3 July 2025

The Right Decision

Recommendation

Making decisions is hard, and understanding new theoretical approaches to decision making can be even harder. Mathematics professor James Stein does a fine job of explaining these theoretical frameworks, converting abstract theory to applicable tools and illustrating his explanations with numerous examples. Stein offers many case studies, so readers can apply their understanding of the theoretical tools. But he doesn’t always provide sufficient explanation of the factors involved or the reasoning behind how the decision makers in the scenarios weigh their choices. That aside, this is a useful introduction to a complex subject. BooksInShort recommends Stein’s methods to planners, managers, strategists and anyone who wants to make better decisions.

Take-Aways

  • Making decisions is incredibly important: “You are what you decide.”
  • Decision making has three stages: identifying the need for a decision, determining the “menu” of options and making a choice.
  • When making your mind up, identify the “payoff”: What is important to you?
  • Eliminate the options that don’t offer your core payoff.
  • Minimize the risk or loss.
  • Maximize the long-term benefit.
  • In some cases, the best option is to make the most of your profits during the limited time that an opportunity exists. “Make hay while the sun shines” is good advice.
  • To make better choices, get more information, even if it is costly.
  • When multiple payoff systems are at play, you must compromise.
  • When other people – and their values and interests – are involved, decisions get riskier and more complex.

Summary

Decision Theory

At some point in your life, you’ll have to make a tough decision. You might have to choose between two risky and complicated medical treatments, for instance, or you may have to select between diverging career paths. The first decision might determine if you live or die. The second might set your future happiness and prosperity. For the best outcome, apply the “branch of mathematics known as decision theory.”

“You are what you decide – and there’s a really good way to make those decisions.”

Decision theory derives from mathematics, and its principles rest on sound and tested foundations. You don’t have to know much math to apply decision theory. You simply have to assign numerical values to a few options, and – most of the time – estimate how likely various outcomes might be. The rest involves reasoning based on applying a few core principles.

Three Stages

A decision has three main stages: First, you face a situation that requires a decision. This can range from having to select a restaurant to deciding which way to jump when a tiger leaps at you. Second, you “lay out a bunch of alternatives,” and, third, you “choose among the alternatives.” That third step involves action: You go eat at your restaurant of choice, or you jump left, not right, to dodge the tiger. You can improve your decision making by reviewing past choices, either yours or judgments made by others – anyone from acquaintances to historical figures – and examining what happened at each step.

“Decision theory is a collection of tools for structuring and choosing among a finite number of qualitatively different alternatives.”

As you study these verdicts, look for the “payoff factor,” the single most important element in the decision. Your options will be stronger or weaker depending on whether you “maximize the payoffs associated with that factor.” Assign specific weights to your various alternatives and judge among them according to the payoff factor. Discovering the payoff factor in a specific decision is a crucial step, allowing you to identify the units by which to measure your payoff – for instance, the amount of money you’ll make or the hours of free time you’ll gain.

“Who you become depends to a great extent on what you decide – but who you are and what you value frequently determine what the best decision is.”

The values that determine your payoff factor may be personal and emotional. The rules you use to make the judgment are logical, and the process applies to anyone.

Evaluating Payoffs

Focus on how you identify your alternatives. Decision theory applies only to realistic choices, paths you can actually take. For example, if you are trying to decide whom to date, Angelina Jolie is not an option for most people. Limit your “menu” of alternatives to a few choices to make the framework more useful and to make choosing easier.

“Thinking is hard work, and most people simply don’t want to do it.”

Rather than, say, selecting among all kinds of wine, pick a type of wine, then a price category, and buy from this more limited menu. Three possibilities is a good target: That way, you have two extremes and a middle option. To construct your menu, “figure out what the extreme alternatives of the decision are.” Then find or create a compromise as a middle choice. When you identify the centrist choice, weigh the results for everyone involved: Will the increased payoff for those who like the middle choice outweigh the decreased payoffs for those who don’t? When assessing these trade-offs, identify the proper parameter to measure results. Assessments are simpler when you only have one parameter to track – such as how risky an option is or how much money you can earn. With multiple parameters, certainty becomes more elusive. You have to juggle multiple “payoff systems,” all using different units to measure value.

“One of the most important factors in improving one’s decision-making abilities is the acquisition and use of information.”

Your identity, your situation and your values determine your payoff. A highly competitive athlete might intentionally lose a game to her son, for example. Judge the quality of a decision only in its context, never in the abstract. Understand what is at stake and how to measure your payoffs. You must clearly perceive the substance of a decision.

