There are a lot of things that you should do before going head long into investing.
If you do right things, you could be the next Warren Buffet (The Albert Einstein’s equivalent for investors) or if you do crappy things, you might lose your pants. Whatever you do remember a few things, that might come often in various jargons.
1. Liquidity – How much money that you could take off in a moment’s notice. Say, if you have million dollars in a home, you might not be able to sell them off in a day for the expected worth, while you coud take off money from your checking account in a second. This is very important for investors and should always have minimum liquidity to carry on your daily life and anticipated difficulties and emergencies. Historically, gold was the most liquid instrument. Nowadays, you could have good savings banks, money markets and short tem Certified Deposits in the bank, to give you adequate liquidity.
2. Risk Worthiness. How much could you afford losing? You are starting a business. In the right conditions it will prosper and will bring you copious returns. But, what if things go a bit wrong, you might lose your pant if you had put all your money into it. Same thing with any investment (house, stocks…) and based on your age and immediate requirements, have a controlled risk portfolio and know the risks before investing. Not all investments are risky, and thus you should allocate different amount for each. But, the basic axiom is Risk & Rewards always go together. You cant have one without the other.
3. Information asymmetry: Not all things are equally risky and profitable, and some time there is an asymmetry in information. If you are investing in lottery tickets, everyone knows the same information, and so theoratically anyone could win. However, in investments like stocks the more you know & understand the subject, the business and underlying factors, you could be better off than other plays. The converse plays also. So, make sure you are at the right end. The joke goes that in stock markets bulls & bears win and the pigs get slaughtered. I’ll come back to this later.
4. Bulls – In investing terminology, bulls are the optimists who keep putting more money and raise the market. Being bullish means you are positive and willing to put more money and with bulls, the market will appreciate (go high).
5. Bears – Bears are the pessimists who either predict the end of the world, or believe that the market is getting carried away by over valuation. They generally take off money and try to push down the system.
6. Pigs – These are the common investors who dont know what’s happening out there. They just invest just because their neighbors do (or for any other silly reason) and dont have any intellectual predictions on the market. As axiom goes, these people will be the first losers in any collapse.
7. Stocks. In capitalistic societies, companies are subdivided into millions (or billions) of small components called shares or common stocks or equities. Since, normal people cannot buy out an entire company, they buy a small portion of it and have ownership to it. Thus, modern companies are all an aggregate of a large number of such smaller owners and the earnings are divided among them. Generally, the control of the company also rests with the shareholders, who together elect a board of directors to oversee the management of a company. If the company has greater earnings, share prices go up and converse holds true. Pricing a share is one of the most difficult things and its the whole of stock investing.
8. Bonds are similiar to bank deposits & loans. Big corporations and government raise money through this. When you release a bond, you try to get money and in return agree to give the principal after an agreed time and pay interest. Sometimes, you might get bankrupt and might not be able to return the money. So, you might have to give more interest to get your people as people will find you risky. In general, government bonds (called treasuries) give the lowest interest (as their risk of defaut is lower) and for corporations the interest is based on the amount of risk they face. In general, bonds are stable and since it is loaning (in contrast to owning stocks) you wont be rewarded extra when when the company progresses up, nor penalized during tougher times.
9. P/E or Price to Earning Ratio – This is the fundamental mantra for the investors. Price is total value of the Company (or Real Estate) in question and Earnings is the annual profit we can get out of that. In stock market, the companies are priced by multiplying the price of each stock by the total number of stocks, and this value is known as Market Capitalization. The ration of this price to the annual profits give the P/E. If P/E is 20, it means that for every 20 bucks you invest, you would annually earn 1 buck or 5% interest.
10. Fundamental Analysis Vs. Technical analysis – The whole science of stock market investing is about pricing a stock. There are two schools here. The Fundamental folks price by the earnings, the management worth, the market, consumers, etc and the Technical folks use the fundamental analysis of others, but totally predicting the stock by how much it moves, the direction, volume etc. You can learn more on this, as you start maturing.
