What is investing in the stock market? This is a very direct question and deserves a direct answer.
Investing in the stock market is buying and selling shares in the ownership of companies. When you buy shares, the money you hand over provides capital for the companies who use these funds to run their operations to achieve profit and grow their business. As a part-owner of the companies you are entitled to a distribution of profits in the form of dividends and if the value of the companies goes up, you can reap greater profits by selling the shares you bought at a price higher than you paid for them.
That was arguably a bit of a long-winded explanation but I tried to avoid using any stock market jargon and just stick to the basics.
Savings vs investing
There have been many wise words spoken and written about investing. Here are some ideas combined to illustrate a point.
Most of us embark on our economic lives as young adults when we start earning. At some point, we start saving. If we can, we will transition from saving to investing. If we are able to take things further we move on to multiplying our investments.
That can sound like dangerous pie-in-the-sky thinking but I did want to put it out there. For the moment let’s focus on the transition from saving to investing.
From a saver to an investor
I made my first cautious steps into stock investing in my late 20s after my father-in-law said to me.
You are someone who should look into investing in stocks.
That was a fairly straightforward suggestion. I thought about it and realized that he was right. So I started reading and when I had accumulated some money in my savings account I went to see the investment advisor at the retail bank where I had my checking and savings accounts.
After the usual conversation about my investment goals and risk-tolerance he suggested a rather bland selection of about half a dozen stocks that “he liked”. I remember they were mostly large companies from different industries including a heavy machinery manufacturer, some high-tech, a financial services provider, and a few others.
For each of these upright organizations, he had a story to tell about how their products were doing well or they were gaining market share, etc. I guess he thought that was the kind of thing I needed to hear to feel comfortable with where I had entrusted by funds.
What happened then
This was a long time ago, before the internet and online brokerage platforms. If you wanted to watch what the prices of your shares were doing you had to check the daily financial papers. Of course, I did, every day, religiously. Some went up a bit, some went down a bit and some didn’t do much of anything at all.
Every so often I’d get a call from my broker guy at the bank inviting me to follow some hot stock tip he’d just received. Sometimes I did, sometimes I didn’t have the money. Strangely these were always tips about what companies to buy into. I don’t recall him ever calling me to suggest selling any of my positions.
Before I left for a new job in a different country, I went to see him to say goodbye. We shook hands and he said how we had enjoyed some winners and some losers in our time together. I think it was the pat speech for the occasion though not insincere. All pretty much par for the course back then I think.
The development of stock exchanges
The world of stock markets and investing is very different now. You no longer have to go and sit with some guy in a bank and persuade anyone of anything. But first, let’s look at what stock markets and publically listed companies are.
Some hundreds of years ago, the power of kings, queens, and the nobility was being challenged by burgeoning merchant classes. These merchants realized that they could spread their business risks by getting other people to invest in their enterprises. Joint-stock companies were born. Then came the notion of limited liability, whereby if you invested or were the owner of a limited liability company, the bailiffs wouldn’t try to throw you out of your home and auction your furniture if the company went bankrupt. You would only risk the money that you paid in as capital.
Wealthy merchants and members of the nobility who had already been taking shares in each other’s enterprises started buying and selling or transferring these shares in ownership between themselves. These markets in business debt and ownership went through many developments and permutations.
The first market that was recognizable as a stock market was founded in Amsterdam in 1611. Rules, regulations, and laws governing the activities of companies and the people who traded in them all evolved over time.
Stock exchanges today
Today public stock exchanges are markets where any member of the public can buy shares in the companies listed on the exchange.
Companies listed on the stock exchanges are also called publically-listed companies. To achieve and maintain a public listing there are many criteria that have to be met. The larger exchanges like the New York Stock Exchange have more stringent requirements than smaller exchanges like the NASDAQ.
There are many thousands of companies listed on the stock exchanges in the US and similar numbers in other countries. Laws, rules, and practices differ between countries. One common feature is the fact that control is exercised by large and powerful groups.
In some situations, relationships between controlling groups are reinforced by complex cross-ownership and board representation arrangements. All that is hardly surprising and could be the subject of extensive discussion but not for now.
What is means to own shares
Shares have a face value and a market value. When the shares of a company are first issued the face value and the market value may be close. Though this differs from country to country, the face value of a share is really just a number printed when the certificates are first issued. After they have been bought and sold even for a short time the market price will likely move further away from the face value.
The face value or nominal value of a bond, on the other hand, has much more significance. The nominal value of a bond is the sum returned to you when the bond is redeemed.
Let’s say XYZ company when it was first listed on the stock exchange issued 10 million shares with a face value of $10 each. You bought 10 shares each now worth on the market $100 per share, so your position cost $1,000. You have effectively purchased a millionth-share of the company.
The fact that you own those shares gives you rights of ownership. Those rights mean you get a share of the profits and voting rights for the duration of time that you own them.
Profits will come to you in the form of dividends usually paid out every four months. Not all companies pay dividends and those who do can choose to increase or decrease the amounts they payout. In today’s world of low-interest rates, dividends amount to a few percents of the cost of shares at best. So relying on dividends from companies isn’t really a great way to earn much from shares. The real gains come through appreciation if you are able to sell them for a price higher than the price you bought them for.
It is also possible to benefit from movements in the market price of shares through trading derivatives such as options or futures. You can benefit from price appreciation but also from price declines if you take positions in options or futures. These have greater profit potential but also greater potential for loss and if you are not careful and things go really against you, you may get an unwanted visit from the bailiffs.
The other benefit of owning shares is that you get to vote. Of course, your vote is proportional to your ownership. If you have a millionth-share your vote will count a millionth towards the outcome of a vote. Matters that get referred to a shareholder vote include, the election of the board of directors, whether to undertake a stock split or issue new shares, and in some cases whether to accept a take-over or merger proposal.
