Investment Basics - Course 101 - Stocks and ETFs Versus Other Investments

By: Steve Bauer | Wed, Sep 1, 2010
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This is the first course in a series of 38 called "Investment Basics" - created by Professor Steven Bauer, a retired university professor and still a proactive asset manager and consultant / mentor.


 

Stocks & ETFs Versus Other Investments

Introduction:

We all have financial goals in life: to pay for college for our children, to be able to retire by a reasonable age, to buy and own the things we need and want. Unfortunately, spending less than we earn is typically not enough for us to reach our goals. We have to do more; we have to invest our savings and put our money to work. Stocks are quite simply one of the best ways to make your investment dollars work the hardest.

Investing in stocks is not rocket science. The only real characteristics shared among successful stock investors are basic math skills, a critical eye, patience, and discipline. However, you must not discount the importance of "experience." Combine these with an understanding of how money flows and how businesses compete with one another, along with a dash of accounting knowledge, and you have all the mental tools needed to get started. Then it's a matter of discipline, practice and experience.

Prof's. Guidance: I will teach you all these things and more over the coming weeks.

Although you don't need an advanced college degree to invest in stocks, selecting stocks is nevertheless an intellectual exercise. It requires effort, but it can bear many fruits. After all, investing in stocks not only leads to potentially higher returns on your investment dollars, it also leads to a greater understanding of how the world operates, like it or not.


What Is a Stock?

Perhaps the most common misperception among new investors is that stocks are simply pieces of paper to be traded. This is simply not the case. In stock investing, trading is a means, not an end.

A stock is an ownership interest in a company. A business or company is started by a person or small group of people who put their money in, as seed capital investment. How much of the business each founder owns is a function of how much money each invested. At this point, the company is considered "private." Once a business reaches a certain size, the company may decide to "go public" and sell a chunk of itself to the investing public. This is how stocks are created, and how you can participate.

When you buy a stock, you become a business owner. Period. Over the long term, the value of that ownership stake will rise and fall according to the success of the underlying business. The better the business does, the more your ownership stake will be worth.

Prof's. Guidance: This is best measured by the "earnings" of the company. And the earnings are subject to many variables.


Why Invest in Stocks?

Stocks are but one of many possible ways to invest your hard-earned money. Why choose stocks instead of other options, such as bonds, rare coins, or antique sports cars, Etc? Quite simply, the reason that savvy investors invest in stocks is that they have historically provided the highest potential returns. And over the long term, no other type of investment tends to perform better.

On the downside, stocks tend to be one of the most volatile investments. This means that the value of stocks can drop in the short term. Sometimes stock prices may fall for a protracted period. For instance, those who put all their savings in stocks in early 2000 are probably still underwater today. Bad luck or bad timing can easily sink your returns, but you can minimize this by taking a long look and different investing approaches.

There's also no guarantee you will actually realize any sort of positive return. If you have the misfortune of consistently picking stocks that decline in value, you can obviously lose money.

Prof's. Guidance: That is why you are taking your time to learn. Of course, I think that by educating yourself and using the knowledge in these courses, you can make the risk acceptable relative to your expected reward. I will help you pick the right companies to own and help you spot the ones to avoid. Again, this effort is well worth it, because over the long haul, your money can work harder for you in equities than in just about any other investment.


ETFs (Exchange Traded Funds)

Exchange Trade Funds (ETFs) are very much like mutual funds. That is, they are baskets of stock that are bought and sold, just like stock. They differ from mutual funds in that shares of ETFs can be traded at any time while the host stock market is open.

Many ETFs are based on an Index, Sector, Industry Group, County, Commodity, etc. making them exchange traded (specialty) funds.

For example: An Index fund is a passively managed collection of stocks that Index. One of the more common Index funds is one that closely matches the holdings and performance of the Standard & Poor's 500 - Index (S&P 500).

Prof's. Guidance: I recommend sticking with the big name ETF firms such as, iShares, PowerShares, or ProShares - that is if they have an ETF of interest.


Other Basic Investment Choices:

Let's see how stocks stack up to some of your other investment options:

Mutual Funds. Stock mutual funds can offer similar returns to investing in stocks on your own, but without all the extra work. When you invest in a fund, your money is pooled with that of other investors, and then it is managed by a group of financial analysts, (professionals) who try to earn a return by selecting stocks for the pool.

