What to Expect From Investing
Expectations are so important. If you've heard from many people that a film you're about to see is stupendous and amazing, well... it had better be! If it's just pretty good, you'll be disappointed. If, on the other hand, you've heard nothing about it, or maybe one friend trashed it, then you'll probably be pleased if it seems pretty good. Same movie, different outcomes -- just because of expectations.
Expectations play a critical role in finances, too. There are many adults who have never invested in stocks because they remember the stock market crash of 1929 and the Great Depression that followed. Others did invest in stocks, but they got burned once and never returned. If only they'd known what to expect.
Below are a bunch of different things that you need to understand before you jump into investing in the stock market. The more you know, the more realistic your expectations will be, and the better you'll likely do.
Expect a Risk-and-Return Tradeoff
Some people avoid the stock market because "it's too risky." But it can be riskier to not invest. If you put all your savings under your mattress, it probably won't be enough to sustain you in retirement. If it's all in a bank account earning 3% per year, on average, then that will barely keep up with inflation, at most. You can do better than that.
A key concept to understand is the tradeoff between risk and return. If you have a large and heavy fireproof safe, and you keep all your money in it, it's close to 100% secure. But what return are you getting on it -- how quickly will that money grow? It won't grow. So the tradeoff there is (just about): 100% reliable, 0% return. At the other end of the spectrum are options like the lottery. With a major lottery, you have more than a 99.999% chance of losing the money you "invest" in it, but if, against all odds, you win the jackpot, you get an incredible return on your "investment." This shouldn't be a very appealing proposition, either.
Reasonable people should aim for something in the middle. You should be willing to take on a little risk in order to make a decent return. Your most safe options include bank accounts, money market funds, CDs, and government bonds. Most bank accounts are insured (your bank is most likely protected by insurance, but you can ask, just to be sure). Government bonds are backed by the governments that issue them. As long as you have faith in the United States, U.S. bonds should be considered very safe. But... these investments don't offer the best potential returns.
The best place for long-term money is in the stock market. You do take on some risk with stocks, as all stocks go up and down. But over the long run, the market has gone up and so have most stocks in solid companies.
Here's a summary of how various investments have performed on average each year, between 1925 and 2000:
|Long-term Government Bonds||5.3%|
If you invest in the stock market for just a year or two, don't expect to earn exactly 11% or 12.4%. You might earn 19% -- or you might lose 23%. Over the long run, though, the stock market has averaged just about 11%, and over many years, you'll likely earn an average annual return that's somewhat close to that -- perhaps 9% or 13%. Long-term money should grow fastest in stocks.
Expect to Own Pieces of Companies
Many people think of stocks just as pieces of paper that change in value from day to day. Wrong.
A share of stock represents real ownership in a company. If you own a share of the Gap, you literally own a piece of the company. If Gap introduces a new kind of jeans, and they're flying off the shelves, then the company will make more money and will be worth more money. If so, your share will be worth more, too. If you own shares of Philip Morris, which is a major cigarette manufacturer, and the government outlaws cigarettes, the company will suddenly be worth a lot less, and so will your shares.
You can buy shares of stock in any company that is "public" (public means the firm's stock is publicly traded). Almost any major company that you can think of is public. Here are some and their ticker symbols: Coca-Cola (NYSE: KO), PepsiCo (NYSE: PEP), Abercrombie & Fitch (NYSE: ANF), Starbucks (Nasdaq: SBUX), Apple Computer (Nasdaq: AAPL), Dell Computer (Nasdaq: DELL), Microsoft (Nasdaq: MSFT), Intel (Nasdaq: INTC), AOL Time Warner (NYSE: AOL), Ford Motor Company (NYSE: F), General Motors (NYSE: GM), Boeing (NYSE: BA), Nike (NYSE: NKE), Callaway Golf (NYSE: ELY), Wal-Mart (NYSE: WMT), Home Depot (NYSE: HD), Scholastic (Nasdaq: SCHL), General Electric (NYSE: GE), General Mills (NYSE: GIS), Kellogg (NYSE: K), Viacom (NYSE: VIA), Eastman Kodak (NYSE: EK), ExxonMobil (NYSE: XOM), McDonald's (NYSE: MCD), Wendy's (NYSE: WEN), Johnson & Johnson (NYSE: JNJ), and many, many more.
Expect Stock Prices to Go Up and Down
When you invest in shares of stock, expect the prices of those shares to go up and down. They will, every day, sometimes for understandable reasons, sometimes for no apparent reason. Here are some of many reasons why a stock price will move significantly up or down.
