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Investing in Stocks
The two sources of capital for a corporation are equity and debt. In the following paragraphs, we will discuss both. With equity, a corporation gives up control, but gets access to money by issuing equity, in the form of shares of corporate stock.
A company or a corporation is an artificial entity whose body consists of people. The brains consist of the Board of Directors, the chief of which is the Chairman of the Board. The brawn consists of the employees, the chief of which is the CEO. The parents, or owners, consists of the shareholders, the chief of which are usually the entrepreneurs that started the company in the first place.
A company starts out as just a piece of paper filed with some Secretary of State. The shareholders are usually the entrepreneurs themselves. It usually takes some money to get their idea off the ground, so the entrepreneurs sometimes look for investors, usually called Angel Investors. These angel investors give the entrepreneurs money in exchange for shares of stock. The entrepreneurs use this money to buy or create assets that generate income. There are certain limitation as to who can meet the legal requirements necessary to become an angel investor, so the shares of stock cannot be openly sold to the general public. As a result, the investors receive “private” shares of stock and have to wait until the company is acquired by some other larger company (mergers and acquisitions), or they have to wait for the company to “go public”.
Going public means that the company’s shares of stock get listed on a public stock exchange, so that it can be bought and sold by the general public. That event is called the company’s Initial Public Offering, or IPO. That does not usually happen until the company has grown significantly. Before it reaches that point, the company usually needs a couple million more dollars from investors, so it usually turns to Venture Capital firms.
These venture capital firms are small teams of professional investors and former entrepreneurs who create an investment fund, get wealthy people and retirement pensions to place money in their fund, then invest that money into the companies of promising entrepreneurs. The owners of the venture capital firm usually invest a couple of million dollars and take a seat on the board of directors, plus a good percentage of the ownership of the company. Their goal is usually to get about 1,000% return on their money over 5 years. They actively oversee the management of the company and may even place a hand-picked seasoned professional as the CEO.
If the company grows large enough and needs much larger amounts of money than the venture capital firms are willing to provide, then Private Equity firms may step in. Private equity firms usually invest much larger amounts than the venture capital firms do, and they expect to make 200% to 300% return on their money in 2 to 3 years. Even so, all the private investors make their money when the company gets bought out or during the IPO. By this point, the founding entrepreneurs who started the company in the first place usually own a relatively small percentage of the company, but their shares of stock are worth a lot more then when they started. Up to this point, all the money that was invested into the company was able to be used by the company to grow the business.
After the IPO, the shares of stock become traded on the secondary market. When someone buys a share of stock on the secondary market, because they think it will go up in price, they are buying it from another investor who is selling the share of stock because they think it will go down in price. Thus begins the “greater fools” theory. All the real money was made before the IPO. After the IPO, investors usually expect traditional stock market returns, which typically average 5% per year over the long run, as opposed to the 1,000% or 200% that the earlier investors were looking for. Publicly traded stocks are on a secondary market driven by speculation on the expected future earning of the company. The secret to making a good stock investment is to find a good professional stock investor, a professional trader. Amateurs see stocks investing as an easy way to make a lot of money, but amateurs loose their shirts every day on the stock market.
When financial planners help people invest in stocks, they usually mention mutual funds as one of their main tools for asset management. A mutual fund is an investment company that buys other companies’ shares of publicly traded stock. They are supposed to provide the amateur investor with the ability to diversify their investment, while having a professional investor at the helm. Sadly, though, in the long run, most mutual funds don’t even keep up with the average return of the stock market as a whole. The standard investment method is to “buy and hold” a stock. This is a method where you have no control over the return and it puts your investment capital completely at whims of the stock market. There are limiting rules that mutual fund managers have to follow, so most mutual funds just follow this traditional investment method.
Another increasingly popular way to have a professional trader help you get returns from investing in the stock market is through a Hedge Fund. The managers of hedge funds don’t have the same restrictions as mutual fund managers, with regards to what strategies they can use. They usually charge a fixed management fee plus take a percentage of the profits they generate for you, in the form of a performance fee. In addition, you usually have to meet certain Accredited Investor requirements in order to invest in a hedge fund.
