20 Investing Questions You Were Too Embarrassed to Ask
So you have some basic questions about investing -- so basic that you don't even want to mention them to your finance-savvy friend or investment adviser. If that's the case, check out these 20 answers. We probably have you covered.
1. Am I missing out by not investing in stocks? And is there any proof that buying stocks would make me money?
Well, no and yes. There are no guarantees in investing, and the markets are impacted by many forces like company earnings, consumer emotions, political events, and natural disasters. Historically speaking, from 1926 to 2010, the S&P 500 returned an average annual 9.8% gain. For long-term investors who can absorb risk and ride with the ebb and flow of the market, experts typically concur that stocks are the most promising place to grow your money.
2. How do I find research by analysts? And how would I know if an analyst is any good?
Analyst research can be found online through independent sources like Morningstar, Zacks Investment Research, and Yahoo Finance. Brokerage firms typically offer access to analyst recommendations to their customers free of charge as well. You can also research the track record of an analyst based at Zacks "All Star" Analyst Portfolio. 'Just remember, analyst recommendations should be part -- but not all -- of your decision-making process as an investor.
3. What are the most important indicators of a stock's health?
Whether a stock is "healthy" often relies on your objective. If you seek high returns and high risk, you'll want stocks with a relatively large price range over a short time period. If you are looking for less risk and moderate growth, stick to stocks whose price ranges over the past 52 weeks are narrow. All publicly traded companies issue quarterly earnings reports to the Securities and Exchange Commission (SEC). You can find a few key pieces of data in the reports to evaluate a stock's health:
--Earnings per share (or EPS): Ratio of total earnings divided by the total investor shares. You can compare stocks with this number.
--Price/Earnings ratio (P/E): What customers are paying for a dollar of the company's earnings. There is no magic number to look for, though according to the Financial Industry Regulatory Authority, the long-term average number has been about 15. A stock with a high P/E might mean that the future looks bright -- but it has to work harder to keep the performance. A low P/E might mean that a price increase is on the way -- or that a company is in trouble.
You also need to ask some commonsense questions, like whether the company's products and industry are in demand, what its past performance is like, and how much debt it carries. All of these issues are addressed in a company's annual financial report, which is usually available via its website in a section labelled for investors.
4. What's a dividend?
It's a portion of the company's profits that's paid to investors, typically on a quarterly basis. Not all stocks pay dividends, however. You'll typically find dividends attached to steady, established (read: slow growth) companies. Because these stocks are not making major gains, companies pay out dividends to keep investors satisfied.
5. If I hear about an upcoming IPO, how can I buy into it?
Sorry, there's some bad news here. Many initial public offering, or IPO, shares are reserved for large-scale investors only, so you may not be able to buy into them. If the sale is open, find a broker who is affiliated with a bank involved with the IPO, or a discount brokerage firm that has a relationship with a traditional investment house. You can find names of the banks involved in an IPO by looking at the "Underwriting" section in a company's SEC registration, which you'll find at the SEC's EDGAR database.
6. I always hear about investors shorting a stock. What does that mean? And is there "longing" a stock, too?
Investors who short stocks believe that the current stock trading is overvalued. To make money, these investors "borrow" the stock from a brokerage house, and it is sold to another buyer. If the stock price dips, the investor who shorted keeps profits from the difference in prices, less whatever is owed to the brokerage house for the borrowed funds (this is also called trading on margin, and is often controversial).
To short a stock, you must trade through a broker using a margin account, which essentially lets you borrow more money to trade than you actually have in the account, for a fixed interest rate. Shorting stocks is an aggressive investment strategy. You can make money, but if your "bet" is wrong, you must replace the lost money in the margin account quickly. "Longing a stock" is the fundamental of investing -- you buy and hold the stock for an undetermined amount of time.
7. What are the differences between preferred and common stocks?
Common stocks are ownership interests in a publicly traded business, and owners of it are called shareholders. If a company liquidates or goes bankrupt, common stock shareholders likely won't see any equity distribution. Preferred stocks are less volatile than common stocks, and pay dividends at a regular interval. However, with reduced volatility comes reduced reward, and there is very little chance that a preferred stock will ever produce large capital gains for an investor.
