Chapter 5: The Investment Process

Knowing how stocks and bonds are traded, why prices fluctuate, and the role brokerage firms have will help you purchase the investment products that fit your needs.

The Stock Market
The stock market is the general term for the organized trading of stocks. A stock exchange is a market for buying and selling stocks. The New York Stock Exchange is the largest stock exchange in the in the world. The National Association of Securities Dealers (NASDAQ) is also an important exchange. Stock prices are determined by supply and demand – by sellers and buyers willing to buy or sell at a certain price. As demand goes up, the price rises, and when demand goes down, the price follows suit.

Indexes
An index takes a sample of stocks and uses it to measure the market as a whole or by a specific industry. Three of the most common indexes are:

• Dow Jones Industrial Average (DJIA) is comprised of 30 blue chip (well-established, financially sound companies) stocks.
• S&P 500 consists of 500 stocks chosen for such factors as market size, liquidity (the ability to convert an asset into cash quickly and penalty-free), and industry types.
• Wilshire 5000 tracks the performance of most publicly traded, U.S.-headquartered stocks available on the major exchanges.

Therefore when you hear reports that the DJIA is up, that means that the larger companies are doing well, and so too should your investments if they are in that sector.

Brokerage Firms
So how do you actually invest your money? To begin, all you need is to open a brokerage account:

• Your financial institution. Many credit unions sell investment products. They may even have financial planners on staff, who can help you make wise decisions at no charge.
• Traditional broker. These companies provide a wide range of services. They offer professional money managers who can help you with investment advice (for a fee). Traditional brokerage houses tend to have higher commissions than other options.
• Discount broker. If you want to invest without professional assistance, a discount broker may be the right company for you. You will be charged for making trades, but it will be considerably less than if you had an expert assist you. Commissions are even less if the company is Internet-based.

As soon as you open your account, you can begin to buy and sell securities. You may make trades with the assistance of a broker, over the phone, or online via the brokerage firm’s website.

Research Before You Buy
Even if you trust your broker completely, it is important to do your own research before you purchase any security. After all, it is your money on the line – win or lose, the person or company who sells you the investment product earns a commission. Remember too, to have realistic expectations. Don’t take “hot” stock tips that promise a huge payout, particularly if you hear about it through an anonymous email!

Monitor and Manage Your Portfolio
Setting up an investment portfolio is not a one-time event. Your life changes quite dramatically over time, and your holdings should reflect your current and future needs. Be sure to monitor your portfolio on a regular basis. Keep good records, track your progress, and above all, be patient. Saving and investing is for the long term. Expect setbacks and keep learning – you’ll be on the road to riches before you know it.