Beyond requiring much less effort, one key advantage of funds is that they can be less volatile. Simple statistics says that a portfolio is going to experience less volatility than the individual components of the portfolio. After all, individual stocks can and sometimes do go to zero, but if a mutual fund held 50 - 100 or more stocks, it would be very unlikely that all of those stocks become worthless.

The flipside of this reduced volatility is that fund returns can be muted relative to individual stocks. In investing, risk and return are intimately correlated--reduce one, and odds are you will reduce the other. Another disadvantage to offloading all the effort of picking individual stocks is that you must pay someone else for this service, often more than you may be aware of. The professionals running mutual funds do not do so for free. They charge fees, and fees eat into returns.

Plus, the more money you have invested in mutual funds, the larger the absolute value of fees you will pay every year. For instance, paying 1%, 2% or even 3% a year in fees on a $1,000 portfolio is not a big deal, but it's a much larger deal if the portfolio is worth $500,000. In the past, mutual funds often made the most sense for those with relatively small amounts to invest because they were the most cost-efficient. But with the advent of $10 (or less) per-trade commissions on stocks, this is no longer the case.

Just as picking the wrong stock is a risk, so is picking the wrong fund. What if the group of people you selected to manage your investment does not perform well? Just like stocks, there is no guarantee of a return in mutual funds.

It's also worth noting that investing in a mix of mutual funds and stocks can be a perfectly prudent strategy. Stocks versus funds (or any other investment vehicle) is really a personal decision.

Bonds. At their most basic, bonds are loans. When you buy a bond, you become a lender to an institution, and that institution pays you interest. As long as the institution does not go bankrupt, it will also pay back the principal on the bond, but no more than the principal.

There are two basic types of bonds: government bonds and corporate bonds. U.S. government bonds (otherwise known as T-bills or Treasuries) are issued and guaranteed (in the US) by Uncle Sam. They typically offer a modest return with low risk. Corporate bonds are issued by companies and carry a higher degree of risk (should the company default) as well as return.

Bond investors must also consider interest rate risk. When prevailing interest rates rise, the market value of existing bonds tends to fall. (The opposite is also true.) The only way to alleviate interest rate risk is by holding the bond to maturity. Investing in corporate bonds also tends to require just as much homework as stock investing, yet bonds generally have lower returns.

Given their lower risk, there is certainly a place for bonds - but be weary of owning bond mutual funds in most portfolios, but their relative safety comes with the price of lower expected returns compared with stocks over the long term.

Real Estate. Most people's homes are indeed their largest investments. We all have to live somewhere, and a happy side effect is that real estate tends to appreciate in value over time. But if you are going to use real estate as a true investment vehicle by buying a second home, a piece of land, or a rental property, it's important to keep the following in mind.

First, despite the exceptionally strong appreciation real estate values have had in the past, real estate can and does occasionally decline in value. Second, real estate taxes will constantly eat into returns. Third, real estate owners must worry about physically maintaining their properties or must pay someone else to do it. Likewise, they often must deal with tenants and collect rents. Finally, real estate is rather illiquid and takes time to sell--a potential problem if you need your money back quickly.

Some people do nothing but invest their savings in real estate, but just as stock investing requires effort, so does real estate investing.

Bank Savings Accounts. The problem with bank savings accounts and certificates of deposit is that they offer very low returns. The upside is that there is essentially zero risk in these investment vehicles, and your principal is protected. These types of accounts are fine as rainy-day funds--a place to park money for short-term spending needs or for an emergency. But they really should not be viewed as long-term investment vehicles.

The low returns of these investments are a problem because of inflation. For instance, if you get a 3% return on a savings account, but inflation is also dropping the buying power of your dollar by 3% a year, you really aren't making any money. Your real return (return adjusted for inflation) is zero, meaning that your money is not really working for you at all.

Prof's. Guidance: Just so you will know, my personal investment focus is the stock market and investing in Companies and ETFs.