Applying Decision-Making Criteria

Decision theory provides “four major decision criteria.” The first is the “admissibility criterion.” To apply this standard, examine the alternatives and eliminate any that don’t deliver a big enough payoff. If you are sorting through health insurance plans and want to keep your current doctor, apply this principle by eliminating all insurance options that don’t underwrite seeing this doctor.

“Other people’s decisions sometimes appear inexplicable – often because your payoffs are different from theirs.”

In some cases, the availability of certain options isn’t always clear. Think through the situation to see how your current choices will work. For example, are your preferences viable in the long run or only in the short term? To apply this principle, be clear about your payoffs: If you don’t know what you’ll gain, you can’t eliminate bad alternatives. To sharpen your ability to use the admissibility criterion, examine past decisions to determine which choices were inadmissible.

“The key to many successful decisions is to recognize that there is one quantifiable factor of paramount importance and that the decision succeeds or fails based on maximizing the payoffs associated with that factor.”

The second widely applicable qualifier, the “minimax criterion,” stems directly from decision theory. It calls for settling on one “alternative that minimizes the maximum danger” – that is, the choice that identifies and prevents the worst outcomes possible. You can also reverse this principle: If you are likely to lose, you might take a big risk to maximize the possible benefit from your actions, like throwing a long pass when your team is behind late in a football game.

“Game theory, probably the most famous branch of decision theory, is the study of decisions involving strategic interactions with other parties.”

The third of the four principles is the “Bayes’ Criterion,” named after Thomas Bayes, an 18th-century British mathematician who did important work in probability theory. It involves choosing the alternative that creates “the greatest long-term gain.” Estimate the “expected value” of your choice. You can measure expected value in different units: In a business deal, project potential profits; in a military campaign, judge according to lives saved; to clarify a confusing assessment, emphasize or de-emphasize some single quality for long-range advantage.

“Maximizing long-term payoffs can be done not only by maximizing the quantity of payoffs but the quality of payoffs as well.”

When evaluating expected value, draw on other decisions or a body of other cases. When you’re placing bets at a casino, the likelihood of a desired result is a matter of probability. The choices have a calculated, finite number of possibilities with set likelihoods. Unfortunately, in the larger world, matters aren’t that simple. When you lack a statistical reference, you must estimate the expected value. You can apply this principle to seeking the maximum quality payoff rather than seeking a maximum quantity of units of reward. Because businesses emphasize short-term returns, this principle can be hard to apply, even when it leads to better outcomes.

“Sometimes an apparently muddled decision gets clarified by realizing that there is a single quantity that you are looking to either maximize or minimize.”

The fourth qualifier is the “maximax criterion.” This applies when you can maximize returns on a good situation, but only for a finite period of time. This principle says, essentially, “Make hay while the sun shines.” You have a limited time to gather the most benefit, profit or return on a particular investment. This principle is difficult to apply, because resisting immediate return is very hard. Another tough dilemma arises if a situation offers a lesser quality but immediate payoff – like a college football player who has the skills and desire to play quarterback but must determine how to answer the coach who offers a short-term chance to start in another position. The player could participate and contribute – and even shine – but he wouldn’t be quarterback.

“Vindictive solutions always have the potential for blowback.”

As golfers have to select the right club situation by situation, so, too, must you use the right decision-making tool to render the best choices. How will you know which criterion to apply? Disqualifying options that don’t offer the right payoff is “always valid,” so start with admissibility. This criterion works best in simple scenarios with a clear payoff. However, its utility fades when faced with two or more payoff systems. Instead, you’ll need to trade off and compromise, weighing a higher payoff in one system against a lower payoff in another. Clearly, many decisions don’t fit a straightforward admissibility criterion. They call for applying one of the other three criteria. For instance, if you’re making a decision about a situation that recurs frequently, apply Bayes’ Criterion.

“It’s important to make hay while the sun shines because for most of us, the sun doesn’t shine too often.”

Ideally, disasters happen rarely, but that’s when you should apply the minimax principle. Minimax decisions are essentially conservative. They guide you to act cautiously and reduce risk. The minimax principle applies when you’re well established, as an individual or a firm. Mature entities have more at stake to protect and preserve. By contrast, start-up companies or adolescent workers have little invested, so they rarely apply minimax to their judgments.

