Disclaimer: None of the following is legal or financial advice in anyway, and respective advice should be sought from an appropriate professional.
If you’re only just getting started with securities, equities and the stock market as a broader whole, it could be very easy to become overwhelmed by the staggering number of financial products & instruments that exist, and the ways that you can invest or trade them. Markets can be intimidating places and one question is where does one start?
Perhaps the most important aspect of investing is to ‘know thyself’, to know what your goals are and especially, to know the risks that you’re willing to take to get there.
Perhaps now, more than recently, investing is more important than ever. Inflation is devaluing your money whilst there is an increasing need to have more of it. Being able to service a loan is getting harder and harder and this can all but rule out investing in property for the vast majority of people out there.
Although there is a recurring theme in this blog, the stock market is one of the most accessible places one can earn and grow their wealth. But that being said, money markets are loaded with jargon and can be a very intimidating place for beginners. What is worse is, that what is possible and what actually happens are often two different things.
So, for beginners or even for those that perhaps want a bit more clarity on where to put their hard-earned dollars, the question becomes … where to start?
There are countless places to get information about the stock market, and everyone has a different philosophy or strategy. Here is no different, but what we will do is to take a look at three specific market choices anyone who wants to manage their own money can look into. We’re going to look at Exchange Traded Funds [ETF’s], Individual Stocks and Option derivatives.
Firstly, lets take a peek at ETF’s.
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So, what is an ETF?
“An exchange-traded fund (ETF) is a type of pooled investment security that operates much like a mutual fund. Typically, ETFs will track a particular index, sector, commodity, or other assets, but unlike mutual funds, ETFs can be purchased or sold on a stock exchange the same way that a regular stock can.” [1]
In essence an ETF is a singular investable / tradable product that is comprised of other assets. Think of it like a box filled with smaller things, but you’d be invested into the box itself.
Big deal, so what?
The big deal behind ETF’s is that (depending on the ETF) you are inherently diversified from the very moment you invest your money. Although there are many, many ETF’s to choose from, the very nature of them means that they should be far more stable, relative to the assets that make them up. Diversification theoretically increases when you are invested into multiple ETF’s.
If one stock within an ETF experiences a high degree of volatility, then this will be muted by other assets that either don’t experience the same movement or possibly counter-act it.
So why invest or trade an ETF? From my perspective, the answer is simplicity … although that does not mean one can be reckless about it. An ETF allows a trader or investor to fundamentally get into the market at the highest level, without needing to really dive into the individual assets that make it up.
What about Stocks?
Stocks are the next level down when it comes to investing and trading. In order to stay on the fence here, I won’t drop any names at the risk of them being taken as suggestions, but stocks are simply buying a share in a publicly traded company.
So, in contrast to an ETF where you might be buying into a sector, industry or bucket of stocks, buying or selling an individual stock is making your trade or investment into a single company … and then having your investment subject to the relative fluctuations that single or multiple companies may be subject to.
On one hand this could seem quite risky, particularly if a stock is known to be volatile or expecting volatility … but on the other hand, a stock or stocks that are on the move can have tremendous impacts on your bottom line. Unfortunately, when owning the stock outright, a stock that does not move, really doesn’t offer all that much.
Related: Dividends. Are they Worth it?
What about Options?
As the final market choice discussed here, there are Option Contracts. To be clear, ETF’s and Stocks can have Option Contracts available to them, but there are some key reasons as to why Option Contracts ‘can’ be attractive to an investor.
Firstly, in comparison to the underlying stock or ETF’s … they’re dirt cheap … depending on the time period you get them for.
Yes … Options have an expiration date!
So, … where you can hold a stock or an ETF as long as you like, you may, by choice … only have an Option Contract for days, weeks … or perhaps up to a year or so.
But what can make option contracts the most attractive, is how they can be tailored for any type of scenario the underlying asset may go through, whether it be trending, sideways or traded for volatility. There is literally too much to go into here, and I can testify that the vast majority of beginner traders out there, get utterly confused and overwhelmed by some of the key option strategies out there.
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So, they’re cheap, they’re flexible … they can offer leverage … what’s the downside?
The downside is … they’re flexible, and you need to know what you’re doing, and I mean ‘need!’
Let me lay it out. If you buy a stock, your value goes up when the price does … and vice versa.
With an Option contract or an Option Spread, different things can happen depending on the trade that you have placed, or depending on the intent of the trade.
In Short, Option Contracts are … CAN BE an excellent place for beginners to get into the market; why? Because Options ‘can’ make the market accessible. They’re also the worst place to start, because there are so many ways they can be used, coupled with ‘what you don’t know can hurt you!’, not to mention the risk of over-thinking absolutely everything about them. They also require you to keep an eye on them, especially with future expiration dates!
So, where to start?
We get back to the root question, where to start? *sigh*
As I said earlier, ‘know thyself’, know what you want, and what you’re willing to do to get it. The next biggest thing is, how much leverage (money) do you have to actually deploy?
Its’ here that we get to the conundrum! Small investments will only yield small results. The larger the investment, the larger the risk. The larger the risk, the smaller the investment … and so on.
Part of knowing where to start is perhaps doing some math.
A $100 stock or ETF that moves 50% up, will give you +$50.
A $3 option on the same asset that experiences the same move, will be grow from $3 to $50 … 15x growth.
The cost and potential lead to a clear and decisive winner, but the actual answer can only be chosen by you, the investor, the trader … the strategy must suit you!
Potential means nothing if you don’t understand what is happening or why! It also means nothing if it causes you stress, anxiety or stops you from sleeping at night.
Related: So … How is your relationship with Risk?
