Stock Market Primer for Physicians
Sebastien Chevrier - Mar 11, 2017
If you’re like many physicians, you’ve spent a lot of time focusing on your medical education, residency and establishing your practice.
If you’re like many physicians, you’ve spent a lot of time focusing on your medical education, residency and establishing your practice. In the midst of all of that, you may not have had a chance to focus on maximizing your personal wealth. Making a great income is definitely a meaningful first step towards a robust financial future, but it’s how much of that money you actually save (future articles will review how to maximize your savings through various strategies and tax efficiency) and then how that money works for you (investing) that really counts.
Successful wealth planning involves creating a financial plan (which we reviewed in our last post) and then investing your savings in vehicles (ie stocks/bonds/etc) which are designed to generate income (interest, dividends, capital gains). In other words, it takes money to make money. Successful investing does not necessarily mean beating the market, but rather involves utilizing your financial plan as a roadmap with your investments delivering a healthy rate of return, in the context of your risk tolerance and stage of life, to meet your financial goals.
This post will review the basics of the financial markets so that you can learn the lingo.
What are the main investment vehicles/asset classes?
Investment vehicles are categorized within asset classes. The 3 main asset classes are: Equities (Stock); Fixed Income (Bonds); and Cash (Money Market). Commodities (agricultural products, oil, metals, foreign currencies, financial indexes, etc.) and Real Estate are other well-known asset classes.
Each asset class is expected to reflect different risk and return characteristics, and tend to perform differently from each other in any given market environment. Portfolio risk can be moderated through asset class diversification which minimizes the impact of market volatility as the high-performing asset classes can balance out the underperforming classes.
What is a Stock?
Companies issue stock (equity) to raise funding for growth, and because buying stock entitles you to a share of company profits, stock owners are also called shareholders. Essentially, shares are pieces of ownership of a corporation.
While some companies share their profits by paying out cash (dividends) to shareholders, others increase value by reinvesting profits back into growth operations (retained earnings).
Common stock and preferred stock are the two main types of stocks that are sold by companies and traded among investors.
Shares can be purchased in individual corporations, or in groups of selected companies by way of a fund.
What is a Stock Market?
Stock markets, or exchanges, are where investors come together to buy or sell shares. While these used to be physical locations, most markets today are virtual, and operate through electronic trading. When you buy or sell shares of stock in a company, you don’t deal with that business directly, but rather with other investors who own, or want to own, that company’s stock.
There are dozens of stock exchanges around the world – including the Toronto Stock Exchange (TSX) and the world’s largest, the New York Stock Exchange (NYSE) – and investors can purchase shares of companies in any of these markets.
By regularly showing investors the average value of a representative group of companies, stock market indexes let you track the performance of specific market sectors (industries) over time. Some well-known NYSE market indexes include the Dow Jones Industrial Average, and the S&P 500 (see below for descriptions of these indexes).
How Does a Stock Market Work?
Proposals to buy or sell shares of stock are called bids and offers (or asks), respectively. And because it’s the investors who decide how much they’re willing to bid or ask for a stock at any given moment, short-term price fluctuations can be frequent - and are based on supply and demand.
Over the long term, most stock prices are largely determined by some combination of a company’s actual value, and its perceived value in the eyes of investors. For that reason, both a company’s current earnings - and expectations about its future earnings – are what drive the ups and downs of the various stock markets.
Some Common Stock Market Terms:
Common Stock: Stock that entitles the owner to certain voting rights, and a share of company profits through increasing dividends and rising share price. Dividends paid on common shares can fluctuate, and in the event of bankruptcy, common shareholders get paid last. When people talk about stocks, they typically mean common stock, the most popular and widely-held type of equity.
Preferred Stock: Stock that entitles the owner to a share of company profits. Dividends paid on preferred shares are fixed, tend to be higher than those paid on common shares, and in the event of bankruptcy, preferred shareholders get paid after bondholders, and before common shareholders.
Index: A hypothetical portfolio of securities representing a particular market or a segment of it. It allows investors to benchmark the overall performance of major groupings of stocks.
Standard & Poor's (S&P) 500: One of the world's best known indices and one of the most commonly used benchmarks for the stock market. It includes 70% of the total stocks traded in the United States.
Dow Jones Industrial Average: Often referred to as "the Dow," it is one of the oldest, single most-watched indices in the world and contains 30 of the largest and most influential ‘blue chip’ companies in the U.S. including General Electric Company, the Walt Disney Company, Exxon Mobil Corporation and Microsoft Corporation.
NASDAQ: The National Association of Securities Dealers Automated Quotations exchange was the first electronic exchange where investors could buy and sell stock. The Nasdaq Composite Index is a market capitalization-weighted index of approximately 3,000 common equities listed on the Nasdaq stock exchange. It is heavily weighted in technology and Internet stocks. Along with the Dow Jones Average and S&P 500 it is one of the three most-followed indices in US stock markets.
Market Capitalization: The “market cap” of a company is determined by multiplying the current market price of one share by the total number of outstanding shares. This number gives you the total value of the company or, in other words, what it would cost to buy the whole company on the open market. Market cap is sub-categorized into small, mid, and large cap. Companies with larger market capitalizations tend to grow more slowly and are less volatile, on average, than mid and small caps.
Bond: A debt investment in which an investor lends money to a company or government for a specific period of time, in return for regular interest payments at a pre-prescribed rate.
Mutual Fund: A collection of assets that may include stocks, bonds, or other securities. It provides individuals an opportunity to participate in the market in a diversified manner. The fund is financed and shared by a pool of investors and professionally managed by a fund manager. The goal of mutual funds is to outperform the market.
Exchange Traded Fund (ETF): A basket of securities whose performance is based on its correlating index. They trade like an individual stock on a stock exchange. The goal of an ETF is to yield the same return on investment (ROI) as its correlating index.
MER: The annual management fees, operating expenses and taxes charged on a fund make up the Management Expense Ratio (MER). Expressed as a percentage of a fund’s average net assets for that year.
Alternative Investments: Investments that fall outside the usual stocks and bonds, including assets like real estate, commodities (oil, gold, wheat), and rare collectibles.
Real Estate Investment Trust (REIT): Similar to a mutual fund or ETF, this collection of assets includes only commercial and residential properties or mortgages.
Hedge Fund: A limited partnership of investors that uses alternative methods with the goal of realizing large capital gains.
Capital Gains: An increase in the value of a capital asset (investment/real estate) that gives it a higher worth than the purchase price. The gain is realized only when sold and is reportable on taxes.
Bull market: A sustained period of time during which stock prices experience a general trend upward. It is a reflection of investor confidence and willingness to invest in the markets.
Bear market: A period of time where stock prices fall significantly (typically accepted as a greater than 20% fall from their 52 week high). It reflects a lack of investor confidence and selling increases.
Understanding the basics of personal finance and investing will give you a huge leg up in planning for your life and your future. Whether you choose to do it yourself, or seek the guidance of a trusted advisor, it’s important to be informed. Putting theory into action as soon as possible will allow you to realize your financial/lifestyle goals and to retire years sooner - Stop thinking about it and ‘just do it’!
“Our goals can only be reached through a vehicle of a plan, in which we must vigorously act. There is no other route to success.”
- Stephen A. Brennan
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