Investing 101: How to Make Money Investing in Stocks
New investor: there are 3 ways to make money investing in stocks (also called equities) and the third way is not normally considered to be within the realm of stock investing for beginners. But you should know about it – just in case you arrive at the stock party late… like in 2014.
The 3 ways to make money: price appreciation, dividends, and going short. When you buy shares and the price then goes up, you are experiencing price appreciation. This is where the vast majority of gains come from in a good market. How did stock investing produce a total return of about 150% going into the year 2014? The answer is that share prices went up for about 5 years… and that’s called price appreciation. As a new investor you should know that this is called a bull market, and bull markets don’t usually last more than 5 years without a significant correction.
The new investor should also note the following. You do not really lock in these gains from rising share prices until you sell and take a profit. Buy low and sell high, as they say in stock investing for beginners 101.
The second way you make money investing is through dividends. These are payments made to shareholders quarterly, and are declared and paid on a per share basis. For example, a quarterly dividend might be 25 cents per share, which amounts to $1 a year. If the share price is $50, the dividend yield is 2%. Dividends can be increased, decreased or discontinued and not all companies pay them. If you are a new investor don’t worry about it. If they are declared you will receive your fair share.
The nice thing about dividends is that this money is either sent to you or credited to your account, so it is always yours to keep or reinvest (unlike price appreciation). Now, the new investor might turn his or her nose up at a paltry 2% dividend, which for 2014 is about the average for dividend paying equities. Some companies pay much less and some pay considerably more.
The issue here is whether growth (price appreciation) or divided income is your prime objective. Growth companies do not pay big dividends. They reinvest their profits in the company to create more growth instead of returning it to investors in the form of dividend income. It’s your choice as to how you prefer to make money investing in stocks. Here’s another thought in regard to dividends and stock investing for beginners. In a year like 2014 a 2% yearly dividend income looks quite attractive when bank accounts are paying close to zero.
The third way to make money often surprises and sometimes alarms the average or new investor. If you get to the stock party late you will likely hear talk about “short selling”, “selling short”, or just going short if 2014 or 2015 turns ugly. This concept or practice is not new and, yes, it is legal. Some investors got filthy rich selling short in the Great Depression of the 1930s. Some got rich in 2007-2009 when the stock market tanked about 50%. Let me explain how you make money selling short or going short.
You simply sell high and then buy low vs. buying low and then selling high. Your broker takes care of the details if you go short this way, the traditional way. You can also just buy PUTS, which are called “options”, but these are way too risky for the new investor. Today there is an easier way to do this. There are stocks you can buy that are called ETFs, or exchange traded funds, that are simply a bet that the stock market will fall.
For example, if you buy shares of SDS (the ETF stock symbol) you are betting that the S&P 500 Index will fall, with 2 to 1 financial leverage. In other word, if the market falls 20%, SDS shares should go up about 40% in value. I am not necessarily recommending you try to make money this way, but if 2014 turns sour, you now know how you can offset other losses in your port with one simple transaction.
Getting back to stock investing for beginners 101, you now know that there are 3 ways to make money investing in stocks (equities) and two of them you must understand as a new investor. After all, when we talk about equities, we’re talking about the primary growth engine available to all investors. Once you get more comfortable with the basics, give some thought to your third option. The party could start to wind down in 2014 or 2015.