Stock Market: What it is and How it Works
If you are looking up the stock market, then chances are you’re looking for alternative ways to make passive money or to make your money grow significantly. You’ve probably heard rich people talk about the stock market as a haven for wealth creation or you’ve seen videos of people who have become millionaires from trading the stock market. The truth is, such outcomes are possible.
When it comes to buying stocks, it’s important to know and understand what you’re doing. It is by providing you with the knowledge that you can enter the stock market armed and ready to make smart investing decisions. That’s why we are bringing you this guide. Sit back, relax and prepare to get some clarity on what stocks are and what they can do.
Understanding the Basics of Stocks
Stocks are equities of a company that represents ownership of a certain fraction of a corporation. This invariably means an individual who owns stock of a company is entitled to the assets and profit of a corporation. The profit they make is directly proportional to the number of stock shares they own.
Stocks are predominantly bought and sold by stock brokers which have to follow governmental rules and regulations to ensure fairness and transparency.
Why Do Companies Issue Stocks?
Companies decide to issue stock because they want to raise money. Rather than issuing bonds, which are loans from bondholders to the company, a company might decide to “go public” by issuing stock. The money a company gets when an investor purchases shares doesn’t have to be paid back. The company can decide whether and when to issue dividends to shareholders. Plus, issuing shares spreads risk to investors rather than keeping it all on the shoulders of the company owners. When you buy stock, you become a partial owner of the company that issued the shares. You have what’s called shareholder’s equity. Like home equity, shareholder’s equity increases your net worth.
How to Buy and Sell Stocks
There are two ways you can buy stock in a company. The first, is you can either go to the company and buy directly from the company or the second, and more common method, is to buy stocks through a stock broker.
If you buy through a publicly traded company, you can buy a Dividend Reinvestment Plan (DRIP). This DRIP will take your initial investment and use it to buy company shares. As the shares pay dividends, those dividends will be put to work by buying more shares.
If you buy through a brokerage firm, you have options. You can take the DIY approach which would be to buy and sell shares in different companies of your choosing. Online brokerage firms make this easy, but you’ll have to pay a fee, often on a per-trade basis. For an extra fee, the brokerage may offer financial planning assistance, but you’ll still be responsible for making your trades. When you buy your shares, it’s important to make sure you’re diversifying your investments. When you diversify your investments it means you’re investing in companies of different sizes and from different sectors of the economy as well as from the U.S. and abroad.
There is, however, also a third option. With this option, you can invest in a fund that holds shares in many companies at once. These majorly come in the form of mutual funds and ETFs. Mutual funds hold a variety of stocks based on the fund managers’ decisions on which companies are safe and less risky investments.
Exchange-Traded Funds (ETFs) are similar to mutual funds, with the added advantage of trading on a stock exchange and they offer competitive tax options.
Finally, they could be index funds. Rather than trying to beat the market, index funds hold shares from a representative sample of companies and try to mirror the performance of the overall market. It’s called an index fund because it aims to mimic the market as closely as possible. For example the S&P 500. Index funds involve less management, so generally charge lower fees. Plus, research shows they consistently outperform actively managed funds.
So You’re Ready to Start Investing in the Stock Market
Investing comes with risk. In any form of investing, there is an associated risk involved. For individual investors who are risk-phobic, diving straight into stocks is not advisable. However, the reality is, that unless your salary is very high or you have a big inheritance coming your way, you’re unlikely to save enough for retirement without investing in stocks. Bonds may feel safer, but they don’t offer the same inflation-beating returns as stocks do. That’s why it’s important for investors to find the balance between bonds and stocks that are appropriate for their goals – and the time you have before retirement.
Tips for Investing
- As you build your portfolio, you might want some guidance — especially if you find the stock market intimidating. If you don’t have a lot to invest in or you’re just starting, you might want to consider a Robo-advisor. Robo-advisors, which are entirely online, offer lower fees and account minimums than traditional financial advisors.
- However, if you have a more complex financial situation or prefer talking face-to-face, consider working with a financial advisor. A matching tool like ours can help you find a person to work with to meet your needs. First, you will answer a series of questions about your situation and goals. Then the program will narrow down your options to up to three registered investment advisors in your area. You can then read their profiles to learn more about them, interview them on the phone or in person, and choose who to work with in the future. This allows you to find a good fit while the program does much of the hard work for you
- Become a Planning Made Simple Member. Members of Planning Made simple have access to educational resources meant to help guide them on their financial journey as an investor. Whether you plan to invest yourself or seek the help of a financial advisor becoming a member of Planning Made Simple not only means access to furthering your knowledge through courses and materials but the opportunity to interact with like-minded investors who can provide real-time advice and suggestions. Members also have a Planning Made Simple Coach with years of experience in the financial industry. Their goal? To help guide you along the way, answer questions you may have, and ensure you’re empowered to take your retirement and investing goals into your own hands.