I want to keep this simple because stocks do not have to be complicated, but can get wicked complex fast. For your investing journey, the theme is: start simple, get fancy later.
On that note:
Stock Definition: A security that represents ownership in a corporation.
If we go back to The Awesome Lipstick Company, time has been friendly to us. The years have passed, and you and I now own the most successful lipstick company in the history of well, lipstick.
Now we have a new problem.
It is the year 2021—we have refinanced our 2020 debt with a new bond issue: The Awesome Lipstick Company 6.7% 07Nov2025, but to expand into Europe, we need to raise $50,000,000.
Our Investment Banker advises us that it would be difficult for us to issue that amount of debt (through a secondary (another) bond issue) and that our best option would be to take our company public.
What does this mean?
It means that you and I will no longer be the only owners of the company. We are going to keep 51% of the company for ourselves (so we will always have a voting majority). And we are going to sell 49% of our company to the public for $50,000,000.
How are we going to do this?
Think of company ownership like a pie. We are going to keep 51% of the pie pieces. And the remaining 49% of the pieces of the pie are going to be sliced (very carefully..) into 1,000,000 pieces.
And then we are going to allow investors to purchase each pie piece—called stocks or shares—for $50 each.
Therefore, if an investor purchased 200 shares at $50 (at a cost of $10,000), she is the legal owner of .0098% of The Awesome Lipstick Company.
And that is the short version of how and why the world created stocks.
Why would an investor want to own stocks?
Short answer: Because they rock.
A couple of notes on why:
Stock markets in the developed world delivered an annualized return of 8.5% over the last 100 years. (Historical rate of returns for bonds are just over 6%)
Common stocks allow you to (potentially) receive dividends (a portion of the company’s income distributed in cash). Dividends have accounted for over 40% of stock market returns since 1930.
While investing in shares does not (sadly) allow you to manage the company, holding the common stock of a firm allows you to vote at the company’s annual general meeting. This benefit may not be the primary reason to purchase stock, but you have to admit, it’s still pretty cool.
At the risk of repeating myself, please do not invest directly in stocks. Even if the company is the best company in the world, with the greatest prospects for growth, you almost never want to be exposed to the risk of a single company.
Buying stocks is what? Active management. And does active management beat passive management over the long term? No.
So do not think that investing in stocks is going to get you a higher rate of return that a balanced and diversified portfolio of ETFs. It won’t.
That’s it for today’s lesson!
A Primer On Compound Interest
Inflation—What the Heck?!
Mutual Funds 101
Exchange Traded Fund (ETFs)
The Dreaded MER (aka high fees)
Bonds? I’ll take one, thanks!
So you want to own stocks? Me too.
An Introduction to Asset Allocation
RRSP or TFSA?
Bonus: Dividends, your new BFF
PS. If you absolutely want to to invest in stocks, because you want to try it, not because you think you need to, my online course, Zero to Portfolio, An Investing MasterClass, has a bonus module on how to pick stocks (hint: we cover fundamental analysis, technical analysis and value vs. growth strategies). But no, sadly—no hot stock tips.
The Fine Print:
Investing Bootcamp is provided as an educational resource and should not be construed as individualized investment advice, nor as a recommendation to buy or sell specific securities. The investments and scenarios discussed in the course are examples only and may not be appropriate for your individual circumstances.
The investing strategies presented in Investing Bootcamp will result in losses during any period of decline in the broad stock and bond markets. All investments carry the risk of loss. It is the responsibility of individuals to do their own due diligence before investing in any index fund or ETF mentioned in this course.