds are typically government issued, they have an excellent quality, but often low or negative return. Lower rated bonds have higher coupon, but are not reliable into paying it.

The fact that bonds can generate a passive income with the coupon and their safety makes them an interesting way to secure your portfolio. Imagine the stock market crashing. If you have some bonds, it can greatly help you to absorb this downward trend, easing the psychological impact.

Price determination

The bond price may vary, depending on many factors, interest rates, company credit quality, etc. Therefore, its price is different from its face value. Lets look at this price variation, by analyzing the coupon rate influence.

An interesting property of bonds is that their price relation with the coupon is inverted. Let’s take the example that you own a bond that has a face value of 100 CHF with a coupon of 4%. Every year, you gain 4 CHF as a coupon.

Now, imagine that the issuer decreases the coupon of future bonds to 1%. Your bond still paying 4% will become more valuable. Its price has increased.

It is the opposite. If the interest rate increase, the value and price of your bond decreased.

images/phang-nga.jpg Bond is a good asset to secure your golden pistol ;)

Indexes

Indexes is a measurement method indicating the performances by grouping assets following criteria. The criteria may be the 30 largest US publically traded corporations, like the Dow Jones, or the 500 largest, like the S&P 500. These are an excellent indicator to the health of the large-cap US companies. Other well known US indexes are Nasdaq, Russell 2000,

For Switzerland, the most famous indexes is the SMI, which contains the 20 largest swiss stocks. Other swiss indexes are:

Indexes are the basis of a wide spread investment strategy. Its purpose is to replicate indexes, in a passive manner, to invest in a large selection of stocks.

This stragtegy reduce the portfolio volatility. If a company value drops, it will have a minor impact on the index, and therefore on the portfolio. To invest in indexes, the easiest type of investment is ETFs.

ETFs

Which stock should I invest in? It is a simple question which implies a complex thought process. ETF is an asset that can help you solve this process, and reach your trading goals. Let me introduce it.

Exchange Traded Funds represent a selection of assets, such as stocks, bonds, commodities, … ETFs usually regroup assets that have similar features. These may be:

This is a great method to diversify, simplify and stabilize the volatility of your portfolio. Some investing strategy relies on just buying 3 or 4 different ETFs. This kind of strategy, that can be understood and applied by anyone, have good long term results.

These funds may be actively or passively managed. A NASDAQ ETF consists of copying the index. This implies less work than a value based ETF, which implies a stock-picking process. The active management process has an impact on the fund fees, passively managed funds have usually lower fees.

ETFs look complex, but you simply buy them like a stock.

And like stocks, some ETFs also pays dividends. What a good news! They usually keep the dividends from their stocks and redistribute equally each quarter. These ETFs are called distributing funds. Others, called accumulating funds reinvests the dividends, having an indirect impact on your investment.

Many different investing alternatives exist, such as options, futures, preferred stocks, convertible… I won’t explain them in this post, as it will not be subject to the investing articles.

Following the KISS principle (Keep It Simple Stupid) is great. Keep your portfolio simple and easy to understand is a great way to avoid headaches and complex situations while rebalancing it or investing new money. Simple does not mean bad and brings you a better view of your portfolio states.

These alternatives may be also beneficial in some really specific situations, requiring experience and skills to spot. So if you feel adventurous or simply curious, I encourage you to visit investopedia.com, a real gold mine.

I hope this article was helpful and that you have learned something. Don’t hesitate to leave a comment if you have a question or remarks.