Another in the 'getting stuff out of my head' kind of posts, this time rambling about everyone's favorite financial institutions, the Stock Markets. No earth shattering information, and nothing that's going to make you some money, but hey ya might learn a thing or two.
The basic concept of stock is simple. One share represents a certain percentage of that company. Say there were 100 shares of Apple. If you owned one share, you'd own one percent of Apple, its assets, it's income, its debts, all would be 1% yours. On the surface, this would make it easy to determine how much that share is worth, 1% of the balance sheet would belong to you, a nice simple straightforward way of doing things.
This is NOT how the stock markets work, in fact it's usually viewed as the exact opposite. A company is generally valued at the combined worth of its stock. So, to use our 100 shares of Apple example, if your one share was trading at 100 dollars today Apple would be considered to be worth $10,000. It's this sort of thing that can create bubbles like the dot com bubble a few years back that made some people millionaires and cost many others a lot of money. If enough people think that a company will be worth a fortune in the future it can drive up the price to levels that the company's true value simply can not justify.
Before I go on, I feel I should say that this piece is in no way meant to suggest Apple, or any other stock is over or undervalued. I use Apple simply because it's a company many people are familiar with, an no one who has heard of it would ever consider it's value to be anywhere near $10,000, or that there could ever be as few as 100 shares outstanding.
The original idea of selling shares in a company was started by the Dutch, although the French had been trading shares of debts before that. It started as a means of sharing the risk of the overseas trade that was booming. All it took was a pirate raid or a good storm and an individual investor could be wiped out, but by selling shares of the company both the risk and the reward was shared by many and a single disastrous voyage, while painful, was not the end of a person's fortune.
Again, this sounds like a great idea. So how do we get from there to where we are today? Wil's law's of course! Mostly the second one in this case, but as with most things the other three have their influence as well. At some point some person forgotten to history needed to get some of his money back that he had invested before the ships came back. So he found someone who was willing to buy his shares from him and presto, new guy has shares, old guy has money, everyone's happy. Then someone else comes along, they want in on a company that's all sold out of shares because they think it's a great investment, so they find someone who has some shares and offers to buy it from them for more then the first investor paid. Some negotiating goes on and presto, new guy has shares, old guy has more money then he started with, everyone's happy. New guy winds up making money, talks about it to some friends, they try it, some make money, some loose some, but in general everyone likes it. Over time things became more formalized, with rules and laws springing up as they often do whenever money is involved in things. People being people they got creative with things, inventing futures and short selling and all other sorts of clever ways to separate others from their money.
Now, that's not to say the stock market is a bad thing. In its simplest form it's a wonderful way to spread around both risk and wealth in order to allow more of society to benefit from investment. The problem is nothing we humans do ever seems to stay simple. We've introduced margins and short selling and all sorts of speculation, and everyone and his brother thinks they're on to the next big thing. People make decisions based off rumors and guesses and ignore facts and figures to the point that no one can predict with any accuracy what is going to happen next. Ultimately, this is one of the greatest tragedies of the capitalistic system. Stocks exist to share the wealth the companies generate, but those who need it the most understand it the least.
How do we fix things? As with many things in life, it starts by getting people interested and educated. Between 401k's, stock purchase plans at work, discount brokerages and more there are fewer barriers to entry into the stock market then ever before, but so few people want to because they don't understand it, or they think it's only for rich people, or they're so scared by the coverage of the occasional crashes that they want nothing to do with it. The tragedy is that it is both one of the best ways to influence business and one of the best ways to generate wealth so long as you're patient and pay attention to the numbers and not the talk. Even if you're only able to put away a few dollars a week, after a few years it can add up to impressive amounts. Now, the odds of you being the next Warren Buffet are slim to none, but if you are careful, patient and use your head to invest instead of your heart, you can accomplish amazing things for yourself and your loved ones. Yes, you are at a disadvantage in the stock market. The rich have more information, more resources, more connections, and probably more time to spend on it then you do. The thing is, so long as you are careful, diversified and don't let Wil's laws mess you up too much you can share in the wealth they enjoy, and hopefully better your life.
If you want to find out more about things, I can't recommend The Motley Fool enough. They're a business like any other, so they will try to sell you things, but there is a wealth of free knowledge there if you're looking to learn the basics. Their CAPS system is also a great way to practice before investing real money, especially since it not only tells you how much your stock has changed, but what the market in general has done in that same time. I personally use ShareBuilder for my own investing, but everyone's situation is unique and you should look carefully at several different brokers before deciding on one to find the best fit for you. Most importantly of all, never stop looking at your situation. Your life changes day to day and year to year, the investment plan you came up with when you're 20 is not what you should be using in your 60's.