A less known, but potentially more powerful way for a professional trader to help you rake in profits from the stock market is through a Managed Account. Unlike a “fund”, where you give the professional investor custody of you money, you can actually keep control over your own funds by using a managed account. Your account is held in your own name at a brokerage firm. You then hire a professional
trader to make trade recommendations for your broker to execute on your behalf. It a form of professionally assisted automated trading. The money remains in the account is in your name only. The professional trader cannot place money into nor take money out of the account. And if the professional trader doesn’t perform according to your expectations, you simply fire them and have a different professional trader send their trading signals to your broker. You can even find some professional traders who charge only a fixed management fee, and others who charge only a performance fee. Some of these professional traders can dramatically outperform the average return of the stock market.
The average return of the stock market is measured by a stock index. The most popular stock index is the Dow Jones Industrial Average. It shows how the stocks of 30 of the largest US based publicly owned companies are performing. When finance professionals refer to “the market”, however, they are referring to an index called the S&P 500. The S and P 500 Index was created by the ratings company, Standard and Poors, and it tracks the stock values of the 500 largest publicly traded companies in the United States. When the chief financial officer and the treasurer are calculating the expected return of an investment project, they usually compare it to “the market” return, which is the historical return of the S and P 500.
Another way for a company to raise money in order to buy assets that generate income is through issues I.O.U.s. These are called Bonds. It’s like a bank loan, except that it’s from a private investor. They company issuing the bond promises to repay the principal plus the interest. It can be a very good way to get access to capital without having to give away control. Warren Buffet uses this method to get access to billions of dollars at very low interest rates, without having to give up any equity or any control. It is a form of investment debt. However, because bonds are also traded on a secondary, public market, they change in value as interest rates change. Bonds are usually viewed as “safe” investments, but bonds actually lose value when interest rates increase. However, buying and holding bonds is not the only investment viable strategy. You can also have a professional trader do active trading in the bond market for you through a managed account.
When most people are saving for retirement, they buy and hold stocks and bonds as their 401k investments, their IRA investments, or their 403b retirement. What they don’t realize, though, is that there is more to life than the finished products that large publicly traded companies produce and sell. You have two more investment markets, namely, commodities and the foreign exchange (forex or currency trading) markets. These make up the main alternative asset class and many alternative funds are linked to these alternative asset investments.
Before Kellogs makes raisin bran, they must first buy the raisins and the wheat from farmers. They exchange these commodities in the commodity market. The farmers reduce their risk by getting a contract today to sell their commodities at a price set 12 months into the future. That way the farmers and the manufacturers can plan their incomes and expenses ahead of time, thereby reducing their risks. Investors can also participate in these futures contracts. As a result, professional traders can buy and sell these futures contracts on the open market, and make profits as the prices change. This is called commodity trading, or futures trading. Suddenly, the price of tea in China actually does matter. As does the price of coffee, oil, pork bellies, soybeans, corn, wheat, and the list goes on and on. Some professional traders may even specialize in one particular category, such as agricultural futures. It can be very imposing to learn how to trade commodity futures, but the average person can tap into the profits of this market by having a professional trader trade a managed account for them. Such accounts are called Managed Futures. Unfortunately, most 401Ks and IRAs do not allow for commodity trading through managed futures. In order to tap into the profit potential of this investment method, people usually have to do a rollover 401K into Roth IRA or self-directed IRA. Roth IRAs are unique in that you don’t pay taxes when you pull your money out after the age of 59 ½. These can be good if you make a lot of money through these kinds of alternative investment.
The other main financial market that falls under the category of alternative investments or non-traditional investments is trading the currency markets, also called currency trading, Forex trading, 4x, or the Forex Spot Market. A country’s currency can be viewed as a measure of value of that country, like a share of stock. If the country’s economy gets stronger, then the value of the currency will get stronger in relation to the value of other currencies. However, the opposite can also be the case, as happened recently in Europe. When one of the members of the European Union had financial difficulty, that member being Greece, the value of the Euro dropped in relation to other currencies.
The average person might not care what happens to the currencies of other parts of the world, but the informed investor knows that trading currencies can be of the best ways to make money. The main technology platform used for currency trading is the Meta Trader 4 platform, called the MT4 platform. Even though it uses advanced technology, it can be downloaded onto your home computer. However, like the other financial markets, the secret to making money in 4x currency trading is having world class professional traders do the trading for you, through forex managed trading. While amateurs can lose a lot of money, the professional traders certainly can make a lot of money.