Gathering Information

To reach better conclusions, get more data. The quality of your information is correlated with the quality of your decision making. Gathering data can change your relationship with the people involved. Information costs effort and emotion, and its value is time specific. An insider tip on how a horse is running matters a lot more before the race than after it. You can take data gathering too far, to a point of diminishing returns. Then you’re no longer improving your assessments by amassing more data; you may be stalling. Such delays impede good decisions or even damage them. On the other hand, sometimes you can usefully delay an evaluation and gather more data in the process. Consider a college student who decides to take her required courses first. She has to take them anyway, so she’s not wasting time, and she learns more about her talents and preferences.

“Strategic Interactions”

Often you don’t reach verdicts in isolation. In the business world and in other arenas, your decisions interact with other parties’ circumstances and choices. These strategic interactions shape your results, so take them into account. Game theory cautions that other players might be allies or enemies, so tipping a decision one way or the other might affect the “balance of power” or the “equilibrium solution.” In such situations, like an extended friendship, conditions are stable and only a large disagreement could shift the relationship. This is the setting for win-win solutions, or resolutions both parties find beneficial. The equilibrium solution need not be positive: You may have reached a stable negative situation, as in a long-term feud or war. If you are in equilibrium with other parties whose interests differ from yours, their actions shape the outcome of your decisions. Before deciding, anticipate their reactions to your choices and consider how those reactions will affect your overall payoff.

“You can’t make a winning decision if that winning alternative is not on the table.”

If your equilibrium solution involves parties whose interests clash or compete, take their viewpoints into account. In the most extreme version of this situation, some people might choose “vindictive solutions” – choices in which other people allow themselves to be hurt so that you will get hurt even more. Know enough about the emotions on all sides to remain aware of this option. If you are tempted to choose a vindictive solution, take care. History shows that while negotiating parties can accept serious punishment, going too far can produce backlash.

“Coalitions and Cooperative Solutions”

Other evaluations must involve addressing the circumstances at hand through coalitions and cooperative solutions. When facing a decision requiring cooperation, ask, “Do you really need people?” Every coalition necessarily requires compromise, so the payoffs have to be larger for the solution to be worth it. Coalition decision making is complicated; the more people involved, the higher the risk of something going wrong. The most common complication is that parties seek different payoffs. Your values may clash, and your decisions might not make sense to the others involved. Consider whether the added risk and complication are worth it.

On the other hand, some coalitions are synergistic: They produce better results through cooperation than the individuals produce on their own. The better sense you have of the interpersonal “chemistry” among the parties involved, the more likely you are to make good choices. Have a specific purpose when you form an alliance: Organizing for the sake of organizing wastes time. When you’re responsible for a group, recognize that the payoffs for that group – be it a company or your family – differ from your independent payoffs. Look beyond immediate self-interest to make good decisions for your organization.

Be realistic about the relative power of the parties involved. If other participants have much more power than you do, they have little to gain by allying with you. If you are more powerful than others, you don’t have to form an alliance; you can dictate terms. However, take care: Anytime you beat someone in a competition or determine their outcome, they may resent you.

About the Author

James Stein is a professor of mathematics at California State University and the author of How Math Explains the World.


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The Right Decision

Book The Right Decision

A Mathematician Reveals How the Secrets of Decision Theory Can Help You Make the Right Decision Every Time

McGraw-Hill,


 



3 July 2025

The Shift

Recommendation

Marketing certainly needs to be jolted into the 21st century, and this book may be a good first step in that direction. Scott M. Davis, working with Philip Kotler, who wrote the foreword, and with other chapter co-authors, urges tactical marketing executives to become “Visionary Marketers,” a transformation process that requires “five shifts” in practice and focus. To buttress his case for change, Davis includes real-world examples of top corporate marketers who transcended their traditional roles and earned the serious regard of senior management by affecting the bottom line. However, while his case studies have practical applications, he presents little new information and his descriptions of the five transformational shifts sometimes bog down. That said, he makes a compelling point that marketing must change and focus on the larger goals of the company, armed with superior knowledge of customers. As a result, BooksInShort recommends Davis’ book to serious marketers who want to update and transform their tactics in a radical way and, by doing so, step into a more influential role in their companies.

Take-Aways

  • “Visionary Marketers” are masters of strategy and organizational change.
  • A marketer with profit and loss experience has more credibility with executives.
  • A marketer’s success depends on working with the company’s most influential people and understanding its marketing “archetype.”
  • Corporate marketing archetypes include: “instinctive, high-powered, aspiring, disciplined” and “old-school.”
  • Marketers earn top-level leadership roles by undergoing five transformative “shifts.”
  • They go from generating marketing plans to influencing financial results.
  • They shift “from controlling the message to galvanizing your network.”
  • They advance from making small fixes to spurring “pervasive innovation” that rejuvenates companies and sustains growth.
  • They go from running ad agency activities to “inspiring marketing excellence.”
  • And, they shift from focusing on operations to paying intense attention to customers.