Why Stocks Go Up
- Increasing sales and profits
- A great new executive is hired to run the company
- An exciting new product or service is introduced
- Additional exciting new products or services are expected
- The company lands a big new contract
- A great review or flattering coverage in the media
- Scientists discover the product is good for something important
- A famous investor is buying shares
- Lots of people are buying shares
- An analyst upgrades the company, changing her recommendation from, for instance, "buy" to "strong buy"
- Other stocks in the same industry go up
- Most of the stock market is up
- A competitor's factory burns down
- The company wins a lawsuit
- More people are buying the product or service
- The company expands globally, and starts selling in other countries
- The industry is "hot" -- people expect big things for good reasons
- The industry is "hot" -- people don't understand much about it, but they're buying anyway
- The company is bought by another company
- The company might be bought by another company
- The company is going to "spin-off" part of itself as a new company
- For no reason at all
Why Stocks Go Down
- Profits and/or sales are slipping
- Top executives leave the company
- A famous investor sells shares of the company
- An analyst downgrades his recommendation of the stock, maybe from "buy" to "hold"
- The company loses a major customer
- Lots of people are selling shares
- A factory burns down
- Other stocks in the same industry go down
- Most of the stock market is down -- perhaps in a temporary recession or bear market
- Another company introduces a better product
- There's a supply shortage, so not enough of the product can be made
- A big lawsuit is filed against the company
- Scientists discover the product is not safe
- Fewer people are buying the product
- The industry used to be "hot," but now another industry is more popular
- Some new law might hurt sales or profits
- A powerful company becomes a competitor
- For no reason at all
You can expect that your money, invested in the overall American stock market, will increase in value -- over the long term. You can expect a long-term average annual return of around 11%, give or take a percentage point or two, for the stock market as a whole, if the decades ahead are like the decades past.
You can expect your wealth to compound. With compounding, expect the growth to start out slowly, but then begin to snowball as the years go by.
Expect to Wait
With sensible investing, it usually takes time for you to see significant results. Don't jump in, see your holdings drop a bit or not move much for a while, and then jump out, in an impatient huff. Engage in long-term, not short-term, thinking. Expect to wait. Investing is a marathon, not a sprint.
One thing that often throws new investors for a loop is volatility. Volatility refers to how much a stock's price tends to jump up and down from day to day. The stock of some companies (often sleepy ones, such as cement firms or real estate enterprises) tends to go up or down by a fraction of a percent on most days. Companies with more volatile stock (often ones in fast-changing and heavily technology-dependent industries) often see their prices move by a few percentage points each day.
Over a few days or weeks, a volatile stock might surge by 50% or drop by 40%. These are big swings and they can frighten uninformed investors into selling when they sometimes shouldn't. Look at the stock price of Microsoft over the years, for example:
(The prices above are "split-adjusted." That means although the price wasn't really $1 in 1989, that's the correct value of the shares at that time, because there have been "splits" since then. Don't let yourself get distracted by the concept of stock splits now -- you can learn about them later.)
Imagine yourself owning stock in Microsoft at various times. If you owned it from August 1994 to January 1995, and the stock wasn't gaining in value much, would you get impatient and sell? If you did, you'd have missed out on significant gains after that.
Expect volatility with some stocks. Don't stress out too much about how much the shares swing up and down. As long as you have faith in the company (based on ongoing research, not just a whim), the company's long-term performance is what counts. Microsoft's stock has gone up and down a lot, but just about anyone hanging on for five or more years has made good money.
Expect to Lose Some Money
This might be alarming or depressing to hear, but if you invest in the stock market, be ready to lose some of your money. If you invest in the overall market and not in individual stocks, then over many years, if not a few years, you should come out ahead and not lose money.
With stock in individual companies, though, you could lose money on some of them. It happens to the best of investors.
The more you know, the fewer losses you'll probably end up having, but some losses here and there are inevitable. As long as your money is divided between a handful of stocks, and not parked just in two, you'll minimize your risk. If you own stock in seven companies, and one or two tank, the others could gain enough to more than make up for your losses.
Expect Conflicting Information and Advice
Be prepared to be confused a little, if you choose to learn more about investing. You'll run across people giving you conflicting advice. Some will tell you to always have all your long-term money sitting in stocks. Others will say that it's okay to keep a lot of your money in cash, waiting for the right time to invest it. Some will tell you not to buy more shares of a stock if it starts falling. Others will counter that if you still believe in the stock, you might want to buy more shares, as the price is lower.
Don't let these and other contradictions throw you. Expect them, think about them, and invest in ways that make sense to you. Many times, investors can do well using either or both of two conflicting principles.
Expect Work -- And Fun
Investing can be pretty simple. The next article will show you just how simple (here's a clue: index funds). But if you want to take things a step further and shoot for maximum returns, then you'll need to do a little work. If you choose to invest in stocks of individual companies, to do well you'll need to learn a lot about each company you consider.
The good news, though, is that it can be a lot of fun. Especially if you invest in companies that interest you. If you love Starbucks, how painful would it really be to get to know how the company operates? If you're fascinated by airplanes, then learning a lot about Boeing or Southwest Airlines and their competitors shouldn't be too boring.
Not only can the research be fun -- the investing can be, too. You get to watch your holdings grow in value. You might even compare how you're doing with friends or siblings. You'll follow how your companies do over time and get to know them even better. You'll root for your home teams -- your companies. It can be work, but fun work.
Expect to Keep Learning
Learn a lot more about money and investing in our book, The Motley Fool Investment Guide for Teens: 8 Steps to Having More Money Than Your Parents Ever Dreamed Of, from which this article is adapted.
If you have some questions about anything you've read here, you can ask them on our Teens and Their Money discussion board. Or just drop in and see what other teens are saying.