Confusing charts and Leonardo DiCaprio playing in The Wolf of Wall Street…They’re just some of the things that come to mind when we think of the stock market right?
Whilst the stock market may seem intimidating to the everyday beginner, we all have to start somewhere. We’ve dedicated today’s blog to help you understand the basics of the stock market (it might not be as daunting as you might think!).
What is the stock market?
The stock market is a place where investors buy and sell stocks of publicly traded companies that are listed on stock exchanges, such as the FTSE, New York Stock Exchange or NASDAQ.
But what exactly is a stock? A stock, or also known as equity, represents the ownership stake of a publicly held company. This means that when you buy a stock, you own a part of the company.
Why do people invest in the stock market?
For many investors, stocks are a fundamental part of their investment portfolio and strategy. This is because stocks historically tend to perform well over a long-term period, and some of their advantages are undeniable. This is because investing in stocks;
- May help to beat inflation, if the rate of return is higher than the inflation rate. This means that your money won’t lose its value from being left in the bank or your savings account, as saving accounts and banks often offer low-interest rates.
- Helps to build wealth through dividend payments or if your initial investment grows in value (but more on this later!).
- Diversifies your investment portfolio, which essentially helps you to spread your risks across different asset classes. This means that you won’t have to rely solely on one asset performing well.
What are the risks associated with the stock market?
Investing in the stock market can be risky because you can’t perfectly predict or time the market. This means that there’s no guarantee on profits and you may make a loss on your initial investment if the value of the company decreases.
The prices of stocks are determined by the market’s supply and demand, however, many factors affect it. Because of this, the stock market is highly volatile in the short term as prices are always fluctuating.
When investing in the stock market, it’s important to keep in mind that you should only invest what you can afford to lose and be comfortable with knowing that you may not get back your initial investment.
So before investing, be sure that you’re in a good financial position, and no, this doesn’t mean you need to have a ton of money! It simply means to ensure that you have a stable income, an emergency fund (that is separate from your investments) and that you have prioritised your other financial responsibilities. For example, if you have high-interest debt, you may want to consider eliminating that first as your debt can accumulate very quickly.
What can you invest in the stock market?
A common misconception of the stock market is that you can only invest in individual stocks, so we have broken down some of the key financial instruments that are traded;
- Individual stocks. This is most likely to be the most common and traditional form of investing in the stock market and it’s where you buy stocks from individual companies. For example, you may decide to invest in Apple and would own part of a small part of the company, pretty exciting, right?
- Bonds. Bonds essentially represent a loan between a lender (the investor) and a bond issuer. Bonds are typically issued by governments or corporations who use investors’ money to grow their business. Bond issuers are required to pay back the amount to the investors after a set period of time, along with interest rates for borrowing from the investors.
- Mutual funds. These are made up of a pool of money from investors to invest in a changing list of securities such as stocks and bonds. Mutual funds are professionally and actively managed portfolios that aim to beat the market to produce a profit.
- Index funds. An index fund is a selection of companies or securities which are grouped together based on things like sector or by size, so for example, a group of tech companies. The index fund is set up to match the investment returns of a benchmark stock market index (e.g. the S&P 500) and allows you to spread your risks across different companies rather than investing in one individual company or security.
- ETFs. ETF stands for Exchange-Traded Funds. These are similar to mutual funds and index funds where it tracks a selection of companies or securities which are grouped together. The difference between ETFs is that they can be exchanged just like stocks, meaning that you can buy or sell them at any time.
How can you make money from investing in the stock market?
There are two main ways that investors earn money from investing in the stock market;
Dividends
Dividends are when a company uses its profits to pay shareholders on a regular basis to reward them for their loyalty. However, some companies choose not to pay dividends as they’d rather reinvest their profits into growing the business.
Appreciation
When a company grows in value, the price of its shares increases. This means that you can make a profit if you decide to sell your shares at a higher price than what you had originally bought them for.
The bottom line
With the basics broken down, investing in the stock market doesn’t have to be just for the experts. However, it’s important that you research and are diligent before investing in anything you don’t completely understand!