Summary

A Golden Moment

Marketing executives stand at a pivotal point within their organizations. Instead of being limited to managing advertising agency relationships and providing sales support, “Visionary Marketers” are becoming corporate leaders. They are earning this role by translating their knowledge of media use and customer behavior into new products and new consumer experiences. They move up in corporate leadership by transforming their marketing departments into engines of innovation and growth.

“Successful marketing executives today aren’t acting quite like marketers of the past.”

Today, visionary marketers have moved into top corporate positions at Best Buy, Wal-Mart, Burger King, General Electric and other companies by discovering what factors drive their customers and contribute to organizational growth. This new breed of marketers fulfills corporate demands for more bottom-line accountability. Marketers who focus only on devising creative messages and strategies are avoiding their responsibility to add to overall growth. Visionary marketers provide development ideas at the board level and drive companywide expansion through branding, product innovation and business strategy.

Thinking Strategically

Most traditional chief marketing officers (CMOs) have a strong mastery of marketing tactics but limited involvement in strategic thinking. To become visionary marketers – and, thus, strategic corporate partners – they must develop deeper insights into their customers and companies. Marketers need to evolve from being tacticians to being facilitators and leaders. This includes exceeding expectations, building executive-level credibility, driving strategic discussions, innovating, teaching and inspiring others. Such an evolution within any corporate setting depends, of course, on the corporation – particularly the CEO’s and board’s predisposition toward marketing, and the organization’s marketing culture. Such cultures fall into five “archetypes”:

  1. “The instinctive marketer’s organization” – Some CEOs, including Howard Schultz of Starbucks, Michael Dell of Dell Inc. and Arthur Blank of The Home Depot have a vision of their customers’ relationship with their products. These leaders built their companies and then turned them over to nonmarketing CEOs who eroded profitability. As chief marketing officer in such a company, expect the CEO to have strong marketing opinions. Your success will depend on how well you get along with the CEO and fulfill the board’s marketing and strategic objectives.
  2. “The high-powered marketing organization” CEOs who are former chief marketing officers or sales executives acknowledge marketing’s strategic corporate role. They include Bob Harris at Lending Tree, A.G. Lafley of Procter & Gamble, and Meg Whitman, former CEO of eBay. To become a visionary marketer in such companies, think strategically and take actions that directly affect the bottom line.
  3. “The aspiring marketing organization” – Business leaders who understand the real potential of marketing seek transformative CMOs. For instance, Burger King’s executives reinvigorated their marketing and made it the primary engine behind new products and revenue sources. Other companies with this approach include Ford, Diageo and Wal-Mart. Visionary marketers in such companies have “stretch opportunities,” wide latitude and time to make an impact, but they also face large risk-reward ratios.
  4. “The disciplined marketing function” – Traditional business-to-business, industrial, sales and manufacturing firms often lack strong marketing traditions but recognize the role marketing can play in growth. Experienced marketers can set their own course, but they need bold personalities, “talent and tenacity,” and the ability to inspire and teach.
  5. “The old-school marketing function” – The CMO is typecast as a tactician and can succeed fairly easily in that narrow role. The visionary marketer “can never win” until the company is ready for a total reorganization that breaks old patterns and opens new doors.
“Clearly this is a golden moment in time for all marketers to rewrite the traditional playbook and shift their responsibilities from supporting sales to direct line responsibility for successful and profitable growth.”

A marketer’s success depends on working with the company’s most influential people and understanding its marketing archetype. To join the corporate conversation at the highest strategic level and serve as a growth catalyst alongside other top executives, the marketer and the marketing department must progress through five transformative “shifts”:

Shift 1: “From Creating Marketing Strategies to Driving Business Impact”

Traditional marketers develop strategies. They start becoming visionary marketers when they focus on bottom-line results. Marketers who understand how their companies make money can develop a “profit and loss mind-set.” Having P&L experience enhances a marketer’s credibility and the support he or she is likely to receive from other executives, especially the chief financial officer. Visionary marketers deal with the company’s needs at the strategic level, beyond ad tactics alone. They maintain relationships with other units, particularly finance, human resources, information technology and sales. They commit resources to achieve small, steady successes. Marketers who accomplish these goals have the opportunity to gain the CEO’s attention by holding strategic discussions that address ways to boost shareholder value, drive growth, enhance efficiency, motivate the workforce, serve customers, make sales and reshape the business.

