Confused about the difference between buy-side and sell-side analysts? What about share buybacks or 529 savings plans? You'll find answers below, included as examples of "Ask the Fool," one of the features of our newspaper column.
Q. What's the difference between "buy-side" and "sell-side" analysts?
A. Let's set the stage first. Much of the trading of stocks occurs between large institutions, such as pension funds and mutual funds. These institutions rely on the research and opinions of analysts to determine which stocks to buy or sell. Analysts who work for brokerages, dispensing recommendations to clients, are sell-side analysts. If you hear that a Morgan Stanley Dean Witter analyst has rated a company as a "strong buy," that's a sell-side analyst. Buy-side analysts don't sell their research to outsiders. They work for mutual fund companies or other financial institutions and give recommendations internally, almost exclusively to portfolio managers and other money managers.
Imagine a retail situation, where you're shopping for a new pet at Groundhog City (ticker: WDCHK). The guy who works there, describing and recommending various groundhogs to you, would be the sell-side clerk. He's out to drum up business and make sales. Meanwhile, a friend of yours who's giving you advice on why you should or shouldn't buy groundhogs at these prices would be on the buy side, aligned with you, the buyer.
Q. What does it mean when a company announces that it's buying back shares of its own stock?
A. It's generally a promising sign, suggesting the company thinks its stock is undervalued and inexpensive enough to buy. Many companies (such as Boeing
Buying back shares is also a way for a company to reward its shareholders. If the Britney Spear Supply Co. (ticker: OBABY) is sitting on some profits, it could use that money to pay down any debt or invest in its growth (buying advertising, building factories, etc.). It could also choose to issue a dividend to shareholders or to buy back some of its shares. Shareholders will be taxed on any dividends they receive, so a buyback might be more attractive.
When a company buys back shares, it essentially retires them -- resulting in fewer shares outstanding. That means that each shareholder's stake in the firm is bigger. It's like cutting a pizza into fewer slices; each piece will be bigger.
Q. I've just heard of 529 plans for saving for college. What are these?
A. Nearly every state now offers 529 plans and they're worth investigating, if you're saving up to cover college expenses one day.
These plans are attractive because they permit your savings in them to grow tax-free. When you withdraw funds to pay for college costs, the part of the withdrawal that's earnings is taxed to the student, who is usually in a lower tax bracket. There's a lot more to know about 529 plans, and states' plans vary, so make sure to research which plan is right for your needs. Anyone can contribute to a 529 plan, and you're allowed to deposit a hefty amount (up to $100,000 or more per student).
Q. Why do you say that stocks are better than bonds?
A. We advocate stocks for long-term investments because they've historically offered the best return. Money you won't need for five or more years is likely to grow fastest in stocks.
According to Jeremy Siegel in Stocks for the Long Run, the stock market advanced an annual average of 10.6% between 1926 and 1997. During the same period, long-term government bonds returned 5.2 percent. At that rate, $10,000 invested for 30 years in the bonds would grow to nearly $46,000 (pre-tax), while it would top $200,000 (pre-tax) in stocks. That's a big difference.
Of course, note that returns are far from guaranteed in the stock market, while government bond interest rates are guaranteed. The more risk you take with investments, the higher the returns can be.
Q. Who are 'institutional' investors?
A. Institutional investors are the big guys. They include mutual funds, pension funds, banks, and insurance companies. You might think that the market is mainly made up of individual investors like you, but in reality, since institutional investors trade in such large volumes, they can account for more than two-thirds of daily market activity. Whether a stock is in or out of their favor can have a big effect on its price. You can benefit, though, if you discover a small gem and invest in it early. When institutions eventually start buying, they'll drive its price up.
Next: Part 2 »