I first heard of investing from my Dad when I was in high school. I don’t recall any specifics except the idea that you can own a part of a company by buying stock in that company. It was about the time Alaska became a State and I had finished a term paper on ‘Alaska – the Last Frontier.’ I had to get a piece of the action so I had Dad buy me some stock in Alaska Airlines.
How could I miss? New state, airlines were getting jet planes, etc. A sure bet! Well, it never ‘took off’ and I later sold it for a negligible gain or loss.
During this time, I learned that when you buy a stock, you own a prorata share of the company. Bonds are funds that are lent to the company and represent no ownership of that company, but they are in a preferred position. Stocks are considered ‘equity’ while bonds are considered ‘debt’ or loans to the company. Both stock and bonds ‘earn’ interest; which over time equates to a return in investment. Also, most stocks pay dividends, a sharing of the profits of the company.
On the surface, it’s rather simple. You or I could start a company as follows: You put up $500 and I’ll put up $500 and we will go to the race track for the day. If we lose some, you get the first $500, I get the rest; however if I get more back than my $500, you get 10% of the winnings while I get 90%.
This simplistic example demonstrates what it would be like: you own a bond in our company, I own the stock. This scenario shows that bonds may be more secure, though with lower returns, and stocks, though riskier, may have higher reward.
A similar example can be applied to real estate which we are all exposed to whether we own or rent.
In 1968, may friend and I decided to by a duplex in Newport Beach.
The cost or sale price was $39,000. ( “once upon a time never comes again”)
The down payment was $ 3,000 (equity which if it was a corporation would be ‘stock’).
The seller provided a loan of $36,000 which would be a ‘bond’ in the corporate world.
We split the work load: I manage the property, he did the accounting. We sold it about a year later for $51,000, so our profit was $12,000 minus our related costs of about $3,000 or $9,000
So our downpayment was $3,000 (equity)
We received after costs $9,000 (profit)
Our return on investment was 300% for the year.
But this is misleading! Why? It doesn’t factor in the value of our own labor, which I estimate to be $3000. This reduces the profit total to $6000, or 100% return in investment, a big difference. I mention this because, should you ever be the promoter of an investment venture, you need to know that your efforts are worthy contributions.
Over the years since, I like to reflect on what the valuation of my first $1500 has become as a result of reinvesting the proceeds. It’s now grown to at least $150,000. Investing not only can augment your savings, it can protect your money from depreciation in value that comes naturally from inflation. When you have money in a savings account, or ‘cash under the mattress,’ that money will buy you less 1 year from today than it will buy today.
Inflation can be a friend or an enemy for young people. We’ll be going over more about inflation, risk factors, loans, and more in later blog posts, so stay tuned for more.
RJM
