Investing may seem like a foreign concept, however, you invest in yourself every day. By investing your time studying, you hope to achieve a better grade than say spending an evening in The Ville. Simply being here at K-State is an investment. By spending thousands of dollars today, you hope to have a higher salary than you would with a high school diploma. Much like these forms of investing, financial investing occurs with the hope that if one puts a little money away today, there will be more money in the future. The financial markets can sound like an intimidating, scary, and complex world, but with a better understanding of some of the underlying terminology, you can gain a better grasp of how they operate and one day be able to invest in yourself financially.
Financial Market
A financial market is any marketplace where buyers and sellers trade assets such as stocks, bonds, commodities, and derivatives. In today’s world most of these transactions take place online and an individual can get involved by setting up an account with an online brokerage firm, such as E*Trade, Schwab, or Scottrade.
Stocks, Bonds, and What??
Stocks, bonds, and derivatives are all financial instruments, but they all come with various advantages and disadvantages. Stocks are a financial asset that give you partial ownership of a corporation. When you purchase stock in a company, you are entitled to some of their earnings which come in the form of dividends, however companies are not required to pay dividends. Stocks are extremely volatile and their prices fluctuate often as the market fluctuates. While historically stocks have performed well, the return is not guaranteed. These factors make stocks extremely risky, however the return on your investment is approximately 5% greater than the return for bonds.
Bonds are a debt instrument, thus when you purchase a bond, you are lending money to the government, a municipality, or a corporation. When you buy a bond, or give out a loan, you make your return by earning interest. Bonds are less risky than stocks for several reasons. Unlike stocks, when you purchase a bond the issuer promises to pay back the face value, or the amount you purchased the bond for. The amount of interest earned is also backed by a promise from the issuer and the interest rate is often fixed. Historically the bond market is less vulnerable to changes in market price.
There are hundreds of financial instruments out there including derivatives, options, futures, CDOs, and swaps. These assets are more complex than stocks and bonds. For more information on any of these financial instruments, you can go to www.investopedia.com.
Market Indexes
In the news you may have heard phrases such as “the Dow drops 600 points” or “the S&P 500 soars.” The Dow Jones Industrial Average and the S&P 500 are both examples of stock market indexes. A stock market index simply measures the value of a section of the stock market. The Dow and the S&P 500 are two of the most widely analyzed indexes. The Dow Jones index includes 30 of the largest and most influential companies in America. Since it includes some of the most well-known companies in America, the Dow usually corresponds to changes in the entire marketplace, though it may not be on the same scale. The S&P 500 is made up of 500 of the most widely traded stocks in the U.S., and it represents approximately 70% of the total value of the U.S. stock markets. Since it is more diverse, it generally gives a good indication of the overall movement in the U.S. marketplace. Points for these indexes are simply a whole number in the index value used to more easily measure the increase or decrease in the indexes.
Portfolio
A financial portfolio includes all of the investments you have, whether that includes stocks, bonds, or other financial assets. In order to minimize risk, your portfolio should be diversified. It should include different types of financial assets, all with varying risks and maturities. For example, a diversified portfolio may include riskier investments such as junk bonds or stock in a new company as well as government bonds and stock in a well-established company. It is also important to invest across market segments (technology, energy, etc.) rather than put all of your investments in one industry. Risk is important to reduce, however, the lower the risk, the lower the return. Vanguard has created some model portfolio allocations (https://personal.vanguard.com/us/insights/saving-investing/model-portfolio-allocations). These allocations show varying types of portfolios and the historical risk and return associated with each. Many advisors recommend investing in riskier assets when you’re young, such as stocks, and investing in safer assets as you near retirement, such as bonds.
What now?
The best way to invest smart is by understanding the markets and being knowledgeable about the financial world. Paying attention to the financial news today, even if it is just looking at an article a week, will help you gain a better understanding for when you’re ready to invest. The Wall Street Journal, Google Finance/Yahoo Finance, and other credible news sources are all excellent ways to stay up-to-date in what the market is doing. Investopedia is also a great source for understanding different aspects of the financial world. As with most things, practice makes perfect. Luckily, there are several free stock market simulators out there to help you gain a better understanding of how it works without risking your own money! Investopedia Stock Simulator, Virtual Stock Exchange, and Wall Street Survivor are some of the most popular simulators out there. By expanding your financial knowledge and seeing how the market operates, you will be able to make smarter financial decisions and be prepared to invest in your future.
Sources:
http://www.vdmtrading.com/2010/05/top-6-best-stock-market-simulators.html
www.investopedia.com
Jillian Taylor
Peer Counselor I
Powercat Financial Counseling
www.k-state.edu/pfc
