Equity is ownership in a company. When investing in equity, most investors purchase publicly traded shares on an exchange such as the NYSE or NASDAQ through an online broker.
There are two main ways to go about investing in stocks, passive investing and active investing.
- Passive investing is “buying the market”, or gaining exposure to a diversified portfolio that performs in line with the stock market average. This is also sometimes referred to as index investing. There are many indexes out there but the more popular ones are the S&P 500, Dow Jones Industrial Average and NASDAQ Composite. Retail investors like you and me can invest in products such as exchange traded funds (ETFs) and mutual funds that are designed to track these broad market indices. For example ticker symbol SPY. These types of funds generally have low fees. The concept of ‘beta’ is important here as it measures correlation with the market index. For example if an investment in XYZ has a Beta of 2 with respect to the S&P 500. XYZ will return 2 times whatever the return on the S&P 500 is. If the S&P goes up 5% XYZ goes up 10%. If it goes down 10%, XYZ will go down 20%.
- Active investing on the other hand is “trying to beat the market”, or trying to outperform a benchmark. Active investors generally try to beat the market through superb stock selection or having some “superior strategy”. Individual investors can try to beat the market themselves or invest with a professional asset manager. These asset managers offer their services through hedge funds, mutual funds and ETFs. As one may expect, actively managed funds come with higher fees than passive funds. Asset managers seek to generate ‘alpha’ which means to generate returns that exceed the benchmark index. Alpha = doing better.
- There is also semi-active investing or enhance indexing. In this case the bulk of your position is in a passive fund that tracks an index while you have a smaller bucket to make your own bets. This method is also described as being underweight or overweight certain stocks or sectors based on your opinion. For example, lets say you think the market is going to go up in general but think that energy companies are going to outperform while retailers will underperform. With a semi-active approach you could invest ~90% in an S&P 500 fund and 5% in an energy focused fund and a 5% bearish retail position (go short an ETF or buy put options). Derivatives such as futures may also be used instead of holding cash.
Investing Strategies-
- Value Investing – Low P/E (Price to Earnings) and/or P/S (Price to Sales) ratios
- Growth Investing – Higher P/E ratios
- Market Oriented – a mix of both value and growth styles
Analysis Tools
- Fundamental Analysis
- Technical Analysis
- Quantitative(Quant)/ Algorithmic (Algo) Analysis
Categorizing Stocks – Investors may want to gain exposure to only certain kinds of stocks and there are many funds set up to do just that. Here are some ways stocks are categorized,
- Market Capitalization (Size) – Large Cap (Blue Chips), Mid Caps, Small Caps
- Industry – Technology, Energy, Financials, etc.
- Region/Country – Europe, Emerging Markets, BRIC (Brazil, Russia, India, China), etc.
Indexing
- Price Weighted – represents 1 stock of each company in the index. Biased toward stocks with higher prices regardless of market cap. Example – Dow Jones Industrial Average
- Value/ Market Cap Weighted – weighted by market capitalization. Bigger companies get more representation which can lead to less diversification. However this will account for stock splits and dividends. This is the most common type. Example – S&P 500.
- Equal Weighted- invest the same dollar amount in each company, therefore will have more exposure to smaller companies. This requires more frequent re-balancing, higher transaction costs. Example – Value Line Composite Index
Good information. I need to start investing in something other than retirement.