Shift 2: “From Controlling the Message to Galvanizing Your Network”

Nike is an innovative manufacturer that has created new, better ways to connect with its consumers. Similarly, Starbucks and Apple customers do not just buy coffee or computers; they buy an identity. While trying to create and expand similar identity-rooted brands, some marketers have built social media networks of aligned customers. In the process, they have realized – not always comfortably – that their customers actually want to take control of their brands themselves. This is the reality of the “Network Era” of marketing based on instant, two-way communication between companies and customers. In this free-for-all, marketers must deal with unprecedented customer input. They risk losing control of their messages. Marketers cannot just lecture such involved customers. They must court them and participate with them, joining online forums and initiating aligned services that enhance their brands. Since consumer networks transmit and check information continuously, marketers must be truthful in every communication.

“CEOs and boards are demanding that marketing become a strategic growth driver and catalyst for profitable growth.”

To visualize networking’s impact, diagram different customer contact points so you can identify key audiences, particularly groups who directly or indirectly influence purchasing decisions, deliver extra value and shape the market environment. Barack Obama’s presidential election campaign followed this strategy as it harnessed networking across many communication channels, focusing consistently on the need for change. In 2008, Advertising Age magazine cited Obama as the Marketer of the Year, largely due to his networking success.

Shift 3: “From Incremental Improvements to Pervasive Innovation”

Continuous innovation rejuvenates companies and builds business. Innovation can be “traditional,” which leads to new products, or “pervasive,” which uses fresh approaches to goods and services across departments to transform customer relationships and energize growth. Visionary marketers know that the pervasive-innovation mentality can generate new customer experiences, create novel business models and change the corporate culture. General Electric, Dell, Google, Adobe, Cargill, Procter & Gamble, Best Buy, Toyota and Apple have pursued pervasive innovation with positive results. Such firms now recognize the customer’s major role in sparking innovation. Procter & Gamble no longer relies solely on internal research and development to generate new products. When its customers identify the need for a new product, the company’s researchers shape the demand into a statement of a problem that scientists can solve, prepare a technology brief and release it to a network of technology entrepreneurs. Already, this process has produced Swiffer cleaning tools, the Crest SpinBrush and Olay Regenerist.

Shift 4: “From Managing Marketing Investments to Inspiring Marketing Excellence”

The limitations of traditional marketing – incomplete data, poor measurement processes and backward-looking analyses – highlight the need to find new ways to derive comprehensive, big-picture data. This is becoming more important as product proliferation and the lack of differentiation makes it harder for corporations to reach their growth objectives. Marketers face increasing pressure to measure results more accurately. Visionary marketers must propose and implement ideas that show measurable outcomes in overall corporate growth. The Internet, which provides faster feedback mechanisms than other marketing channels, has become the primary medium for gauging the return on investment (ROI) in advertising and direct-response marketing. Visionary marketers at Capital One and Harrah’s devised comprehensive online programs that track revenues, market share and profit margins.

“Forward-thinking CEOs are asking marketing to join them on the journey to growth.”

The speed of online consumer interactions puts additional pressure on marketers to correct poorly performing programs with great speed. This requires developing relevant, efficient metrics that quantify the business (market value, price-to-earnings ratios), its activities (sales, profitability, market share), its brand (value, price premiums, brand equity) and its ROI on marketing activities, not just in terms of money, but also in terms of customer lifetime, value and loyalty.

“You need to be all-in and relentlessly focus on your customers.”

To make this shift, visionary marketers must bridge the gap between corporate and marketing budgets. Businesses can no longer allocate funding only to individual departments, but must apply resources companywide to build brands, stimulate product demand and promote growth.

General Electric accomplished this goal by creating a marketing team of internal and external specialists who pushed innovation and studied various markets to set specific growth goals. Charles Schwab’s marketers developed an online community to elicit questions from younger investors. This proved more significant than advertising since it focused on a target audience.

“Two-thirds of companies consider innovation one of their top three strategic priorities; however, 57% are not satisfied with their return on innovation efforts.”

To emulate this approach, create “marketing playbooks” for specific market segments or geographic regions. Such playbooks should cover cost and return estimates, marketing variables, available tools (pricing, promotion, merchandising, communication) and other factors that are unique to the target group and that enable innovative, growth-oriented marketing.

