A Common Misconception About Owning Stocks

As promised, the Booby will occasionally share advice regarding your money, and how to potentially make it work for you and increase your options, opportunities, and power. If you’re careful and disciplined, owning stocks can contribute to all the above.

Owning stocks is not foolproof, of course. There are risks, and doing it right requires long-term commitment. However, for fellas who possesses the discipline and who choose well, stock ownership can gradually increase their power and independence.

Whether you choose to invest in stocks is entirely up to you, and only you can decide whether that’s an option you wish to pursue. The Booby is not here to tell you whether you should invest in stocks, or if so in which stocks, or how much of your portfolio should be devoted to stocks. The Booby’s job is simply to help educate you.

Or are you still waiting for your teachers to educate you? Hopefully not.

There is a common misconception about owning stocks. Many people, including some fairly savvy investors, believe that you buy stock in a company simply because you believe it will increase in value at a tantalizing rate.

Now, to be sure, there’s nothing wrong with buying a piece of a company and then watching its price rise at a tantalizing rate. However, no one knows for sure which stocks will do just that, and it’s also a fact that companies whose values ascend rapidly often tend to be those whose values descend rapidly when things go awry.

Instead, think of company stock like any other kind of product you would go shopping for, like a TV, for example. When you buy a TV you should have some idea of what that product will do and what features you want it to have. Maybe you want smart technology, or perhaps something portable. Based on your needs you then find a TV that offers the best combination of meeting those needs at the best price.

Stocks aren’t entirely different. You are buying a product, in this case ownership in a company. Of the many things you should look at is quality. Is the company established and stable? Does the stock price have the potential to increase over time, even if only modestly? And – most importantly for the purposes of this lesson – does the company pay its stock-holders a good dividend, or in other words, income?

A Second Income: Man’s Best Friend

The dividend is what you use to your long-term advantage by building a yearly stream of income. Let’s say you purchase 100 shares in Company X at $10/share. You have just paid $1000 for 100 shares of a company. But what are you expecting your purchase to do for you?

Today’s discussion is about income. Hopefully you researched the amount of income (what investing geeks call “yield”) that your company pays out annually to shareholders like you. If the “yield” is 4% of the purchase price per year then you can reasonably expect to be paid $40 per year in income from your 100 shares regardless of whether the stock price goes up or down.
_______________________________________________________________________________

1 Share of Company X is worth $10.

You own 100 shares:  100 X $10 = $1000

Each share pays $0.40 per year to shareholders annually (which equals a 4% annual return based on $10 per share paid)

100 shares = $40 paid annually to you, the shareholder
_______________________________________________________________________________

Too many investors will purchase shares in a company, then click on the internet every day to track the stock price, to see whether it’s going up or down. This is not necessary. If you purchase your stocks with the intention of holding them over long periods of time you should mainly concern yourself with the annual payments – ie. the income – that the stocks are paying you. You just purchased a product that you hope will pay you $40 per year into the foreseeable future.

Yes, of course we want to see the price of our stocks go up over time. However, a meticulous long-term investor will be less concerned with the day-to-day stock price than with creating a steady source of income from the aforementioned dividends.

Why? Because hopefully the stocks you purchased this year will only be the first.

Next year, if your finances permit, you will buy more shares, perhaps in Company X again, or perhaps you will purchase shares in a new company, say Company Y.

Now, if Company Y pays you $35 per year in dividends, then that means your combined shares in Company X ($40) and Company Y ($35) are now paying you $75 per year after two years.

If you can keep this up every year then your annual income will keep growing, and if the market price of your shares increases then your paper net-worth will increase, too.

Your goal should be that one day the annual dividends will provide you with a significant second income. A second income increases your power. You are less dependant on your job, less beholden to your employer. If you lose your job you still have some income coming in.

If you are smart enough to resist spending your second income every year, and reinvest it instead (what you reinvest it in – whether more stocks, bonds, or GICs – is less important than the fact that you reinvest it) then your alternative income will only grow larger, faster.

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There are, of course, risks. Consider these:

Companies are not obliged to maintain the annual dividend payouts to shareholders. Depending on the financial health of the company, it’s executives may deem it necessary to lower the annual payout (of course, they can sometimes increase it, too).

The company’s share price may not necessarily go up, or it may experience volatility. You may find that two years after buying the aforementioned 100 shares in Company X for $10 per share, the market value of those shares has dropped to $7 per share. This is the nature of markets, and there is no guarantee any company’s share price will increase.

Companies sometimes go bankrupt. It’s possible that a company will suffer catastrophic financial losses and see its share’s value drop to zero, or close to zero. It’s not common, but it happens.

You can mitigate these risks by doing research, and using common sense. For example, a startup mining company is unproven and thus has a far greater chance of going out of business than a company like Coca Cola, which has prospered despite world wars, depressions, and currency crises.

In light of this it is up to you, friends, whether you wish to invest in the stock market. That decision is yours and yours alone. If you feel the risks do not outweigh the potential rewards then you should not feel pressured to buy stocks.

If you do choose to buy stocks, keep in mind that you are best served by having a long-term strategy, like the example the Booby outlined for you above. You should not simply buy a stock with with hope/expectation that your financial gain will come quickly, and exclusively from increases in share price.

Websites like Investopedia.com can provide you with a glossary of some of the terms that arise in finance. Don’t be intimidated by the jargon. Learn the jargon and be in the know.

As always, fellas, keep your financial assets close to your chest, and if possible seperated from those of your significant other (see here). This should potentially protect you from one of the biggest risks to your net worth.

Good luck.

 

 

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