Thursday, May 10, 2007

MMM: The Stock Market, Part 2

Alternate Dimension Andy (ADA):

The stock market is much more complicated than a flea market to facilitate the trading of parts of goatee wax companies. In fact, in the real world, there is not a single "goatee wax and wart remover" company that sells stock. (I'll talk more about this in a future post, "MMM: Starting a Goatee Wax And Wart Remover Company.")

For starters, there are dozens of different types of companies: automotive, software, oil... even comic book companies.

Plus, "the stock market" isn't even an actual place. There is a place where stocks are traded; that's called a "stock exchange." The stock exchange you're probably most familiar with is the New York Stock Exchange (NYSE). Worldwide, there are hundreds of exchanges. When people talk about "The stock market," though, they're just talking about the activity that is buying and selling stocks.


The most important thing for you to know about the stock market is that it's risky. If you put money into the stock market, it's not going to grow at a fixed, predictable rate like your savings account. One day, a company's stock might go down 20%. A company might go out of business, making your shares worthless. If you put all of your money into the stock market, you might very well lose it all.

Why on earth would rich people put their money into the stock market, then? 'Cause there's an even better chance that your shares will gain money. Not only that: on average, they'll gain money even faster than if they invested it in something else. Bonds and other investments typically bring in between 6 - 7%. The stock market, on the other hand has, over the long haul, averaged about 10.5%.

Asterisk. Footnote. Bullet point.

It is not the case that a given stock is guaranteed to bring in 10%. It's just the case that the whole market will, on average, over many years, return about 10%. So... if you put $d into the stock market, then waited n years (where n is at least 20), in the end you'd probably have about $d(1.10^n).


Some years, you might go way up, some years you might go way down. What's even more nuts is, this "10%" number isn't even for individual companies. It has to do with the market as a whole. Like, if you added up the value of all the shares of stock, then a bunch of years later, added up the value of all of those shares of stock, the number would be 1.1^n times larger. But for an individual stock, the numbers could be much more whack. Hella whack, even.

There is another downside to spending your money on a stock: it doesn't put cash into your pocket. If you want to cash out of the stock market, you have to place a "sell" order and wait for someone else to agree to your price. If there aren't a lot of people trading the stock, you could be waiting for weeks.

Some companies are all, "That's bullshit, yo! People who own part of this company should get a paycheck!" So, every so often, they send those people money. This money is called a dividend payment.

Coca-Cola (NYSE: KO), for instance, pays out dividends every quarter (three months). Usually, they pay out about 0.5% of the share price. So, if you bought a share of Coca-cola for $100, Coca-Cola would send you a check every three months for $0.50 (along with a note that said "DON'T SPEND IT ALL IN ONE PLACE LOLZ!").

What's particularly awesome about dividends is that you can still cash out on the stock. So in the Coca-Cola example, you'd still be able to place a "sell" order and get your $100 back. (Well, sort of. Once Coca-Cola pays out that $0.50, the shares are worth $0.50 less 'cause the company is worth slightly less. But for the sake of simplicity, let's just say you could sell the stock for your $100). Over time, while the shares are increasing in value (as most stocks tend to do), you're receiving dividend payments.

A possible way to be totally rich: buy d dollars worth of shares of a dividend-paying stock every week when you get paid. Do so for 30 years. If we assume that the dividend stock grows at an average of 8%:
  • You'll own about $6413d in shares of the company.
  • You'll receive dividend payments every quarter for 30 years.
  • At the end of those 30 years, every year, you'll be getting back $32.07d every quarter (about $2.46d every week) forever.
Forever, ADA. Think about that. Free income forever. You can give it to your kids or starving kids in Africa or kids from space. You could even give it to some dude from an alternate dimension who gave you financial advice.

Think about it.

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