by Damon Carr, For New Pittsburgh Courier
I recently received a call from a friend of mine. Normally when he calls, we discuss basketball. We’re both huge fans of basketball. When he said, “What’s up Damon, my mom just told me to buy Amazon stock. What do you think about Amazon stock?” He caught me completely off guard. I had to quickly take off my basketball hat and put my financial planning hat on.
I said Amazon is a great company. What prompted your mom to tell you to buy? He responded. “I don’t know. My mom is good with money. She gave me $1,200 to purchase Amazon stock. So I did.” I said, since your mom gave you the money to make the purchase, no skin off your back. I reiterated that Amazon is a great company. I would have to know your goals, time horizon, and what else you’re invested in to understand if it’s a good investment for you. As he began to answer my questions, it was clear to me, he had no real grasp on what was going on with his personal finances including his existing 401k plan or his financial goals and objectives. I told him, my primary concern is twofold. You’re asking questions, “is Amazon a good investment” — after you already made the investment. You should always investigate before you invest. Secondly, I fear you may be too concentrated—meaning you don’t have enough diversification. Amazon is one of the top companies in the world. It will more than likely do OK. You don’t have a ton of money tied up in it. It will serve as a great training ground for you. Who knows? You may make some money off of it. Considering, moms gave you the money to purchase the stock, you’re already $1,200 richer.
The next day, I received an inbox message. It read:
“Hi Damon. I received the text below via a friend. What are your thoughts?
Good afternoon, I’m not sure if you are engaging in buying stocks but Amazon is currently engaging in a 20 for 1 split for their stocks meaning that it’s much cheaper to purchase a stock now at $125 per stock when it’s typically $3,000 plus for one stock. Google and Tesla also plan to split this year. Be on the lookout.”
I responded, companies split stock prices to attract new investors. Based on the email you received, it’s working. In the end, there’s no real change in value. A stock valued at $10 per share split in 2 means you now have 2 shares valued at $5 each. Total value of shares owned is still $10. In layman’s terms, it’s like making change out of a dollar. If you do a 4 for 1 split with a dollar, you trade in your 1 dollar bill for 4 quarters. Your 4 quarters still equal one dollar. If you do a 10 for 1 split, you trade in your 1 dollar bill for 10 dimes. Your 10 dimes still equal one dollar. If you do a 20 for 1 split, you trade in your 1 dollar for 20 nickels. Your 20 nickels still equal 1 dollar.
Companies including Amazon, Google, and Tesla engage in stock splits when stock is trading at such a high price per share, many hardworking everyday people shy away from purchasing them because of their high price per share. Prior to Amazon initiating their stock split, Amazon cost $2,447 per share. By doing a 20 for 1 stock split, they gave their shareholders 20 shares for every 1 stock owned. As a result, the new stock price after the split was $122.35 per share. You take $2,447 divided by 20 to get $122.35. Instead of shareholders owning 1 stock for $2,447, they now own 20 stocks for $2,447.
Amazon said that they split their stock 20 for 1 to make it more accessible for anyone who wanted to invest in Amazon and to give their employees more flexibility in how they manage their equity in Amazon.
The bigger question for you would be threefold: What’s your goal for investing this money? What do you plan to use this money? How much money are we talking about investing? She responded, “My overarching goal is obvious, to make ‘sum-montee-huntee!’ I ain’t one to play with my skrilla (money). I have less than $1k to invest.”
I probed and asked her questions about her current financial situation. Then I asked her, are you going to purchase Amazon Stock? She replied, “Because I don’t understand the stock market, I’m not sure.” She took the initiative to investigate before she invested in Amazon stocks. She’s a smart woman. I took the time to give her a basic overview of the stock market.
The stock market moves up and down. What you pay for the stock is considered to be your cost basis. If you sell the stock for more than your cost basis, you have a gain. In other words, you made money. If you sell the stock for less than your cost, you have a loss. In other words, you lost money. If you hold onto the stocks for less than a year, if you sell the stocks at a gain, you’re taxed at your ordinary tax rate. If you hold on to the stocks for longer than a year, if you sell the stocks, you’re taxed at the capital gains tax rate of 15 percent, which is generally more favorable than your ordinary tax rate.
Stocks are the best performing asset class. It has made more millionaires than the lotto. You can definitely make money in the stock market. The key to making money in the stock market is to employ a proven investment strategy that ascribes to fundamental sound investing principles such as diversification, dollar cost averaging, low expense ratio, low turnover ratio, and understanding both your goals and your time horizon. Most importantly, the key to doing good in the stock market is NOT to do anything stupid. Too much concentration with one or a few stocks, timing the market, or investing in a stock SOLELY because it split will qualify as stupid.
Turns out her goal was to save for retirement. She planned to retire in 20 years. She currently wasn’t working. I advised her that until she’s back to working full time and her income is stable, she should save her money—not invest it.
(Damon Carr, Money Coach can be reached @ 412-216-1013 or visit his website @ www.damonmoneycoach.com)