Active income vs. passive income
CPA’s and Tax attorneys have their own definition for active income vs. passive income, with regards to tax treatment. However, for practical purposes, a more functional definition may be in order. If active income is where you trade your time for money, and passive income is where you make money even when you don’t dedicate your personal time to doing so, then using managed accounts can be an excellent way to generate passive income, using the services of professional traders. It does not matter if they trade stocks, stock options, bonds, commodity futures, or foreign currencies. What matters most is their rate of return, and the fact that you have complete transparency into seeing the result of each trade, liquidity in that you can withdraw any portion of your funds at any time, and control in that your money is in an account that only you control and you can hire or fire a professional trader at will. Additionally, because you are accessing your accounts online, this is a way to make money online without having to learn how to do any internet marketing, affiliate marketing, or network marketing (multi-level marketing). No products or services to sell or buy.
There is a lot of hype in the media right today about purchasing residential real estate for investment purposes. Sadly, most of the people selling the deals are real estate investors who thought the time to buy was yesterday. The main strategies are landlording (buy and hold), wholesaling, rehabbing (buy-fix-sell), short selling (getting the bank to reduce the amount of the outstanding mortgage), and tax lien or tax deed investing (paying past due taxes in hopes of getting a high interest rate or even title to the house itself). Buyers try to get the properties from sellers who are motivated to sell at a discount, such as in time of pre-foreclosure, REO (the bank already foreclosed and is now trying to get rid of the house), bankruptcy (investors lose their investment properties), probate (offer to buy it from the heirs who want cash instead of bricks and mortar).
One drawback with real estate is that it is not a very liquid market. It is hard to get your money out of the investment, when you want to. Unlike stocks, bonds, commodities and forex, where you have a secondary market with regular exchange between buyers and sellers at retail prices, you do not have that with real estate. If you want to sell your real estate property at retail prices, you have to go through significant time and effort to find a retail buyer. Banks have severely restricted their lending requirements for retail buyers, so there are fewer retail buyers. It is difficult to get financing for a property, and even more difficult to refinance a property. As a result, many real estate investors become equity rich, but cash poor.
Most single family residential (SFR) investment properties do not have very much free cash flow. Equity doesn’t pay the bills if you have unexpected maintenance and repair issues, or if you have unexpected vacancies to deal with. Most amateur investors see SFR as a stepping stone to bigger and better real estate deals, like multi-family (apartments) or commercial real estate (office buildings, shopping malls, industrial parks, self-storage centers). Unfortunately, commercial real estate is even less liquid than residential real estate, and they get hit just as hard by economic downturns. People think they can create passive income by buying and holding real estate, but you always have tenants to deal with, so it is not truly passive. So while buying and holding real estate is a popular investment vehicle, it has the disadvantage of lack of liquidity, limited returns, your investment principle is continually exposed to the risk of the market, and it is not truly passive. In addition, there is a steep learning curve as to how to invest in real estate correctly.
Another increasingly popular method of trying to create a residual income business is by seeking to generate a passive income online. People take steps make money online and seek to make affiliate income. The premise is that if they learn how to design a website and effectively market it online, then have an easy make money online program. Because of the low barriers to entry, there is an extremely high amount of competition chasing that marketing residual. When people compete by lowering their price, then people price themselves out of a profit. This is true for online stores and other affiliate marketing programs. If someone can teach a complete novice how to effectively do internet marketing, then rest assured that the guru is making more money by teaching the novice than by doing the marketing themselves.
The main people that make money online are the companies that provide tools to internet marketers, just like the people who made the most money during the California gold rush were the people who sold picks and shovels and durable clothes (ever hear of Levi jeans, with the copper rivet?). Google is one of the main provider of picks and shovels to the modern internet marketing “gold miners.” If you want a sure way to make money off of internet marketing, get a job at Google. Interestingly, Google is one of the top destinations for newly minted MBAs.
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Legal Disclaimer: The Financial Freedom Foundation is not a United States Securities Dealer, Broker or US Investment Adviser. Forex, futures, stock, and options trading are not appropriate for everyone. Trading and investing in the stock, Forex, futures, and options markets have large potential rewards. However, there is also a substantial risk of loss associated with trading these markets. Losses can and will occur. You are solely responsible for any losses as a result of trading. Never put your money on the line without an understanding of what you are doing, and why you are doing it, based on your own personal knowledge and experience. Results, depicted above are unique to the user. Your personal results will vary. You could make more, less, or even lose money. No system or methodology has ever been developed that can guarantee profits. No representation or implication is being made that using the information will generate profits or ensure freedom from losses. Traders should consult their own financial advisers regarding any securities transaction, and be responsible for their own investment decisions.