20 Investing Questions You Were Too Embarrassed to Ask, Part 1
By Stephanie Taylor Christensen
Curious about the markets but don't know an ETF from an IPO? Here are some shame-free, easy-to-understand answers to common questions.
So you have some basic questions about investing -- so basic that you don't even want to mention them to your finance-savvy friend or investment adviser. If that's the case, check out these 20 answers. We probably have you covered.
1. Am I missing out by not investing in stocks? And is there any proof that buying stocks would make me money? Well, no and yes. There are no guarantees in investing, and the markets are impacted by many forces like company earnings, consumer emotions, political events, and natural disasters. Historically speaking, from 1926 to 2010, the S&P 500 returned an average annual 9.8% gain. For long-term investors who can absorb risk and ride with the ebb and flow of the market, experts typically concur that stocks are the most promising place to grow your money.
2. How do I find research by analysts? And how would I know if an analyst is any good? Analyst research can be found online through independent sources like Morningstar, Zacks Investment Research, and Yahoo Finance. Brokerage firms typically offer access to analyst recommendations to their customers free of charge as well. You can also research the track record of an analyst based at Zacks “All Star” Analyst Portfolio. 'Just remember, analyst recommendations should be part -- but not all -- of your decision-making process as an investor.
3. What are the most important indicators of a stock's health? Whether a stock is "healthy" often relies on your objective. If you seek high returns and high risk, you'll want stocks with a relatively large price range over a short time period. If you are looking for less risk and moderate growth, stick to stocks whose price ranges over the past 52 weeks are narrow. All publicly traded companies issue quarterly earnings reports to the Securities and Exchange Commission (SEC). You can find a few key pieces of data in the reports to evaluate a stock's health:
- Earnings per share (or EPS): Ratio of total earnings divided by the total investor shares. You can compare stocks with this number.
- Price/Earnings ratio (P/E): What customers are paying for a dollar of the company's earnings. There is no magic number to look for, though according to the Financial Industry Regulatory Authority, the long-term average number has been about 15. A stock with a high P/E might mean that the future looks bright -- but it has to work harder to keep the performance. A low P/E might mean that a price increase is on the way -- or that a company is in trouble.
You also need to ask some commonsense questions, like whether the company's products and industry are in demand, what its past performance is like, and how much debt it carries. All of these issues are addressed in a company's annual financial report, which is usually available via its website in a section labelled for investors.
4. What's a dividend? It's a portion of the company's profits tha's paid to investors, typically on a quarterly basis. Not all stocks pay dividends, however. You'll typically find dividends attached to steady, established (read: slow growth) companies. Because these stocks are not making major gains, companies pay out dividends to keep investors satisfied.
5. If I hear about an upcoming IPO, how can I buy into it? Sorry, there's some bad news here. Many initial public offering, or IPO, shares are reserved for large-scale investors only, so you may not be able to buy into them. If the sale is open, find a broker who is affiliated with a bank involved with the IPO, or a discount brokerage firm that has a relationship with a traditional investment house. You can find names of the banks involved in an IPO by looking at the "Underwriting" section in a company's SEC registration, which you'll find at the SEC's EDGAR database.
6. I always hear about investors shorting a stock. What does that mean? And is there "longing" a stock, too? Investors who short stocks believe that the current stock trading is overvalued. To make money, these investors “borrow” the stock from a brokerage house, and it is sold to another buyer. If the stock price dips, the investor who shorted keeps profits from the difference in prices, less whatever is owed to the brokerage house for the borrowed funds (this is also called trading on margin, and is often controversial).
To short a stock, you must trade through a broker using a margin account, which essentially lets you borrow more money to trade than you actually have in the account, for a fixed interest rate. Shorting stocks is an aggressive investment strategy. You can make money, but if your “bet” is wrong, you must replace the lost money in the margin account quickly. “Longing a stock” is the fundamental of investing -- you buy and hold the stock for an undetermined amount of time.
7. What are the differences between preferred and common stocks? Common stocks are ownership interests in a publicly traded business, and owners of it are called shareholders. If a company liquidates or goes bankrupt, common stock shareholders likely won't see any equity distribution. Preferred stocks are less volatile than common stocks, and pay dividends at a regular interval. However, with reduced volatility comes reduced reward, and there is very little chance that a preferred stock will ever produce large capital gains for an investor.
Preferred stock is frequently used by fixed-asset clients who are looking for a steady income payout from dividends, and it isn't typically recommended as part of an investor portfolio until retirement. On the plus side, if a company becomes insolvent, preferred stockholders are entitled to assets before common stockholders.
8. What's a decent return for nonprofessional investors? Over the past 100 years, the stock market has realized close to an average 10% rate of return. Adjusted for inflation, stocks could double your money in just over 10 years at their average long-term return rate. Those are some high benchmarks, but making any rate higher than what you'd earn with a regular cash account is usually considered worthwhile.
9. Can I invest in a hedge fund? Should I? Hedge funds are not a tool for the novice investor, and to invest in one you must meet the income criteria of an “accredited investor.” That means you need to have a household income over $1 million, a sum that could include the value of your home. You would also need to have an individual income of $200,000, or a combined household income of $300,000. (Some hedge funds require a higher income.)
But don't let that relatively low barrier to entry fool you. Investing in hedge funds requires an advanced understanding of how they work and a willingness to risk great sums of money. Many hedge funds purchase financial products that are not regulated by the SEC, and it can be difficult to establish a real value for them, or maintain liquidity, according to the New York Stock Exchange.
In other words, if you're still asking basic questions about hedge funds, you should probably avoid them.
10. What's an ETF and why should I care? Exchange-traded funds (ETFs) combine the flexibility of a stock with the low costs of a mutual fund. Unlike a managed mutual fund, most ETFs trade on stock indices and constantly move with the market, meaning you can buy and sell them at a specific price. By contrast, a mutual fund allows you only to buy at the end-of-day closing price.
ETFs come in many varieties covering all sectors, so make sure you understand the goal of an ETF. If you're rolling over an individual retirement account or investing a large sum of money, they can be a good option, but for smaller investment amounts, a mutual fund is probably a smarter bet.
Minyanville Editor's note: Still have questions? Click here for Part 2.
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