Written by Today we will be answering the question, how does investing work? When it comes to investing, if you start high level… investing is your ability to choose a stock. To choose a company that you’re going to buy at a price that is lower than the price you will sell it at. The difficulty comes in the execution.
How does investing work?
The goal of investing is to choose a company you can buy today at a price lower than you will sell it in the future. The difficulty we face is it’s not always easy to find a stock at the right price. There’s an abundance of information, but it always seems like there’s not enough of the right information.
- What ratios do you use when determining a company?
- How much about past performance should you be paying attention to?
- Should you try to find the company everyone’s talking about and jump in early?
- When I invest in one company, they should go up at some point, right?
It is accurate to say the stock market tends to move up historically over time. However, it is completely different to say your stock is going to increase in value over time.
1. Understand how to evaluate companies
There are three things you will need to understand to set yourself up for success. First, you have to be able to choose the right companies. Whatever your methodology is, valuing a stock is going to be the most important aspect of your investment strategy.
If you can sell your stocks for a profit, you have the recipe for success. Naturally, this is easier said than done. But, all the greats know how to evaluate companies. They recognize when a company is not at a good price and when they are. This is often key to making money during a recession. You have a list of your favorite stocks that are too expensive. When they come down in price during a market correction, you jump at the opportunity.
2. Construct a portfolio
When constructing portfolio, you need to know how much of your money is going to be invested in stocks, bonds, real estate, etc. Then, you need to learn the benefits of different bonds and industries. Stocks in the tech industry don’t operate the same as stocks in finance. Treasury bonds are not the same as municipal bonds.
Some investors diversify their investments over a variety of sectors, while others focus on one they understand. Investing works best when you have a goal you want to achieve. Are you looking t08o pay for your kid’s college? If so, you have more time and can create a different portfolio than someone looking to but a home. When you are buying a home, you can not afford to lose money in the money. As a result, your investments are more focused on capital preservation than anything else.
3. Fund your investments
If you feel good about the market when you invest your money, you can invest it all in one-lump sum. For those who are not sure if they are investing on the right day, they can use dollar-cost averaging. Dollar cost averaging is investing the same amount of money each month over a period of 6 to 12 months. As a result, you will buy the stock at a low price some days and a higher price other days. The average you end up with will be lower than your highest price, but higher than your lowest price.
Which would you choose?
You have $10,000 to invest in 2010. You must choose between Tesla and Moly Corp. Knowing what you know today, you would probably choose Tesla. But did you know, in 2010 Tesla opened at $17 a share and lost value it’s first year? On the other hand, Moly Corp in it’s first year opened at $14 and increased to $49.50. Which would’ve been about a 256% increase.
If you chose Tesla, your $10,000 is worth about $550,000 today. Not a bad hall. For those who chose Moly Corp, even though you had a 256% increase the first year. Yet, in 2015, Moly Corp filed bankruptcy. If you invested $10,000 in Moly Corp in 2010, you would have a whopping $0 in 2022. That is the difficulty we find when it comes to investing. There is no guaranteed approach and there’s no guaranteed result.
Follow the trends
Moly Corp was a rare mineral mine in California. While it started off fast, the mine ran into trouble. The industry as a whole is a solid choice. We use so many minerals in our technology. Yet, mining is difficult to stay on top of. A mine can run dry overnight and you can find yourself losing your investment. For Moly Corp, there were some things that changed from the competitive nature of the mine. They ended up losing everything.
Tesla, on the other hand, has been around for awhile and had a change in leadership. They’ve also been in front of a cultural wave of eco-friendly cars. On top of that, Congress has just passed laws that will benefit Tesla immensely. As you see, understanding the success of Tesla requires you to know so much more than the company’s vision. It requires you to follow the trends of the society, Congress, and the industry as a whole too.
Nuts and the bolts of investing
Investing is as simple as choosing a company at a lower price than you plan on selling it. The difficulty… how do I know which company to choose and how do I value the company? Even if we do that, right, which is not a guarantee. How do we know the company we chose will maintain it’s value? For investing, you ultimately need to decide:
- Which sectors am I gonna invest in?
- How much am I going to invest?
- What frequency am I going to invest?
- And how long am I going to invest?
If you’re able to answer these questions, then you have a pretty good framework to understanding what and how investing works. But, there is no guarantee. So, if you’re going to choose individual companies, you have to stay on top of them. You need to follow them in the news. Keep up with upcoming legislation and the overall sentiment of the people.
For those who aren’t interested in creating their own portfolio, there are hands-off approaches. You can invest in mutual funds, ETFs, or index funds. There fees will vary based on the activeness of the trader. Naturally, you want to research the funds and determine which one is aligned with your goals. Also, keep track of the fees. While they may seem small separate. When added together and taken over a couple decades, they can be the difference between financial success and failure.
Final thoughts
At the end of the day, investing is about making choices. You choose, whether you spend or save your money. For the money you save, you choose whether you want to invest it in the market or leave it in a savings account. Others will be more interested in investing in real estate or starting a business. It is your choice on the best way to achieve your financial goals.
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