Investing 101
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Every day, hundreds of billions of dollars worth of investments are bought and sold around the world. Most of these transactions are conducted by investment banks and other large institutions. Many, if not most, of these organizations act on behalf of other actors, often individual investors. However, many people avoid investing because it seems complicated or they don't understand how it works. Learn more about investing and some of its basic concepts on this episode of Everything Everywhere Daily.

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I have a wide range of people who listen to this podcast. Some are in grade school and others work at universities. That means that some of you are going to be very familiar with investing and may even work in the industry. What I'll be covering in this episode is probably going to seem very basic to you.

However, there are also quite a few people who aren't investors and don't know much at all about investing. And if you're one of these people, maybe you've seen financial news coverage and they use terms that you aren't familiar with. So in this episode, I'm going to cover some of the basic concepts surrounding investing and investments. The goal here is not to provide any particular investment advice. There are plenty of people out there who can do that, but rather to give you some of the tools so you can figure this out yourself.

So let's start with the fact that all investments are in assets. An asset is really anything that you own. There are tangible and intangible assets. Assets can include your house, stocks, bonds, cash, artwork, baseball cards, or real estate. When you invest, you hope that the assets you purchase will appreciate in value.

Some assets you own may depreciate in value as well. If you own a car or a computer, they'll probably depreciate over time as they're used and newer models come to replace them. There are also liabilities. Liabilities are usually in the form of debt. Someone else's liability will be someone else's asset and vice versa. For investing purposes, there are several different types of asset classes that you can invest in. The biggest category that you're probably familiar with are securities.

Securities are any sort of contractual asset that is issued by a corporation or government entity. Securities include stocks, bonds, and any financial derivative based on these contractual assets such as mutual funds, warrants, and options. Stocks are partial ownership in a company. A single share of stock represents a small percentage of ownership. The amount of ownership a share of stock represents will vary from company to company depending on the number of shares they have outstanding.

If you multiply the price per share of stock with all of the number of shares outstanding, you will get the total market capitalization for any given company. Some companies have different classes of stock. For example, a company may have Class A stock, which gives voting privileges, and Class B stock, which provides simple rights to dividends. Each category of stock may have a different price.

Stock prices, in theory, are supposed to reflect the company's future earnings. A company that has good future prospects should have that reflected in the stock price. Again, this is the theoretical reason for a stock price, and there might be a lot more that actually goes into the decision to buy or sell a stock that has nothing to do with expected future earnings. A company's profits can be distributed back to its shareholders in one of two ways.

The first is via dividends. This is literally a distribution of cash to shareholders on a per share basis. The second, and what has become a more popular option today, is via stock buybacks. Instead of distributing cash, the company will buy its own stock shares on the open market, removing them from circulation.

The total value of the company should remain the same, but it will be now split amongst a smaller number of outstanding shares, thus increasing the price per share. This has become a more popular option because, unlike dividends, it isn't a taxable event. The price-to-earnings ratio, or P-E ratio, is the price of a stock divided by its earnings. The ratio is often used to determine if a stock is over- or underpriced.

PE ratios have gone up considerably over time and different industries have different PE ratios. In addition to buying individual stocks, you can buy shares of portfolios of stocks. These are called mutual funds. There are many different types of mutual funds. Some are just diversified stock portfolios and some mutual funds focus on specific industries.

One special type of mutual fund is an indexed fund, which is designed to replicate the performance of specific financial market indexes, such as the S&P 500, Dow Jones Industrial Average, or NASDAQ. An index fund should go up and down in conjunction with the value of that particular stock index. Index funds are widely considered to be one of the easiest ways to invest in stocks.

Stock options give the holder of the option the right, but not the obligation, to buy or sell a stock at a specified price, known as the strike price, and it has to be done before a certain date. They're often given to employees as a form of compensation. If the stock price of a company does well, then an employee could potentially make a great deal of money. The other major category of securities are bonds. Bonds are known as fixed income securities.

They're basically loans in which money is raised from the public rather than from a bank. An organization that wants to raise money will issue bonds that pay a fixed interest rate for a set period of time. For example, you might buy a $1,000 bond at a 5% annual interest rate, which will last for 10 years. Every year, you'll receive 5% of the principal amount, or $50 in this case, and then at the end of the bond's term, you will get back the original $1,000.

A bond can be sold at any time. The value of the bond is a set formula based on the length of the bond remaining, its interest rate, and the current interest rate. If interest rates go down, the value of a bond will go up. And if interest rates go up, then the value of an outstanding bond will go down.

