Economics and Investing: Basics

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This is post one concerning the different types of investments, in a series of posts that will cover topics such as forms of investments, strategies and methods. If you have a specific request, email us at econsoc@uwaterloo.ca.

Economics covers a very wide range of topics and can be applied to almost anything in life, including investing.The analytical skills and knowledge gained from studying economics in invaluable when it comes to investing. It allows us to understand how different factors can affect each economy, on a macro and micro scale, but how do we utilize our knowledge? (See how economics can be applied in my first post here: http://uweconsoc.com/applying-economics/)

Let’s imagine a scenario; you have been studying economics for a little while now and think you have a good grasps of its concepts, as a result, you feel like the software industry is about to explode. So you spend some time researching which companies you think are the best to invest in, you may have a list like this: EPAM Systems (NYSE:EPAM), Qvidian, Miles Technologies, Talentica Software, Ultimate Software (NASDAQ:ULTI), Palo Alto Networks (NYSE:PANW), Cornerstone OnDemand (NASDAQ:CSOD), Jive Software (NASDAQ:JIVE), Red Hat (NYSE:RHT), and Mentor Graphics (NYSE:MENT). You are ready to invest, but you do not know how, well that is why it is important for economists to understand the basics of investing.

I will go over a few of the basic investments:

Stocks – Stocks, this is what I stick to trading. Buying a stock, means you are buying a part of a company. If demand exceeds supply for that company’s stock, the price goes up and if you sell it for more than what you paid for it, the difference is your revenue. Some companies also offer “dividends” for buying their stocks, and pay out small amounts to shareholders on a quarterly or yearly basis.

Options – Options are essentially a group of the same stock. You may put or call, depending which direction you believe the value of the stock is heading, and purchase an “option” for it. When you are buying an option, your first buy the contract, then if you chose to, the stocks. The cool thing about options is that you make an agreement with the seller to buy an option at a certain price, but only if you choose to by the end date of the contract. Otherwise, you just end up paying the contract fee. For example, if you want to buy an option for Apple stocks, the contract may cost $4 and the strike price for the option, $110. Assuming your contract ends one week for today, and Apple’s stock drops 40% so you no longer want to purchase it, you would only pay the $4, times how many stocks were in the option contract (i.e 10). Whereas if it goes up 40%, you still only pay the $4 plus the $110. Options are a very intriguing form of investments, but generally left to the experts. It is advised to master trading stocks before entering the option market.

Mutual Funds – Mutual funds are generally low risk, long term investments. Whereas a stock you can buy in the morning and sell at noon time and make a profit (or loss), you are expected to hold on to a mutual fund for several years. Mutual funds are a group of investments clumped together, they are generally pretty diversified and pretty effective in building long term equity. These ideal investments for people with spare income who can wait a few years before getting their money back. However, mutual funds are not liquid at all for those who need their money back shortly after investing it.

Bonds – Bonds can be bought at the corporate or government level and are generally classified as very low risk, low reward investments. Like mutual funds, they do require you to invest money for a period of time (usually about a year) before receiving the money back. Bonds are simply a loan to an institution for a period of time. For traditionally stable economies such as Canada or the U.S, government bonds are extremely low risk, though offer little return, meanwhile in more volatile economies and less stable governments, such as Greece, the return on investment can be quite high, though as is the risk.

Currencies – Quite simply, using your one form of currency to buy another. If demand for a specific currency exceeds the supply, the value of that currency will go up, and vice versa. A country’s central bank can take several actions to try to keep their currency steady, for example they may buy foreign currencies to increase the supply of the Canadian dollar in the global economy and lower the currency. Why may the central bank want to lower the currency? A lower currency can hurt exporters, as well as industries such as tourism because it costs more from other consumers around the world to buy from Canada. So, if these industries are struggling, the central bank may help them out to keep our economy strong. A lower dollar does not necessarily reflect a poor economy. The central bank’s decisions is also a good indication of where the currency is heading, such as how they determine the interest rate or what they say in their press releases.

Real Estate – Just as you would think of it, purchasing property with the expectation that the value of the property will go up. Generally these are very large investments, however some new start-ups are attempting to make investing options such as being able to crowd-fund a property with many others and own a percentage of it. Real Estate is usually a pretty safe investment, as the supply of land is not increasing any time soon, however the recession of 2008-09 demonstrates that it is important not to put all your eggs in one basket either. Look for properties in areas where you would expect demand to increase in the future. Waterloo, being the “Silicon Valley of Canada” may in fact be a good place to invest.

I hope that clears up some of the more basic forms of investments, stay tuned for more information and strategies in the following weeks. Feel free to email us at econsoc@uwaterloo.ca or me personally at arracher@uwaterloo.ca for any questions or concerns.

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Hi there! My name is Alexander Racher and I am a first year student studying Economics and Business at UW, with a minor in entrepreneurship. I enjoy learning and talking about the practical uses of economics and hope to continue meeting like-minded individuals. I act as the Academic Director of Economics Society and try to make myself available for any questions you may have. Feel free to reach out!
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