Shift 5: “From an Operational Focus to a Relentless Customer Focus”

To solve complex problems, visionary marketers should develop and foster a companywide customer-centric perspective. This approach, though not easy to implement, has worked at Dell, Apple, General Electric, Burger King and Charles Schwab. However, putting it into use generally requires a full organizational transformation, which is possible only if the CMO’s marketing vision earns the backing of other top executives. Unfortunately, one-quarter of all CMOs are “not involved in any way with customer service and support,” and most have poor relationships with their CFOs. This may be why most marketers say their greatest problems stem from nonresponsive senior managers or a faulty organizational culture.

“The goal is to win customers, and the way forward is a fully integrated, go-to-market approach that holds marketing, sales, finance, IT, human resources and other units jointly accountable for the growth of the organization.”

To build strong awareness of customers, study how they interface with the business, especially during periods of stress. This analysis should reveal numerous contact points between customers and key departments. For example, customers with billing problems need input from IT.

One way to develop a customer-centric view is to create a brand council. Such councils were introduced in 2002 and they have become forums for organizational discussions about domestic and global brand building. Many brand councils eventually become growth councils. Results from these groups have helped marketers at Cargill, Zurich Financial, Visa, AT&T and Hyatt become growth leaders.

“No one has the luxury of remaining complacent.”

Marketers must move beyond tactical expertise and rebrand the marketing department, positioning it to drive sales and growth based on customer insights. Shifting marketing’s scope will give companies an enhanced ability to evaluate business initiatives and offer customers new ways to build beneficial relationships with corporations that sell to them.

About the Author

Scott M. Davis is a senior partner at Prophet and a former adjunct professor at the Kellogg School of Management at Northwestern University. He is the author of Brand Asset Management and co-author of Building the Brand-Driven Business.


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The Shift

Book The Shift

The Transformation of Today’s Marketers into Tomorrow’s Growth Leaders

Jossey-Bass,


 



3 July 2025

How to Buy Stocks

Recommendation

In this eighth edition of Louis Engel’s classic stock market primer, former Merrill Lynch Vice President Henry R. Hecht adds updated information for contemporary readers. This critically acclaimed book provides a ground-level explanation of nearly every aspect of the stock market and investing, while also offering savvy investment principles. It introduces readers to common investment terms and provides a broad picture of stock investing. The book is well-organized and clearly written, as befits a traditional reference in the field. As the author says, “This is a book about how to make your money earn more money for you by investing it. It is not a book about how to make a fortune.” BooksInShort recommends this manual to neophyte investors and anyone who wants to learn how to make sound long-term investments in the stock market.

Take-Aways

  • Investment terminology may seem difficult and complex. However, the underlying principles are quite simple.
  • When you purchase a share of stock in a business, you become a part owner.
  • How much a share of stock is worth depends on what somebody else is “willing to pay for it when you want to sell it.”
  • Investors all want to sell their securities for more than they paid for them.
  • Venture capitalists invest large sums to get new businesses going or to help existing companies.
  • Investment bankers help raise money that organizations need for “long-term use.”
  • When you buy bonds from companies or the government, you are actually lending money they must repay, usually with interest.
  • The Securities & Exchange Commission (SEC) is the securities watchdog agency of the U.S. government.
  • People consider the New York Stock Exchange the globe’s major stock exchange.
  • The world has many stock exchanges where securities are bought and sold according to many different strategies.

Summary

The Basics

Do investment terms like “capital gains,” “venture capital” or “inverse yield curve” intimidate you? If so, you’re not alone. The sophisticated jargon of the investment trade has convinced many people that investing is too difficult to understand, deterring them from buying stocks. However, investing only seems complex because it involves many esoteric words; the underlying concepts and processes are actually very easy to grasp. Once you build your investing vocabulary and educate yourself about how the stock market works, you will realize that it holds very little mystery.

“Throughout the financial services industry, everyone is busily developing new investment products tailored to meet the endless variety of investor needs.”

The stock market has always increased over long periods of time, “a trend that isn’t likely to be reversed.” Thus, when you buy for the long haul, instead of dipping in and out of the market quickly, you are likelier to make a sound investment. You can buy stocks and bonds directly, or you can invest in them indirectly – for example, through mutual funds. Stocks, bonds and mutual funds are all examples of “securities,” or “certificates that represent your participation in an investment activity.” Your involvement is “negotiable,” so you can sell your interest, or increase it by purchasing more shares.

“There’s a risk in buying stocks and bonds – and for most people it’s a far bigger risk than it needs to be, because they’ve never taken the time to study securities or find out how to invest in them wisely.”