Preferred stock is frequently used by fixed-asset clients who are looking for a steady income payout from dividends, and it isn't typically recommended as part of an investor portfolio until retirement. On the plus side, if a company becomes insolvent, preferred stockholders are entitled to assets before common stockholders.
8. What's a decent return for nonprofessional investors?
Over the past 100 years, the stock market has realized close to an average 10% rate of return. Adjusted for inflation, stocks could double your money in just over 10 years at their average long-term return rate. Those are some high benchmarks, but making any rate higher than what you'd earn with a regular cash account is usually considered worthwhile.
9. Can I invest in a hedge fund? Should I?
Hedge funds are not a tool for the novice investor, and to invest in one you must meet the income criteria of an "accredited investor." That means you need to have a household income over $1 million, a sum that could include the value of your home. You would also need to have an individual income of $200,000, or a combined household income of $300,000. (Some hedge funds require a higher income.)
But don't let that relatively low barrier to entry fool you. Investing in hedge funds requires an advanced understanding of how they work and a willingness to risk great sums of money. Many hedge funds purchase financial products that are not regulated by the SEC, and it can be difficult to establish a real value for them, or maintain liquidity, according to the New York Stock Exchange.
In other words, if you're still asking basic questions about hedge funds, you should probably avoid them.
10. What's an ETF and why should I care?
Exchange-traded funds (ETFs) combine the flexibility of a stock with the low costs of a mutual fund. Unlike a managed mutual fund, most ETFs trade on stock indices and constantly move with the market, meaning you can buy and sell them at a specific price. By contrast, a mutual fund allows you only to buy at the end-of-day closing price.
ETFs come in many varieties covering all sectors, so make sure you understand the goal of an ETF. If you're rolling over an individual retirement account or investing a large sum of money, they can be a good option, but for smaller investment amounts, a mutual fund is probably a smarter bet.
11. What does Goldman Sachs do?
Goldman Sachs (GS) provides services like investment banking and management, asset management, securities trading, financing and equity research services to a number of different types of clients: corporations, other financial institutions, governments and high net-worth individuals.
In addition, it invests its own money in funds, real estate, and a variety of facilities, underwrites public offerings, makes markets, and is a primary dealer in the United States Treasury securities markets (the debt instruments like treasury bills, treasury notes, and bonds that the government sells in order to operate). As a result, Goldman Sachs is very important to the financial dealings of the country.
If you didn't know the Goldman Sachs name before the housing bubble burst, that probably changed soon after. In April 2010, the SEC filed civil fraud charges against Goldman Sachs, alleging that the company withheld important information around an investment portfolio named "Abacus." The hedge fund manager who put the deal together, John Paulson, expected that the housing bubble would burst and hand-selected the assets in the Abacus portfolio with the intention to short it, and potentially profit from the market failure. He approached Goldman Sachs with his intention, and Goldman Sachs found investors willing to buy into the portfolio -- but did not disclose the hedge fund manager's stake in the deal in any investor marketing materials, including the fact that some of the bonds he had handpicked for the portfolio were included in Abacus, or that he picked them expecting their demise. The bubble did indeed burst, and John Paulson reportedly made around $1 billion. Goldman Sachs made $15 million in fees for its involvement. The Abacus investors, on the other hand, lost billions. The problem wasn't inherently in the fact that the hedge fund made money from the failure of its own investment tool. The SEC charges stemmed from the fact that Goldman Sachs did not disclose the hedge fund manager's shorted position or involvement in selecting the portfolio assets to investors. The bank settled the charges in July 2010, without admitting to or denying them.
