The Quick Guide to Investing

In 1171, 109 years after the establishment of the Dutch East India company — often seen as the first key event in the rise of the stock market –Venice was in trouble. Wars had depleted their coffers. The government was often worried and, indeed, focused on how little money it had — it was eventually forced to take loans from the citizenry. The loans paid at 5% interest per year, had an indefinite maturity date, and represented the start of the bond market.

Now, nine centuries later, stocks and bonds are firmly rooted as a part of our economy, and they invite people to trade with the promise of wealth. But investing is both complicated and risky, and a lot of things must be considered before entering into the stock market.

How Investing Works

When a company starts out, it is owned by its founders who finance their corporation’s plans by themselves or with the help of their friends (the entrepreneur world refers to this stage of financing as “friends, family, and fools”). But once a company has grown so large that it needs more capital than it is able to produce, a company can produce additional funding by one of two ways – taking on debt or raising capital.

When a company decides to go public, they issue shares of stock. In essence, each share represents partial ownership of that company. If a company has 1,000 shares, then each individual share represents ownership of 1/1000th of the company.

Investing works by allowing individuals to buy multiple shares from a variety of different companies. The investors pay the stock price, and then when the stock price rises, the investors can sell of their shares and pocket the additional cash for themselves.

But remember: When you own a share of the company, you carry the financial risk of the company along with you. If the company goes bankrupt, your share loses its value as well, and while your credit isn’t negatively affected, you have lost your money.

Qualifying Risks/Benefits

When it comes to actually investing, the most impotant question to ask yourself is “How much risk am I willing to take?” The amount of risk you’re willing to take will determine how much money you will either gain or lose. As a general rule of thumb, the less risky your investment, the smaller the reward. With a more risky investments you have much more to gain, but the danger of losing money also increases.

Below is a list of some general guidelines for mitigating risk wherever possible, while still allowing yourself some investment flexibility:

  • “Buy low, sell high” – It’s the most repeated cliche in all of investing, but it is much more difficult than it sounds. Buying low and selling high requires predicting the market, something even the best investors have trouble doing. It requires patience, and sometimes taking short term losses in hopes of long-term gains. But, as top economists suggest, it is a method to stick to.
  • Debt – A company’s debt is a good indicator of how risky an investment is going to be. A company with no debt can still fluctuate in value, but no company with zero debt has ever gone bankrupt. However, don’t let the existence of debt scare you away from investment. There are many good reasons to carry debt, and a lot of today’s large, stable companies choose to carry debt. Even companies like Google, who went a long time without any debt, are starting to issue debt. This is because it isn’t the amount of debt that a company has that leads to bankruptcy; it is their inability to manage debt.
  • The Numbers Don’t Lie – It’s never a good idea to go off of a single number when making investment decisions. This is why many investors look at a company’s financal statments, and use ratios like the debt-to-equity ratio to figure out whether or not the company is in financial danger. These ratios provide a better overall indicator of a company’s financial security, which leads to better investments.
  • Dangers of IPOs – When a company makes its Initial Public Offering (IPO), offering shares to the public, they do their best to gain publicity, and thereby raise more money. This can lead to many companies being overpriced during their IPO. While there have certainly been someincredibly successful IPOs, for each success story, there are hundreds of failures.
  • Investing takes time – There is a notion that the investment world is fast paced, making thousands of trades an hour. The image of the crowded floor at the New York Stock Exchange has become a popular one in movies; however, often times investing is done at a much slower pace. It is important to not let yourself get caught up in emotions. Just because a stock drops in price doesn’t mean it’s plummeting. Likewise, just because it rose in price doesn’t mean it’s time to sell.

Online Investing Resources

Despite all of these tips to help mitigate risk, it is still important to remember that all stocks can crash, and if you continue investing long enough, it’s inevitable that there will be days where money is lost. This is why the number one rule when investing resources is do your research. Whether you are planning to invest some of your extra cash , or are looking to dive head first into the face-paced life of investment trading, the following links will provide you all you need to ensure that you’ll be ready to tackle the market in any capacity.

  • www.investingonline.org is a good starting place for those interested in investing online. It covers the steps required to invest online, and also debunks some of the common misconceptions about online trading. It is maintained by the North American Securities Administrators Association (NASAA).
  • http://www.investorguide.com/ offers a huge database on companies currently trading, and is a good source to gather information before you make your trades.
  • If you are still concerned with the potential for losing your money, a virtual stock exchange is a good way to get experience in investing, without risking your checkbook.