Buying stocks in 2020 - Part 1: The market, must knows, and financial magic
Updated: Jan 20, 2020
Everyone knows there is money to be made on the stock market, the highs and lows have minted fortunes and caused a global catastrophe or 17. Not everyone knows that through a little bit of curiosity, the magic of compound interest and a lot of patience anyone can turn small savings into small fortunes.
Disclaimer - I’m not a stock market expert and this should not be taken as financial advice. I’ve read books, watched interviews, and had conversations with friends while actively trading over the last few years. These are some of my initial learnings.
If you haven’t ever invested in stocks you could be forgiven for thinking the stock market is reserved for old rich white guys in pinstripe suits and ties shouting a lot, since it was.
The reality is stock trading has moved online and thanks to the internet we broadly have the same access to the information and tools needed. This means no matter gender, ethnicity, economic background, or education a new world of opportunity has been opened up to you. All you need is a bank account and internet connection and you can build a portfolio from the comfort of your home.
Dispelling common misconceptions which scare people off:
You need to have a lump sum of money to start - Not true, you can start trading with any amount of money, whether it’s $10, $100, $1,000. What’s more important is that you start since the longer you’re investing the better - more on that in the strategy section below.
You’ve missed the boat on the best stocks - I have heard ‘my biggest regret is not buying X’ so many times. When Facebook first became a public company on May 12th 2012 their stock was available to buy for $38. On January 15th 2019, it was available to buy for $148 so you could be forgiven for thinking it was too expensive and you’ve missed the boat. That’s a huge return. Still, on January 15th 2020 Facebook stock is worth >$220, up more than 50% in the last 12 months meaning whoever bought 12 months ago saw a huge return on that investment. The best stocks keep going up.
Investing is a lot of work - This is two misconceptions in one. First, work meaning activity - the type of investing strategy we’re going to focus on is long term and setting aside an hour a month should be fine. The second is work meaning learning - our brains avoid things which seem hard to learn, there are a lot of words unique to stocks but you’ll find the concepts are very familiar. Stick with it!
No matter what you do, within reason, you're going to perform better than a saving account so why wouldn't you try?
Some must-know info to start:
Firstly, what is a stock?
Companies like Google, Apple, and Nike are Public companies which mean anyone in the public can own part of that company. The other type of company is called Private which effectively means they are not available to the public.
A Public company is divided into shares so it can be shared between lots of people. If you buy a share it becomes your stock. Don’t worry if this doesn’t make sense immediately.
If you buy stock in a Public company you get a share of their profits and growth. If you bought a Nike stock for $1 and later they are ‘up’ 10% then that $1 is worth $1.10 at the end of the year. The value of the stock is decided by what the market is willing to pay for it.
When you buy or sell stock there is someone else on the other end of selling or buying which is why it is called a trade. This is what the shouting on the stock floor used to be about.
How is the price of a stock decided?
Before a company is publicly traded they are a private company. When a company goes public they offer a portion of the company for sale on the public market opening them up to normal investors. This is called an Initial Public Offering or IPO. The company will bring in an investment bank to estimate the initial price of the stock and bring it to market.
This might be surprising - there isn’t really a science or rule to how public company stock is priced once they’re being traded. The prices are decided by supply and demand on the stock market, it operates a lot like a traditional market but instead of stalls you have trading platforms or trading floors - this is what the New York Stock Exchange is.
Imagine you’re walking through a market, there are lots of different stands to choose from. Each stand decides the price they are going to sell their goods or stock. Their customers might haggle on the price and they will eventually find an agreement for the price of the goods.
Now imagine you see a stand at the market with lots of people crowded around, everyone is trying to buy goods and excitedly asking for prices. That seller will likely increase their prices and the crowd are likely to pay more since there is so much demand for the goods.
This is how stocks prices are decided. Normally supply and demand find equilibrium at a price that buyers are willing to pay and sellers to fulfil. When supply and demand are balanced, prices will go up and down a small amount. If a company is doing well the price will increase and as buyers try to purchase the stock demand grows.
The market can take a negative turn on a stock in the same way. When the Facebook Cambridge Analytica scandal hit the news people in the market wanted to sell their Facebook stock and take the profits before the prices dropped further. There were more sellers than buyers at that price so the price gets automatically negotiated down.
This market movement is also what fuels the misconception that there is a small window of time to buy a good stock. However, as we talked about above a good stock will continue to increase in value over a longer period of time. Facebook is now at all-time highs, for those who held their stock the good times are still rolling. More money is created, people earn it and invest it, some people take profits, and the market continues.
Exchange-Traded Funds (ETFs) -
An ETF is a collection of stocks which you can trade like a single stock. The most popular is the Standard and Poors 500 (S&P 500), when you buy 1 of this stock you’re actually buying a piece of the top 500 stocks on the US stock market. Other countries have their equivalent, in the UK there is the FTSE 100 and in Hong Kong the Hang Seng Index.
The S&P 500 is great for investors with less time on their hands and who are more risk-averse. It has returned an average of ~10% annually and returned 30% in the last 12 months. You win when the US economy wins, if you lose money pretty much everyone does.
Below is the top 5 of 500 companies in the S&P 500:
Full list: https://www.slickcharts.com/sp500
Compound interest - Your path to being a millionaire.
Compound interest is magic. It’s the best thing you will learn from investing and pretty much everything you need to know about investing.
Interest is what you make when the value of your stock increases. In this situation, you could sell the stock and take the profits, or you can hold the stock - which is effectively reinvesting the interest.
Compound interest happens when you reinvest the interest you earn from your original deposit rather than taking it out. The interest in the next period is earned on the original sum plus the previous interest. The longer you reinvest the interest on your money the more it grows, as below. At 10% interest compounded it takes 7 years to double an initial investment without additional deposits. If you are making regular deposits you can significantly accelerate the growth.
If you invested $1,000 at a 10% interest rate and allowed the interest to compound for 20 years you would have ~$7,000 in comparison to the ~$3,000 dollars you’d have otherwise. Pretty good.
What about if you invested $1,000 dollars every year? Now you’d have $67,000 in 20 years, from investing just $83.3 a month.
If you can save $200 a month and wait 30 years you’ll have >$430,000.
Check out this compound interest calculator. Set the interest period and compounding interval to yearly and then play around with the amounts you deposit each month and how long you will wait to invest (ideally forever). How much do you need to deposit monthly to become a millionaire? It's attainable!
This concludes part 1 - in the next instalment, I'll help you build a stock portfolio and make your first investments. If you want to stay up to date you can subscribe above.
There is a ton of information here so I would love your feedback if you made it this far :)