The practical implication, if you own shares, is that you will get mail inviting you to vote on issues. It might sound like fun but it quickly becomes tedious as the paperwork that comes with these things is turgid in the extreme and seems to be written by humorless automatons who harbor an intense dislike for anyone trying to read and actually understand them.
So what shares to buy?
As noted already, there are thousands of shares listed on the stock exchanges and whichever country you live in, with some exceptions, it is likely to mean you will be faced with a bewildering array of possibilities. This is one of the most common problems of people who want to invest in stocks but don’t know where to start, or how to build a portfolio.
Sectors and industries
There are so many ways to look at shares on the stock market. I should add here that I am using the terms “share” and “stock” to mean the same thing.
Firstly there are companies from different industries. And the industries are grouped into sectors. An example would be the Technology sector, which in turn divides into the industries of Semiconductors, Software, Internet, and Computers.
But let’s imagine that you don’t want to get into all that detail, you are just looking for a simple way to start investing with a small amount of spare cash.
Market indexes and what they mean
Anyone who has listened to financial headlines will be familiar with newscasters talking about the DOW gaining or losing a number of points in a day. The Dow Jones Industrial Average or the Dow for short is a headline figure that tracks the prices of 30 of the largest companies on US Exchanges. If you want a more detailed explanation, check here.
The Dow Jones though is really just a headline figure, most investors and financial professionals look at other indicators or broader market representation, such as the Standard and Poor’s 500 Index or the S and P 500 for short. The S and P 500 tracks the prices of 500 of the largest companies on US exchanges and is weighted by the market capitalization, or size of each company. The Dow on the other hand is just the numerical sum of all the component stock prices at any one time.
One tried and tested approach to long term stock investing is to invest in a portfolio of stocks that is or at least mimics the S and P 500. To see the long-term performance of the S and P 500 and what you can expect this to do for your investments, check here.
It would be easy to think that all you have to do to mimic the S and P is to build a portfolio that looks like the index. So you would need shares in 500 companies with positions in each weighted by their respective market capitalizations. That would cost you millions. Fortunately, there is an easier way through Exchange-Traded Funds or ETFs for short that do all the work for you.
Baskets of shares – funds
The easiest and in some ways safest way for someone looking to invest in stocks starting with a small sum of money is to start buying into one of the many ETFs that track the Standard and Poor’s 500 market index.
Many household name investment companies offer such funds that track the S and P 500. Here are some of the most popular.
- Fidelity 500 Index Fund, symbol FXAIX. Annual cost 0.02%. It tracks the S and P 500 closely but not exactly.
- iShares Core S&P 500 Index Fund, symbol IVV, Annual cost 0.03%
- Schwab S&P 500 Index Fund, symbol SWPPX. Annual cost 0.02%. Like the Fidelity fund, it tracks closely but not exactly the S&P 500.
- State Street Global Advisors 500 Index Fund, symbol SPY. Annual cost 0.09%
- PortfolioPlus S&P 500 EFT, symbol PPLC. Annual cost 0.36%
- Vanguard 500 – symbol VFINX, annual cost 0.14%
As you can see they differ in annual cost. They also adopt different approaches. Some are actively managed and tend to have higher annual costs. Some are passively managed and tend to have a lower annual cost. For a detailed explanation of the difference between active and passive fund management, check here.
A brokerage account
You will need a brokerage account to buy and sell shares and ETFs. There are a number of these available today that require no account minimum and charge no commissions on US stocks and ETFs. For a comparison of some of the main brokerage providers, check here.
Many of these will also allow you to trade fractional shares. This could be important if you are starting out with a small amount of money that you will be adding to regularly.
Many of the S&P 500 Index Funds have share prices around $300. Let’s say you have $100 a month that you want to use to build a portfolio, by opening an account with a broker that allows fractional shares, you don’t have to wait to accumulate whole mutliples of the price of the individual shares in the funds you are buying.
As already noted, for stock market investing you can make use of options and futures contracts and you can buy and sell shares and derivative on margin if your broker is willing to let you. Of these, options are probably the safest to start with and can be used to give you leverage and manage your risk within bounds that work for you.
In a nutshell, the simple and easy way to start investing small sums of money in the stock market is to buy regular dollar amounts of an indexed ETF like one of the ones listed above. You can buy as little as $100 or $50 each month if your broker will allow that.
You always have to remember, prices can go down as well as go up. So there is every possibility that at the end of the first year, you will look back on your account and see that the total value is less than the sum you have put in. That is going to happen in some years. Other years your account will show a total value that is more than all you have put in. You have to ask yourself whether you will accept seeing the value of your account decline as well as increase. If you are not willing to see declines then stock investing is probably not for you.
To find out more about Exchange-Traded Funds, check here.
Some questions answered
Q. What does it mean to invest in the stock market?
A. Read this article, it explains exactly what it means to invest in the stock market.
Q. How do I begin to invest in the stock market?
A. The last four paragraphs of this article explain exactly the easiest and safest way to begin investing in the stock market.
Q. Can I make money in the stock market?
A. Yes, you can make money in the stock market though it is best to expect long-term gains. Another article explains this you can check here.
Q. Is it a good time to invest in the stock market?
A. Now is a good time to start as any. If you make regular purchases of one or more index-linked funds as summarized in the last four paragraphs of this article, then you will minimize any major adverse effects of starting when the market is high and heading for a decline.
Here is a single-page summary of this article. You can download a PDF, here.
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Disclaimer: I am not a financial professional. All the information on this website and in this article is for information purposes only and should not be taken as investment advice, good or bad.
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