Have you ever come across someone who is not familiar with the stock market at all? I mean, not knowing it as a viable investment option. I met someone at work recently who knew all about CD and savings accounts, but not the stock market. He didn’t have a retirement saving plan and never bought a mutual fund or an index fund.
I am going to write about some very basic topics of stock investing, like what kind of market is a stock market and why it’s a very good investment option for the long term.
I’ll talk about basic concepts here. This is for dummies, not for my seasoned readers who know a lot about the stock investing
What is the stock market?
Putting your cash into the stock market is many people’s first step into investment, so it pays to make sure you understand what you are doing.
Buying shares mean exactly that, you buy a share (part ownership) of a company and hope that it rises in price, and you make a profit when you decide to sell those shares.
Most people look at the Dow Jones Industrial Average (DJIA) as their first stock exchange because it includes the top 30 US blue-chip companies. It was first introduced in 1896 by successful businessman Charles Dow.
The DJIA represents an accurate cross-section of the US equity market and has continued to expand. The Dow includes Apple, IBM, Visa, Boeing, McDonald’s, and Nike, as well some Nasdaq firms too. Its size and relative stability are attractive features for investors.
How does the stock market work?
A stock market is a centralized place where buyers and sellers of company stocks can exchange a small share of ownership of them.
Fortunes are rarely made in minutes and most people look towards much longer-term investment goals when buying stocks.
The typical Wall Street image of the stock market includes testosterone-fuelled traders with their sleeves rolled up and shouting buy or sell (not unlike Dan Aykroyd and Eddie Murphy in the film Trading Places).
But the reality is much less glamorous, where long-term investing is more a case of managing a portfolio of stocks and funds – which may rise or fall depending on the market conditions – and where you look to cash them in when you think the time is right.
Why do stock prices rise?
Every stock has an initial price set by the company when it first floats on the stock exchange; however, its price going forward is subject to financial performance.
When a company grows, its price will rise; when it loses money, or market capitalization reduces, then its price will fall.
For example, for Apple, the more iPhones it sells, the higher its share price. However, if markets become saturated and sales of iPhones fall, then so does the stock value.
There are also other reasons, sometimes out of company control, that can affect the price movement of stocks. Take 1999, when the Euro became the single currency of the Eurozone. Because of uncertainty, the stock market fell.
In 2007, when the mortgage crisis happened, the stock markets took another nosedive, almost to the bottom of the ocean. Giants companies went bankrupt overnight. Bear Sterns, Lehman Brothers and Washington Mutual were among the biggest.
Fluctuations in the market can also occur on purpose due to trade wars, where governments impose trade restrictions and quotas on markets of other nations. At this time, the biggest stock market mover is the ongoing trade war between USA and China.
Not all news is bad though. In 1990, the enactment of the North American Free Trade Agreement (NAFTA) liberalized trade within North America, and the Dow Jones Industrial Average responded positively.
In 2016, the dual event of positive Brexit impact and a Donald Trump win (with election promises of cutting corporate taxes) also reaffirmed faith and optimism in the stock market, pushing the Dow Jones up.
Expected investment returns
Everyone wants some sort of return on their investment when they invest in the stock market. That is the aim of investing, but actual returns are not always easy to state.
What makes the stock market attractive to invest in is the poor rates for savings offered by banks and savings accounts.
The historical average for investing on the Dow Jones is actually pretty strong, but it depends on what timeframe you are viewing.
The longer the historical trend the more accurate the expected return rates. However, even for the last ten years, the Dow Jones index has seen its value more than double.
Be wary of taking others’ advice
When a friend or work colleague offers you a stock tip, always think twice about what merits this tip has. When investing in a stock market as a whole, you are hedging your investment over a wide portfolio of companies.
Some might outperform others, and some might underperform, but you gain when the market’s aggregate price rises. Investing in single stock puts your investment at much greater risk.
I do practice only index fund investment and I advise everyone to do the same. With the same return as any mutual fund and a fraction of fees involved, compared to a mutual fund, they present the best stock investing option to the consumers.
Even if you are buying your first stock pick or you’re a seasoned stock market investor, always ask yourself the same question, why are you looking to invest?
Do you have a specific goal for that investment, and what time period are you looking to hold it for? Over the long term, stock markets like the Dow Jones have always performed better than savings and investment funds.
But this doesn’t always mean it will continue to do so. There are no guarantees in investing in the stock market.