Essentials: How to Understand Your Stock Investments
One of our most important mottos at Centered Financial is: Invest with Purpose. We refer to this so much because we feel that it is so important to understand what you are investing in and how your investments match with your financial goals and life’s priorities. Often, we find our money allocated to investments that we don’t fully understand. Whether it is our 401(k) at work or an investment that an advisor chose for us. In this post, we will discuss what to know about stock investments if you are just starting out or if you already
have a portfolio.
Reaching your long-term goals
We all have things that we want in the future. Some of us have goals like a house, a second house, or a major vacation. Some of us have responsibilities like paying for a child’s education or wedding. And most of us want to make work optional at some point (also known as retirement). If any of these goals are more than a few years away for you, one thing that you can count on is that the cost of these items will be more expensive in the future than it is now. This is because of inflation.
Inflation is the concept that our dollar today is worth more than it is in the future and it is the reason that we pay $3.04 for a gallon of gas today on average vs. $1.51 per gallon 20 years ago.
Inflation creates a risk that we need to plan for. Many people who have not invested before, may feel apprehensive about the risk of losing their money when they invest. They have seen the fluctuations in the stock market, and they don’t want to be exposed to the rollercoaster ride with their hard-earned dollars. However, if they leave their money in cash for too long, they are exposed to losing money anyway to inflation.
Stocks have historically provided the best opportunity for our money to grow and outpace the impact of inflation and reach long-term financial goals. Consider the chart below showing stocks compared to bonds, cash, and inflation.
As you can see, the stock market doesn’t go up in a straight line. As an investor, It is important to maintain a long-term perspective with stocks and ride through short-term corrections.
The basics of a stock
When you purchase stocks (also known as equities), you are purchasing ownership in a company. Your stock represents a share in ownership and as an owner you will participate in the appreciation or loss of value in the company. Your value fluctuates as the price of the stock fluctuates. Also, If the company pays a portion of profits to owners through a dividend, then you will receive income from your stock.
As a stock owner (or shareholder), you typically expect to make money in these two ways, appreciation of your investment and income through dividends.
How stocks are categorized
Stocks can be categorized in a number of ways and it is important to understand what these categories mean. Here are the key stock categories to remember:
Domestic vs. International
Domestic stocks are companies that are based out of your home country (U.S. companies for U.S. investors) and international stocks are companies based outside of your home country. It is important to have exposure to our global economy through both of these types of stocks.
International companies are often separated into developed countries and emerging markets. Developed countries are countries that have more established markets such as Europe, Japan, UK, Australia and South Korea. Emerging markets typically have more political risk or less stable economies. These markets are typically represented by India, China, Brazil, etc.
The size or market cap of a company is something that is important to understand. The market cap is the value of all of the company stock combined.
Value vs. Growth
Often, stocks are divided up by the way we value the company. Two important terms to understand are Value and Growth.
Value stocks are shares in companies whose stock price doesn’t necessarily reflect the fundamental value of the company. Typically, the company is undervalued for some reason and investors hope that over time the company will realize its potential.
Growth stocks are shares in companies that have faster sales and/or earnings growth compared to their industry or the overall market. These companies typically reinvest their profits, so they typically pay no or low dividends and have higher stock prices.
Sectors and Industries
The stock market is divided up into 11 sectors that classify stocks based on the industries that they primarily do business in. These sectors are:
1. Information Technology
2. Communication Services
3. Real Estate
4. Consumer Staples
5. Consumer Discretionary
Sometimes you will see investments in your portfolio that are focused specifically on a certain sector.
Putting it all together
In an earlier post, we discussed how important it is to diversify your investments. When you are building a stock portfolio, it is important to choose a variety of stocks from these different categories. However, if you don’t have a significant amount of capital to invest, it can be difficult to build a diversified stock portfolio. Often, we use mutual funds or exchange-traded funds to invest in many stocks within the same category. Through these funds, we are able to pool our money with other investors to gain exposure to more stocks than we would be able to on our own with limited money to invest. Funds provide a great way to diversify and take away the burden of choosing the right companies to invest in.
We can usually understand our investments by looking at the names of the funds that we are invested in. Many mutual funds and exchange-traded funds describe their objective in the name of the fund. For example, I may look at my 401(k) and see the Fidelity Large Cap Growth Fund. From the name, I can understand that this mutual fund managed by Fidelity invests in large cap stocks that have a growth focus. If I researched the fund further, I would learn that it is also only focused on U.S. companies.
Funds can be building blocks to a complete stock portfolio or they can provide total diversification all within one fund. Keep in mind that the stock categories all perform differently, and it is difficult know which categories will outperform others, so it is helpful to gain exposure to a variety of different types of stocks.
I encourage you to look at your investment accounts with the perspective of what stock categories you are invested in. What are your top categories? What companies make up these categories? Do these investments match up with your objectives? Do you feel that these types of investments will perform well in the current environment? How about long-term?
Looking at your funds from this perspective will help you become a more educated investor. Remember, the key is just to be invested in stocks. Over the last 20 years, the S&P 500 has had an average annual return of 7.5%. This means that despite the Great Financial Crisis, the Covid-19 recession, and all of the political, global, and environmental tensions of the last 20 years, a $100,000 investment made in 2001 would be worth about $446,082.
It is important to get started! Look for opportunities to invest through your retirement plan or for non-retirement goals consider a general investment account to help grow your money. Make sure to do your homework and reach out to us with any questions that you have.
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Centered Financial, LLC is a registered investment adviser offering advisory services in the State of California, Utah, Texas and in other jurisdictions where exempted. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. There is no assurance that the techniques, strategies, or investments discussed are suitable for all investors or will yield positive outcomes. To determine which strategies or investment(s) may be appropriate for you, consult your financial adviser prior to investing. Any discussion of strategies related to tax or legal planning is general and is not intended as tax or legal advice. Please consult appropriate tax and legal professionals for recommendations pertaining to your specific situation.
 https://gasprices.aaa.com/; https://www.energy.gov/eere/vehicles/fact-915-march-7-2016-average-historical-annual-gasoline-pump-price-1929-2015  Fidelity Investments. FIAM, Domestic Equity Fundamentals for Investors. 2021  Fidelity Investments. FIAM, Domestic Equity Fundamentals for Investors. 2021  Diversification and the average investor, JP Morgan GTM Q2 2001. This calculation is a basic FV calculation and does not take into account taxes, fees, or any specific investments.