Saturday, October 11, 2008
The stock market is actually a very simple idea to wrap your arms around at it's most basic levels. A company, let's pick an old standard that everyone knows like Coca Cola, wants to make some more money. It wants to make more money for many reasons: it can pay its employees better salaries and offer them better benefits, thus attracting better workers; it can build bigger and better facilities, and purchase newer vehicles to transport their products to market more efficiently; it can research and produce new products that will get them new customers; it can purchase another company that has a product or service which Coke feels would be compatible with their own; it can allow them to advertise more on TV, radio, the internet and thus sell more of their products. All of these efforts by Coke are efforts to make their company better, stronger, healthier. So the powers at Coke decide to 'go public' by offering 'shares' of Coke on the stock market. This means that you can purchase an ownership stake in Coke by purchasing a 'share' at a certain price. A number of people decide to buy these shares, basically giving Coke their money in order to do those things they want to make their company stronger. The market determines what that price will be, so for instance initially Coke might offer shares in their company at $15 each. If you believe that Coca Cola is run well by good people, that their company is healthy, and that it is going to thrive and even maybe expand strongly in the future then you may buy a share. By doing so, you are basically betting on Coke, and you are putting up $15 of your real money in order to get a share. If you buy 10 shares, you have $150 invested in Coke. Now let's say they do well over the next few years, and as they do well the price of their stock goes up. It does so because more and more people believe in Coke like you did, so the people at Coke can raise the price of their shares because people are willing to pay that higher price. Say a couple years later the price of Coke shares is now $25 per share. Those 10 shares that you put $150 into two years ago? Well now they are worth $25 per share, or $250 total, and you have made yourself $100 on your investment. On the flip side, if Coke did poorly, if their company assets were mismanaged or stolen, or if their products were no longer as valuable to the public (in other words, fewer people liked to drink Coca Cola), then the price they could get for thier shares would go down. Say they went down to $5 per share, then your 10 would now be worth just $50. You would have lost 100 on your investment in Coke. That is how the stock market works at its most basic level. What you hear on TV every day as the 'Dow Jones Industrical Average' or simply as 'The Dow' going 'up' or 'down' is basically the world betting on America. You get in on this action, get to 'play the market', by purchasing those shares which are sold by that thing which we call the 'stock market'. Not unlike going to the grocery market for your food, you go to the stock market to purchase your stock shares. The main place that Americans do their purchasing is at the U.S. Stock Exchange, located on Wall Street in New York City, and thus you hear the market sometimes simply referred to as 'Wall Street'. The Dow is the total value of 30 selected stocks that key investors have determined make up a reflection of a wide range of important companies in America. For instance if Coke is worth $15 per share, and McDonalds is worth $10 per share, and Home Depot is worth $16 per share, and Comcast is worth $20 per share, you would add them together and get a total of 61 'points', or the dollar value of all the 'costs per share' of the companies in our little example index. If tomorrow those share values go up, and the new total is 81 points, our index of those four companies has gone up by 20 points. So it goes with The Dow, only in their case it is with the prices of those 30 American companies that I mentioned make it up. So in other words, when The Dow is going up, people are betting that America is healthy and strong. They believe that, in general, the future looks bright for business here, which means that products will get better, that their will be good jobs available, that companies will succeed. When The Dow is down, people believe that America is not going to succeed, that companies will fail. When too many people begin to dislike too many things about too many companies, they may decide that they don't like having their money in shares of stock any more, and so they pull thier money out of the stock market and do something else with it. This makes the shares in the market drop, because they are not as valuable if many people no longer want them, and so the market goes 'down'. If enough people pull enough money out in a short enough period of time, as has been happening recently, we have a market 'downturn' or even a 'crash'. A 'crash' is generally defined as when the overall stock market loses 20% or more of its value in a very short period of time. They happen usually about once every couple decades or so, and are usually seen as being a 'correction' in the market. This means that people have found that prices on company shares were a bit too high and stopped buying them until they got to levels that people were again comfortable with. What always happens is that a time comes when people look at the prices of stock in companies and say to themselves "hey, that stock is getting pretty low, it's really worth more than that" and they jump back in to the market. More and more people do this, and the market goes back up aqain. The very bottom line here is that buying stocks in good American companies is like betting on America to succeed. Do you believe that the United States of America is going to fail? Really, ultimately, completely fail? Or do you believe that 5, 10, 50 years from now there is going to be a United States of America that is still a democracy, that still is a world leader, that still bases its economy on capitalism and the value of rewarding hard work by both individuals and business? If so, then you should do exactly what I am doing by keeping the shares of my retirement plan invested in ways that reflect the market. Despite all the doom and gloom seen on television broadcasts today, I am betting on America. Despite a few hiccups along the way, she has never, ever let me down in the long term of my 47 year life. She might struggle for a bit over the next few months, even the next few years, while some details are worked out and some badly run companies are weeded out. We might even suffer a bit more should Barack Obama get elected and Democrats control Congress, thus raising our taxes and our spending and worsening our situation in those next few years. But in the long run of the next decade or so, she will be back strong, of that I have no doubts. The bottom line for me is that I'm staying in the market, I'm betting on America.