Investment Questions and Answers (Page 1)

What is the value of compounding?

Most people realize how money can compound and grow over time, but many people do not completely realize how powerful the effects of compounding can be. I will give you an example. Let's take two individuals: One decides to invest $2,000 a year from the age of 18 to 28 for a total of $20,000, at which time he stops and invests no more before retirement. The other decides to start investing at age 35 and invests $2,000 each year until the age of 65 for a total of $60,000 invested. Each person's investment earns 9% per year. Which one do you think has more money at retirement? I think the results will shock you. The person that invested from age 18 to 28 will have over $800,000 at age 65 from a 9% rate of return on his/her investment. The person that invested from age 35 to 65 will have just under $300,000 at age 65 from his/her 9% return. Even though the second person invests 3 times as much money, it doesn't compensate for the extra years of compounding earned by the first individual. Now I don't bring this up to discourage you if you didn't invest at an early age, but rather to stress the importance of compounding interest. However, if you can afford to invest more at a younger age, you will be handsomely rewarded at retirement.

Why do some Nasdaq symbols have more than 4 letters?

Nasdaq listings have four letters, if a fifth letter is added it could mean several things. For example, if the stock ends in E, that means the company is late in filing the necessary documents with the SEC. If it ends in Q, that means the company is going through a bankruptcy hearing. If the symbol ends with a F it means that the company is a foreign company while all mutual funds will end with an X. Finally, a Z at the end could mean many different things as it is reserved for "miscellaneous situations".

How do Roth and Traditional IRA's compare?

First of all, you need to determine which IRAs you qualify for. If you are able to choose which Individual Retirement Account to fund there are a few factors to consider. With a Roth IRA, you do not receive a current year tax benefit since after tax dollars are invested. However, with a Roth IRA, disbursements can be redeemed free of taxes, assuming you meet a couple restrictions. The longer time frame you have until retirement the more benefit you are likely to gain by using the Roth IRA. If you are closer to retirement or need a current tax break you may want to consider a traditional IRA. A traditional IRA will accumulate earnings and gains free of taxes; however, you will be taxed when you start receiving disbursements.

How do technical analysis and fundamental analysis differ?

Fundamental analysis is generally considered more of a long term outlook. Over time a stock tends to correspond to its financial health and fundamentals such as its earnings per share, growth rate, p/e ratio, and other financial data. If it is consistently growing and making money each quarter its stock price should follow suit assuming it wasn't overbought or priced too high to begin with. A person buying stock based on fundamental analysis is usually looking to hold on to a stock for a longer time frame as the price catches up with the strong fundamentals. On the contrary, a person using technical analysis relies on chart formations and patterns to determine whether a stock is likely to go up or down. There are numerous technical indicators, but most professional traders use a combination of data to make a determination on a stock's direction. It takes a lot of practice and skill to properly apply technical analysis. Day traders and swing traders rely almost exclusively on technical analysis. Still others use it to determine a good entry point for a fundamentally sound stock.

When does the stock market open and close?

The NYSE (New York Stock Exchange) and Nasdaq both are open for regular trading between 9:30 AM to 4:00 PM eastern time. In addition they both have after hours trading from 4:00 PM to 6:30 PM.

Why is it important to diversify?

Diversification is very important as it spreads out your investment risk. If you put too much of your money into one stock and this stock tumbles, it will pull down your entire portfolio. In addition, it is not a good idea to put all your money into one sector such as technology or health care. The reason for this is that if the sector runs into a declining market your entire portfolio will decline along with it. The best diversification plan is to have your money split out between different sectors and stocks. In effect, this balances out the ups and down. If one sector is performing poorly, chances are another one is performing well. If you don't have the knowledge or money to properly diversify then you should work with a financial planner to select a stock portfolio or use different mutual funds to spread your risk. Further diversification can be done by allocating part of your portfolio into bonds and other investment choices other than stocks.

Is there a minimum number of shares that you have to purchase? Or is an investor allowed to buy as little as one share?

There is not a minimum purchase required to buy stock. If you would like to purchase one share you are allowed to do that. However, some brokerages (online and offline) may charge you a higher commission for trading in odd-lots. A round lot is considered 100 shares and an odd-lot is a purchase for less than 100 shares. Also, if you were to purchase 250 shares of a stock, a purchase of two round lots and one odd-lot for 50 shares would be necessary to fill the entire 250 share order. However, several online trading companies will charge the same commission regardless of the number of shares being purchased.

What is a company's market cap?

A company's market cap is simply the current price of the stock multiplied by the current number of shares outstanding. Often stocks are separated into 3 classifications, small cap, mid-cap, and large cap. Small cap stocks have market caps under 1 billion and large cap stocks have a market cap over 5 billion.

What happens to a company's stock if it is delisted?

If a stock becomes delisted, it simply means it is no longer traded on the exchange it has been delisted from. This is often because the company fails to meet the requirements of the exchange. For example, NASDAQ issues must not fall below $1.00 for more than 30 consecutive days and they are also required to file regular financial statements. If they fail to meet either of these requirements or any of the other continued listing requirements the stock will be delisted. If a stock becomes delisted by NASDAQ it will usually trade on either the OTC (Over The Counter) market or on pink sheets. Many OTC stocks are still actively traded, but some investors will not trade in the OTC market. The pink sheets are traded even less frequently and it is more difficult to receive timely prices and buy and sell stock.

What is a reverse stock split?

A reverse stock split is usually done when a company's stock price is struggling and they want to increase the stock price to appeal to more investors. For example, if a company's stock is at $1 and they do a 10 for 1 reverse stock split, 10 shares of the old stock would be converted to 1 share of new stock valued at $10. The net value of your stock holdings do not change during a reverse stock split. However, it is possible that new investors may purchase the stock at $10 that would not have purchased the previous shares at $1. If this happens, the stock price could rise. The important thing to remember is that nothing has changed with the company except its share price.

Why do I have capital gains if I did not sell any shares of my mutual fund?

Even if you did not sell any shares of your mutual fund, capital gains can still occur. This happens because a mutual fund will buy and sell stocks throughout the year. Depending on the length of time the mutual fund holds the stock, a capital gains will result if the net proceeds of the stock sale is positive. As a result, mutual fund shareholders will incur a capital gain and will be required to pay tax on the gain. However, this may increase your cost basis per share, resulting in less tax when you sell your mutual fund shares. Consult with your tax advisor for more information.