Frequently I’d overhear friends talking about the next hot stock that they were planning on buying and how it was going to take off and make them lots of money. It’s no wonder 51% of Canadians agree that investing is like gambling according to a BlackRock survey. You have to buy the next big stock in order to reach your retirement or other goals…Well I’m here to tell you that’s not true, so you can relax and start thinking strategically with your money. I’m Susan Daley and this is Your Money, Your Choices. Let’s take a step back. If investing isn’t like gambling, what is it and why should we partake in it?
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Our economy consists of companies and governments who borrow your money (excess cash that you don’t need right now), and use that money to fund their business or projects. The return you get on your money is their cost of being able to access your savings. Say I want to start up my own cupcake store in Waterloo. In order to start my cupcake shop, I’ll need some money.
There are two main ways I can get this money (assuming my family isn’t a bunch of millionaires willing to give it to me for free…) The first way is through borrowing that money through debt. I can take out a loan. In return for loaning me this money, the bank or lender will get an annual return, say 5% until the loan is repaid. The second way is through equity.
My uncle has extra cash that he willing to invest. He’s tried my cupcakes and thinks they are fantastic and that my store is going to knock it out of the park. Rather than asking for a set interest rate on the loan, he is willing to provide the money for a share of the profits in return (which are going to be large, since my cupcakes are so awesome). In the public markets, anyone can loan companies or governments money in the form of debt. There are multiple terms for this in the finance world, including bonds, and fixed income. When you lend your money, you receive a fixed percentage return for that money you lent and receive the initial loan balance at maturity.
The interest you receive won’t be higher than what’s stated in the terms, but there isn’t a large chance that you’ll lose all your money. On the other hand, say Amazon needs money to launch their drone delivery service so they issue new shares to fund this project. You like Amazon, so take your extra cash and purchase some shares. When you buy shares, you are buying a piece of the company, and now own a little bit of it. As an owner of that company, you do well when Amazon does well and are eligible for a portion of their profits. You take a hit if Amazon’s profits start to fall and the company isn’t worth as much.
Now you might be thinking investing in Susan’s Cupcake shop, Amazon, or even bonds is risky. In general, buying shares of a company is more risky than buying their bonds simply because the debtholder has a legal obligation to pay you back. With shares, there is no obligation to pay a shareholder, and the company does not control what their shares are worth at any given time.
These individual corporations could go under at any time. If that happens, bond or fixed income holders are closer to the beginning of the queue to get their money, while shareholders are at the back of the line and are paid whatever is leftover once all other interested parties get their money. I know I just told you that you could lose some or all of your money if the company doesn’t do well. Isn’t that the same as gambling?
My answer is no. In order to be an investor, rather than a gambler, you need two things: 1. Time 2.
A reasonable expectation that the organization’s use of your money will create value. If you’re looking for a company to earn you a huge return in a short period of time, with little effort, then that’s gambling, since there is no time for value creation. There is still risk involved with investing, but it can be managed. Only investing in Susan’s Cupcake Shop is risky – what if no one likes my cupcakes, or what if I get a bad batch of flour and someone gets sick after eating one of them and as a result my business goes under. This is where diversification comes into play. Diversification is just a fancy word for not putting all your eggs in one basket to make sure you don’t lose everything.
I’ll cover diversification in more detail in a future video. In contrast to gambling, it isn’t the case in investing that when one person (or company) wins, the others lose. Because more people are buying GM cars doesn’t mean no one is buying Ford vehicles. Both companies in the same industry could (and often) do well at the same time. If you believe that companies will continue to operate in our economy (and others will emerge with new products and services) and earn profits, then you will earn a return on your money.
Unless the entire world economy goes bankrupt, you’ll be wealthier over the long-term (and long-term is the key word here). Investing is risky, so why should we invest in the first place? Because NOT investing is also risky. You heard that right.
It’s risky to not invest your money too. What do I mean by that? I’m going to leave you with that cliffhanger and explain what I mean in the next video. If you want to get notified when it comes out, subscribe and click the bell. I’m Susan Daley and this has been your money your choices.