When you buy a share of stock in a business, you become a part owner. Your return on this “common stock” purchase may consist of dividends (company earnings that are distributed among shareholders) and growth in your stock’s “book value.” However, remember that your stock’s true worth is “only what somebody else is willing to pay for it when you want to sell it.” Indeed, the market forces of supply and demand ultimately decide your profits.

The Risk Takers

Most people who buy stock have one main objective: selling their securities for more than they paid for them. However, individuals widely differ in how much risk they are willing to assume in order to make a profit. Take, for example, these important financial players:

  • “Investors” – According to the traditional definition, investors “take a moderate risk for the sake of earning a moderate return.” They usually buy stocks in sturdier, more reputable companies.
  • “Speculators” – These people take great risks based on the potential to realize huge profits quickly.
  • “Venture capitalists” – Although venture capitalists are a type of speculator, they “take a longer view.” Whereas other speculators generally look for quick profits, venture capitalists infuse cash into brand-new businesses that must grow and become profitable before they make any money on their investment. They face great losses if the companies fail.
“The average stock has paid a better return and provided a better balance of protection against both evident and unseen financial risk than any other form of investment.”

Risk takers like investors, speculators and venture capitalists are crucial in the business world. Without them, new companies wouldn’t emerge and established businesses wouldn’t be able to survive difficult periods or grow.

Investment Bankers

Investment bankers get companies the large amounts of money they require for “long-term use.” Businesses turn to them when they need an infusion of capital or when they want to broaden their base of stockholders – for example, when they wish to offer stock to the general public. Investment bankers carefully research each business, then decide whether to underwrite its stocks. Underwriting involves purchasing all the company’s “new stock” and then offering it “at a set price per share to individual buyers.” When the stock is being made available to the public for the first time (an “initial public offering” or IPO), the investment banker who determines the price must be especially thoughtful about the influences of supply and demand as well as other factors. The price should attract buyers easily but still get the best possible value for the company.

Preferred Stock

Companies may issue preferred stock to close a strategic deal, such as a merger with another company or an acquisition. In some cases, they may issue preferred stock in lieu of cash. For example, if a company wants to acquire a competitor’s business but lacks the funds, it may offer to pay the owners of the competing business in preferred stock. Each year, it would then have to pay them a “promised dividend” – either a percentage or a dollar amount – before it can pay dividends to holders of common stock.

The Securities & Exchange Commission

Congress created the Securities & Exchange Commission (SEC) in 1934 as a U.S. government “watchdog” and a regulating agency. Businesses must disclose specific information to the SEC before they can make a public offering of new stocks or bonds. First, they must file a detailed “registration statement.” In this statement, a company lists “all the pertinent data concerning its financial condition.” Among other items, it must catalogue outstanding securities as well as the new ones it plans to issue. The SEC provides this information to anyone who wants to buy stock in the company.

Bonds

Whereas shares represent partial ownership in a company, bonds “represent borrowed money,” which the issuer must pay back within a certain time frame. When you buy bonds from companies and the government, you are actually lending money they must repay, usually with a predetermined, specific amount of interest. In contrast to stockholders, whose dividends may grow as the company becomes more successful, bondholders earn a “fixed” amount of interest on their investments for a set period of time. The government issues many types of bonds. It offers Treasury bills each week with 91- or 182-day terms.

“Most times, investors have been able to sell their stocks at a profit, especially if held a long time. Thus, they have protected their money against the unseen risk of inflation.”

The Treasury also sells bills every four weeks that mature in 52 weeks. Treasury notes have terms between two and 10 years, and long-term Treasury bonds have terms varying from 10 to 30 years. Almost all money market and mutual funds include some Treasury bills “as the most liquid part of their portfolio.” People consider U.S. government bonds “the safest investments” because the federal government backs them. Investors have virtually no risk of losing their money, and all government bonds earn interest.

“Every investor must of course keep in mind there’s no simple cut-and-dried formula for success – in investing or any other aspect of life.”

State and local governments also offer bonds. These “municipal bonds” are often issued to fund projects such as “schools, roads and hospitals.” Although the federal government underwrites its own bonds, local governments must use investment bankers, like businesses do.

The New York Stock Exchange (NYSE)

In 1792, a small group of merchants who met regularly on Wall Street decided to charge their clients a commission to trade stocks. Since then, the New York Stock Exchange, or “Big Board” has grown exponentially. The exchange itself doesn’t buy or sell stocks, or set stock prices; it is merely a “marketplace” where people conduct those transactions through their brokers. Over the years, the process for buying and selling stocks has changed with the implementation of more and more sophisticated technologies, including computers. But, the basic principle has endured: “Each buy or sell order is exposed to the public auction process, designed to assure each buyer and seller that they received the best price available at the time.”