The reason for this is pretty simple. If you have a bond that pays 5% interest and interest rates suddenly go to 6%, then putting your money in a higher interest investment becomes more attractive than a lower interest investment. Almost all bonds today are electronic. However, in the past, bonds were physical documents. Coupons were attached to the bond, which could be redeemed for interest payments. Some physical bonds were called bearer bonds. Bearer bonds could be cashed by whoever held the physical object.

They offer the ability to hide and physically transfer enormous amounts of money without ever being traced. Some bonds are convertible, meaning that they could be converted into stock instead of paying out interest. And some bonds can also be called in. The bond issuer can buy back the outstanding bond at market prices. The United States federal government will often call in higher interest bonds that they've sold and then sell lower interest bonds so they can save money on interest payments.

The other major category of assets are commodities. A commodity is a basic good used in commerce that's interchangeable with other goods of the same type. The quality of a given commodity may differ slightly, but it's essentially uniform across all producers. There are two major types of commodities. Hard commodities, such as gold, oil, and rubber, tend to be natural resources that are mined or extracted.

Soft commodities tend to be agricultural products or livestock such as corn, wheat, coffee, sugar, and cattle. Average individual investors usually do not invest in commodities directly. They're often bought and sold by corporate consumers and producers of the goods. Commodities lack what is known as counterparty risk.

Counter-party risk refers to the possibility that the other party in a financial transaction may fail to fulfill their obligations. This might be a company failing or not meeting revenue projections or not paying their debt. That is something you don't have to worry about if you purchase a commodity. Commodities are often sold in what are known as futures contracts. This provides investors a means of speculation and producers a means of reducing risk.

A farmer, for example, might want to sell a futures contract for wheat so they know exactly what price they will get for their crop months before it's harvested. To the farmer, this eliminates the risk of a price drop at the expense of a future price increase. Some commodities such as gold or bitcoin can be invested in via an exchange-traded fund or ETF. An ETF can allow investors to invest in something without actually having to hold the product physically.

Commodity traders of oil or wheat, for example, seldom take control of their actual physical products. The end customer would end up being an oil refinery or a food processing company who would buy the contract from the investor. Beyond securities and commodities, there are other assets you can invest in as well. The largest category would be real estate. Real estate is usually considered its own thing rather than a commodity because each piece of real estate is unique.

For most people who are homeowners, their home is probably the most valuable thing that they own. Other people buy multiple homes and try to flip the property at a higher value after fixing up the house. And still other people will try to rent out their property to turn it into a streaming revenue source. Some real estate, such as buildings in Manhattan, can be great investments. But they're extremely difficult to buy and are out of reach for the average person. That is why REITs were established.

REITs mean Real Estate Investment Trusts, and those are companies that own, operate, or finance income-generating real estate, allowing investors to buy shares and earn dividends from real estate investments without having to buy properties directly. Other items such as artwork and collectibles are considered investments, but it's a very niche investment category. It's usually only very wealthy people who can invest in such objects due to their high prices.

However, there are also mutual fund type companies that allow people to invest in fine art where you can make smaller investments for a share of a painting. One final class of asset that's still relatively new are digital assets such as Bitcoin. There's still a lot of work to be done on regulating digital assets, but as of right now, some are considered to be commodities and some are considered securities. Bitcoin is considered to be a commodity because of its distributed and open source nature.

No one person or company controls Bitcoin or produces it. Almost every other digital asset is considered to be a security because there is some person or entity behind it that is benefiting. One thing that has to be considered for every investment is how liquid it is. Liquidity refers to how quickly and easily an asset can be bought or sold in the market without affecting its price. Stocks and bonds are rather liquid in that they can be sold quickly on public exchanges.

assuming you sell when the markets are open. Real estate is a notoriously illiquid asset. Selling real estate can take weeks or months just to find a buyer and then to handle all of the paperwork. Likewise, commodities also tend to be somewhere in the middle. You can usually find buyers when commodity exchanges are open, but if they're not open, you are out of luck. There's a lot you can learn about investing in finance. What I covered in this episode just scratches the surface of what there is to know on the subject.

That being said, if you know what the topics I brought up are, you'll have a much easier time finding assets to invest in and in finding someone who can help you make investment decisions. The executive producer of Everything Everywhere Daily is Charles Daniel. The associate producers are Benji Long and Cameron Kiefer. I want to give a big shout out to everyone who supports the show over on Patreon, including the show's producers. Your support helps me put out a show every single day.

And also, Patreon is currently the only place where Everything Everywhere Daily merchandise is available to the top tier of supporters. If you'd like to talk to other listeners of the show and members of the Completionist Club, you can join the Everything Everywhere Daily Facebook group or Discord server. Links to everything are in the show notes.