12. Is the bond market more complicated than the stock market?
Although bonds are typically considered less risky than the stock market, the bond market is actually more complicated. Bonds are issued by many different entities including governments, corporations, and municipalities, for various time periods. The value of a bond is impacted by many factors, including the health of the issuing entity, determined based on a credit rating score assigned by Moody's (MCO) or Standard and Poor's (MHP). That score can change at any time based on interest rates, consumer sentiment, and the issuing entities' risk of default. Because bonds move inversely with interest rates and are heavily impacted by inflation, bond values are determined by the yield curve, or a line that plots interest rates compared to bonds of equal credit quality but different maturity dates.
13. What about currency investing? If the euro or yen goes down, shouldn't I buy some with my U.S. dollars, and just hang on to it?
Currency investing takes place in what is called the forex market. It trades 24 hours a day, and prices move constantly. Forex trading always involves a pair of currencies compared to another, and by its nature, requires that you go long on one (meaning that you expect its price to rise), and short on the other (you sell in anticipation that it will depreciate). While there is money to be made in the market for those who understand it, it is highly complex, volatile, and risky. Forex trading is based on "leveraging" or "gearing" "actual" money in an account, in order to increase buying power. Because every second counts in the Forex market, "doing nothing" could actually drain your account, leading to a "margin call," which requires you to pay back all losses (not just what was in the account), and whatever fees you owe the broker.
14. Is gold always a good buy?
Though gold has snatched up headlines because of its double-digit growth over the past few years, the climb is something of an anomaly. As a long-term strategy, having gold in your portfolio can be a great diversifier to stocks and bonds -- but so can other commodities. According to CBS Moneywatch's Larry Swedroe, comparably speaking, a portfolio examined from 1970 to 2010 that contained commodities versus one with gold actually performed better, producing annualized returns of 11.32% vs. 11.29%.
15. Can I invest in companies outside the U.S. via a U.S. broker? Like, can I invest in a Chinese company?
You can buy into Chinese stocks through U.S. brokers via many investment firms; there are more than 50 Chinese companies publicly traded on the New York Stock Exchange (NYSE) and Nasdaq (NDAQ). To minimize risk, you can also invest in mutual funds that hold stake in a variety of emerging markets.
16. Can I invest in private companies? How?
Many private companies require investors to meet the definition of "accredited investor," but not all. So-called "angel investors," often contribute as little as $25,000 to an entity, and can network via free sites like Go4Funding. Forming a partnership with established venture capital groups that focus on a similar objective to yours can also be an option, depending on your available funds. If you have a specific company in mind, you can also offer to buy shares directly from a company's founders or employees, if they are willing to sell.
17. Some non-profits seek investors, right? Why would I invest in a non-profit?
Non-profit investors generally do so because they believe in the cause and sustainability over the program, versus investing for pure financial gain. However, there are often tax credits given to non-profit donors, provided the organization qualifies for tax-deductible status.
18. If we head into another recession, would that be a bad time to invest?
Successful investing requires having enough cash reserves on hand to ride out market turbulence, and diversifying your portfolio to manage exposure to a variety of sectors. While a recession could indeed bring stock prices lower, investors can find safer havens in historically recession-proof industries like health care, consumer staples, and utilities—especially when those stocks pay dividends. Economic uncertainty also presents an opportunity to find bargains in the market, as long as you won't the need the cash in the short-term.
19. Is it a good idea to buy stocks in the brands you buy anyway?
Knowing the product and its consumer will help you to understand demands, and spot changes in the industry and marketplace trends, but you should also consider other research like the company's health, P/E ratio, stock price fluctuations and analyst recommendation when choosing stocks.
20. If a company goes bankrupt, what happens to the stock? The bonds?
According to the SEC, a company that files for Chapter 11 can still trade securities until a resolution is reached, though bondholders will stop receiving interest and principal payments, and stockholders will stop receiving dividends. If a reorganization agreement is reached, bondholders may receive stock in exchange for bonds, new bonds, or a combination of the two. Stockholders may be asked to exchange old shares for new reissued shares—though they won't necessarily equal the value of the old shares. If a company is deemed insolvent and declares bankruptcy, bondholders stand a better chance of recovering losses than stockholders, who will likely be left holding worthless shares of common stock.
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