“As anyone reading headlines knows, we haven’t gotten rid of all the wheelers and dealers. You’ll still find scandals on Wall Street, as you do in most areas of human endeavor.”

You can buy or sell stocks according to a “limit order,” if you prefer. A limit order allows you to buy or sell a stock “only if it can be done at a certain price or better.” For instance, you might place a limit order with your broker to buy a certain stock only if you can get it for $18.50 or cheaper. A “stop order” allows you to safeguard your profit when the market dips. With a “stop order to sell,” you tell your broker to sell your stock if it drops to a specified price, so that you are out of the market for that stock before it drops even lower.

“The rules of the New York Stock Exchange provide that all bids to buy and all offers to sell must be made by open outcry. No secret transactions are permitted on the floor of the exchange.”

On the New York Stock Exchange, brokers must buy and sell stocks through “open outcry.” They have to carry out all their orders for public clients on the floor of the Exchange. Even if a broker had an order to “sell 100” for one client, and another order from a different client to “buy 100,” the broker couldn’t privately make the transaction. He or she must submit both orders to the competitive marketplace of the Exchange.

“Both selecting securities on your own and choosing packaged investments such as mutual funds are valid strategies.”

The NYSE’s opening bell rings at 9:30 a.m. each day. Before it opens, specialists determine the “opening price” of individual stocks by analyzing the “imbalance” between “total buy and sell market orders,” total limit orders, and “buying and selling sentiment in the ‘crowd’.” All the preopening orders are filled at the opening price.

Placing Small Stock Orders

An “odd lot” is anything from one to 99 shares of a stock. “Round lots,” 100-share batches, are more common. Odd lots used to appeal to many small-scale buyers, who often found the round-lot costs too steep. However, today’s typical round-lot price of $3,000 is easier for small-scale buyers to afford. Also, many people who would have bought odd-lot shares years ago now “invest in mutual funds rather than directly in shares on the stock exchanges.” In fact, since 1985, odd-lot trading has accounted for less than 1% of total stock exchange volume.

“Above all, keep in mind – and practice – this slogan: Investigate before you invest.”

Another investment option is an “accumulation plan,” which allows you to buy stocks by the dollar instead of by the share. This is much like going to the gas station and asking for $10 worth of gas, rather than requesting the specific number of gallons that $10 represents.

A Different Kind of Stock Market

You can also buy and sell stocks on the Nasdaq Stock Market. This “electronic network” extends through the U.S. and links to the global stock market. Nasdaq computers “instantly show the best currently available bid and offer prices for any stock traded on the system.” Often, you can automatically execute your trade at that price. Nasdaq is considered an “over-the-counter” (OTC) market, which means that its trading takes place away from the floor of a stock exchange. However, “you place your OTC order with the same individual broker at the same brokerage firm you use for Big Board stocks.”

Mutual Funds

Mutual funds and other types of “packaged investments” appeal to many investors. “In essence, by buying a single security [they] acquire a stake in a whole group of investments.” Investors like these kinds of packaged investments because they are diverse, thus “spreading the risk” across a number of companies. Large organizations that operate groups or “families” of funds sponsor most mutual funds. Other kinds of packaged investments include money market funds, closed-end funds, unit investment trusts, real estate investment trusts and limited partnerships.

Following Your Investments

Always research and investigate any investment. As a prospective or active investor, you can “follow the financial news” in specialized publications such as The Wall Street Journal and Barron’s National Business & Financial Weekly; on television and radio programs like PBS’s Wall Street Week and NPR’s Market Place; and in your local newspaper. Many cities’ daily newspapers carry a list of most, if not all, stocks. Today, you can track financial news minute-by-minute on the Internet.

“Balance inflation protection on one hand with a good return on low-risk securities on the other.”

You will want to stay apprised of not just general financial news, but news relevant to your particular investments. Once you own stock, you will receive quarterly and annual reports from those companies, and you can also follow them through specialty publications and the media.

About the Authors

Henry R. Hecht is a former vice president and manager of editorial services at Merrill Lynch. He now works as a writer and an editorial consultant. Louis Engel, the original author of How to Buy Stocks, devoted his career to the investment trade.


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How to Buy Stocks

Book How to Buy Stocks

Little, Brown US,
First Edition:1994


 




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