Wrapping Up:

Though investing in stocks may indeed require more work and carry a higher degree of risk compared with other investment opportunities, you cannot ignore the higher potential return that stocks provide. And as I will share in the next course, given enough time, a slightly higher return on your investments can lead to dramatically larger dollar sums for whatever your financial goals in life may be.

Quiz 101
There is only one correct answer to each question.

  1. Which of the following types of investments provide the largest long-term returns?
    1. Stocks.
    2. Bonds.
    3. Savings accounts.
  1. Which of the following types of investments are the most volatile in their pricing?
    1. Stocks.
    2. Bonds.
    3. Savings accounts.
  1. Which of the following skills sets is NOT needed to be a successful investor?
    1. Discipline.
    2. A critical eye.
    3. Advanced statistics.
  1. Over the long term, which type of investment provides the lowest real (inflation adjusted) returns?
    1. Stocks.
    2. Mutual funds.
    3. Savings accounts.
  1. When you buy a stock, you are:
    1. Making a loan to a company.
    2. Buying an ownership interest in a company.
    3. Investing in the government.

 

Thanks for attending class this week - and - don't put off doing some extra homework (using Google - type "info" and the word or question) and sharing with or asking the Prof. questions and concerns.

 


Investment Basics (a 38 Week - Comprehensive Course)

By: Professor Steven Bauer

Text: Google has the answers to your questions, after exploring Google if you still have thoughts or questions my Email is open 24/7.

Each week you will receive your Course Materials. There will be two kinds of highlights: a) Prof's Guidance, and b) Italic within the text material. You should consider printing the Course Materials and making notes of those areas of questions and perhaps the highlights and go to Google to see what is available to supplement those highlights. I'm here to help.

Freshman Year

Course 101 - Stock Versus Other Investments
Course 102 - The Magic of Compounding
Course 103 - Investing for the Long Run
Course 104 - What Matters & What Doesn't
Course 105 - The Purpose of a Company
Course 106 - Gathering Information
Course 107 - Introduction to Financial Statements
Course 108 - Learn the Lingo & Some Basic Ratios

Sophomore Year

Course 201 - Stocks & Taxes
Course 202 - Using Financial Services Wisely
Course 203 - Understanding the News xxx
Course 204 - Start Thinking Like an Analyst
Course 205 - Economic Moats
Course 206 - More on Competitive Positioning
Course 207 - Weighting Management Quality

Junior Year

Course 301 - The Income Statement
Course 302 - The Balance Sheet
Course 303 - The Statement of Cash Flows
Course 304 - Interpreting the Numbers
Course 305 - Quantifying Competitive Advantages

Senior Year

Course 401 - Understanding Value
Course 402 - Using Ratios and Multiples
Course 403 - Introduction to Discounted Cash Flow
Course 404 - Putting OCF into Action
Course 405 - The Fat-Pitch Strategy
Course 406 - Using Morningstar as a Reference
Course 407 - Psychology and Investing
Course 408 - The Case for Dividends
Course 409 - The Dividend Drill

Graduate School

Course 501 - Constructing a Portfolio
Course 502 - Introduction to Options
Course 503 - Unconventional Equities
Course 504 - Wise Analysts: Benjamin Graham
Course 505 - Wise Analysts: Philip Fisher
Course 506 - Wise Analysts: Warren Buffett
Course 507 - Wise Analysts: Peter Lynch
Course 508 - Wise Analysts: Others
Course 509 - 20 Stock & Investing Tips

This Completes the List of Courses.

Wishing you a wonderful learning experience and the continued desire to grow your knowledge. Education is an essential part of living wisely and the Experiences of life, I hope you make it fun.

Learning how to profit in the Stock Market requires time and unfortunately mistakes which are called losses. Why not be profitable while you are learning?

 


 

Author: Steve Bauer

Steven H. Bauer, Ph.D.

Steve Bauer

Steve has several degrees, i.e. post graduate degrees and doctorate and a great deal of (too much) continued education. For seven years, he did a stent as a University Professor of Finance and Economics.

He owned a privately held asset management firm and managed individual investor and corporate accounts as a Registered Investment Advisor - for over 40 years.

Professionally he is a financial analyst and private asset manager / consultant / mentor.

Steve can be reach at senorstevedrmx@yahoo.com

Copyright © 2010-2011 Steven H. Bauer, Ph.D.

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