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| Academic Performance | Financial Survival | Social Life | Nutrition and Health | |||
By
UniversityAdvice.com Staff,
May 2006
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Stocks Stocks tend to be far more exciting than savings accounts or GICs. Entire television stations, sections in newspapers and magazines are dedicated to the topic. People enjoy trading tips about the latest "hot stock" around the water cooler at work. You may also have received some spam e-mail promoting a specific stock (these e-mails are typically part of a "pump-and-dump" scam, and it is typically unwise to follow their advice). Similar excitement is not usually associated with GIC investing. Stocks are more exciting because they have the potential to rapidly increase or decrease in value and because they require some skill in selecting and purchasing. Stocks also generally increase in value faster than fixed income investments over the long run, making them essential for long-term investments. Unfortunately, they can lose money rapidly which makes them inappropriate for short term investing (i.e. for less than 5 years at a time), unless you enjoy gambling. There exist two types of corporations: private and public. A private company is owned directly by only a few people. Often, as is the case with many smaller companies, there exists only one owner, whom we may call the "sole proprietor". Since it is the sole proprietor's company, he or she may do as they choose when it comes to managing the company. A public company, on the other hand, is owned by many investors either directly or indirectly through mutual funds (more on these later) and pension plans. These investors own "shares" in the corporation. Each share represents a small portion of ownership in the corporation and an investor's total ownership in a corporation is proportional to the number of shares he or she owns as well as the total number of shares the company has issued (the so called "outstanding shares"). For example, if ABC Inc. has 100 shares outstanding, and you own 20 shares of ABC Inc., then you effectively own 20% of the company. If ABC Inc. is worth 100 000 dollars (i.e. if its "market capitalisation" is 100 000 dollars), then you could sell your shares for 20% of that amount (i.e. 20 000 dollars). Of course, most public corporations tend to be worth far more and are usually valued in the millions to billions of dollars. However, enough shares are issued such that the cost of a single share is not too high for the average investor to afford. Usually, public companies have share prices of less than one hundred dollars, though this amount can vary widely (Google for example, has allowed its shares to rise to 700$ each as of December 2007). In the case of ABC Inc., for examples, we could have 1 000 shares at 100$ each for a total market capitalisation of 100 000 (100$ x 1000 shares = 100 000$). As a real example, let's consider Microsoft Corporation, one of the largest public corporations in the U.S. On December 23, 2007 its shares were valued at 36.16$ each. On this same day, the company had 9.36 billion shares outstanding for a total market capitalisation of 337.36 billion dollars. Bill Gates owned 857,499,336 of these shares, making him a very rich man indeed. But who decides the price of these shares? Investors themselves decide the price of the shares and therefore the overall value/market capitalisation of a company. They do so by exchanging the shares between each other on markets called "stock exchanges" or "stock markets". The Toronto Stock Exchange (TSX), the New York Stock Exchange (NYSE) and the NASDAQ are all examples of stock markets. They are places where investors who wish to sell shares can find investors who want to buy those same shares. As in any market, the prices of shares are, quite simply, determined by offer and demand: if there are more investors who want to buy a particular stock at a given time than there are investors who want to sell them at that time, the price of the stock will rise (Thought question: How might this expain how "pump-and-dump" scams work?). Conversely, if there are more investors who want to sell their shares than there are people who want to buy them, the price of the stock will drop. In theory if investors are rational, the stock price of a company should more or less reflect its intrinsic value. However, as we learnt during the tech crash of 2001 and during the crash of October 1929 which lead to a decade long depression, investors are not always rational when valuing companies. Because stocks go up and down based on the number of buyers and sellers on stock markets, they can rise and fall in value very rapidly. This makes investing in stocks both exciting and frightening. It is not uncommon to see a stock lose over 20% of its value in a day. If you just spent last summer busting your chop at McDonald's at 8$ an hour to save up 2000$ to invest in the shares of a company, it can be very painful indeed to see 400$ vanish in a matter of hours. It can be even more painful if your university just sent you your tuition fee bill and you needed that cash to make the minimum payment. Investing directly in stocks is also expensive. In order to buy and sell shares on the stock market, you must go through a stock broker who will charge you a fat commission for having done 5 seconds of really tough work (i.e. pressing a few keys on a keyboard and clicking a mouse button). Most brokers will usually charge around 300$ to buy or sell stocks! If you just invested that 2000$ you made sweating over the grill at McDonald's all summer long, you have just lost 15% of it (yes, the equivalent of 38 hours of gruelling labour flipping those burgers) in one second and are now left with only 1700$ in the stock market. If you want to sell those shares, expect to lose another 300$. At these rates, unless you have over 30 grand to invest in one shot and in a single company, investing directly in stocks is lunacy. There are, of course, online discount brokerages that will let you buy and sell stocks for much less. These range from as little as 5$ per trade (at Questrade) to as much as 29$ per trade (at RBC Direct Investing and TD Waterhouse). Although this is more reasonable, you would still need to invest fairly large amounts at a time (say, around 2000$) if you don't want to lose too high of a percentage right off the bat in brokerage commissions. This would not, however, allow you to invest in a large number of companies if you only have a few grand to invest. For example, if you had 6000$ this would only let you invest in 3 companies at 2000$ each. This would result in your entire investment being concentrated in only a few companies. This lack of diversification is usually a bad idea because it is risky. There is a chance that one or two of those 3 companies could mess up (or even go bankrupt) in which case you will see a large chunk (or even all) of your money evaporate. For example, consider what would have happened if you invested all of your money in Nortel back in 2000 when it was trading at over 100$ per share. A year later, you would have lost almost all of your investment as the share prices collapsed to well under 10$ each and you would be working at McDonald's for another 10 years because you would no longer be able to afford to go to university. On the other hand though, with more risk comes the opportunity to make more money. Had you invested all of your money back in the year 2000 into, say, Apple Computer Inc. or Lululemon Athletica, you could be cruising through university while feasting on some caviar and lobster in your dorm. The moral
of the story here is that although stocks can be compelling for investors
with larger amounts of money to invest, they are generally not advisable
for university students such as ourselves. We simply aren't rich enough
or able to tolerate the risk enough for them to be worth our while at
this stage of our lives. At best, most students might be able to carefully
research a few select companies and invest a modest sum in each of them
- a process which might not be directly financially rewarding, but which
may help individuals acquire the skills needed to invest larger sums in
a more expansive corporation later in life. There is another way to invest
in companies though, and that brings us to the topic of mutual funds. Article
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