• Hannah

What is investing?

Updated: Jul 16, 2020

To better understand the nature of investing, it helps to consider its purpose. The financial markets exist to connect those with an excess of resources (investors) to those who can utilize those resources to grow their businesses, growing the investor's wealth and themselves in the process. How those with resources invest in a company can take various forms, including bonds, stocks, mutual funds, and ETFs. Furthermore, investors can also choose to speculate on market outcomes, hedge risk, or some combination of both through derivative contracts such as options or futures.

Today, market operations are executed and regulated by a variety of entities and individuals. One of those entities is the financial exchanges themselves. A few better-known exchanges include The New York Stock Exchange (NYSE), the National Association of Securities Dealers Automated Quotation System (aka Nasdaq), and the American Stock Exchange (AMEX). Others are more specialized like the Chicago Mercantile Exchange (CME), which focuses on derivatives, or the London Metals Exchange (LME), which traffics in precious metals. You can think of these exchanges as gathering platforms where securities can be traded. These securities used to be traded by individuals in sportscoats who yelled trades at each other on the trading floors of the various exchanges on behalf of their clients. Today, most trading is done digitally, but you can still find individuals on the floors of the exchanges (they're just a little quieter than they used to be – or so I'm told).

When it comes to making trades, most retail investors do so with the help of a brokerage firm such as Charles Schwab, Fidelity, or TD Ameritrade. These actors also function as custodians meaning that before being able to trade your money with them, you first open an account with them and fund it. These companies then maintain your account much like a bank would while you either trade the funds within the account yourself or delegate the trading of said funds to a stockbroker or financial advisor. A major difference between brokerage firms and banks is that unlike banks, brokerage firms do not lend the funds you deposit with them to others.

In the past, most individuals traded their personal funds with the assistance of a commission-based stockbroker. In recent years, much of that business has shifted to financial advisors for various reasons including the fact that brokers and advisors are regulated by different standards. Stockbrokers are held to what's known as a suitability standard. This means that they are required by law to recommend investments that are suitable for their clients. On the other hand, registered investment advisors are regulated by what's known as a fiduciary standard that requires them to consider their clients' best interests when recommending an investment. An example would be when a stockbroker surveys several similar investments and then recommends the one that offers them the highest commission, even if it isn't the best one so long as it's suitable. However, Registered Investment Advisors must recommend the very best investment in their opinion given the information available to them and typically don't operate on any type of commission.

Just because an investment is advertised in a pink font doesn't mean it's a good investment for women. A good investment is a good investment regardless of demographics and doesn't operate differently for different individuals. What makes an investment good for you has a lot more to do with your situation and tolerance for risk than the various ways you identify. When I first started working in the wealth management industry, I worked with an individual who liked to sell investments based on familiarity. He'd sit down with clients and ask them what companies they liked. It went something like, "Have you been to Disneyland? Did you like it? Well then, let's buy you some Disney stock." No. So many nos. This is not a good approach for anyone. At the root of what makes a good investment good is the relationship between its value and its price. You can think of it in terms of shopping. What dictates a good buy for most rational consumers is what you pay for something relative to what you're getting and your perceived value of that item. Store brand milk at $8 a gallon is not a good buy. Unless I'm at Costco, and the jug is enormous. Or maybe the milk is organic, which is an important feature to me – one I'm willing to pay more for. Suppose I can get that jug of milk at a discount, even better. The same is true of investing. Price is vital because it gives us an idea of whether we're purchasing something at a discount or a premium (hint - just like shopping for shoes, it's best to buy investments at a discount).

When you decide you're ready to invest, make sure that you do your homework. The financial markets are powerful and complicated, and it's best to be humble in your approach. If you don't consider yourself knowledgeable about investing, consider employing a professional who can help you make the most of your money. Then hold that professional to a high standard of both accountability and transparency. Ensure that they are someone you trust and that what they communicate to you aligns with what you know to be true. If you'd like to learn more about investing, check out this article on the basics of stocks, bonds, and cash.


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