The stock market is where investing magic happens. And unlike other sources of wonder and amazement, how it works is not all that mysterious. Casting aside its perhaps intimidating shroud of numbers, charts, jargon and acronyms, it’s essentially just a place where you can buy and sell stocks.
So, what exactly are stocks?
Back to basics. Stocks are shares of ownership in a company. That means that even if you own just one share of a company’s stock, you count as a part-owner. So you—and maybe millions of others—have a bit of a say in operations (if you rock the vote at a shareholders meeting or by proxy), as well as a vested interest in the company’s performance. In general, when the company does well in terms of revenues and profits, the value of your share goes up and you get that much closer to reaching your financial goals. But if the company loses money, so do you.
Why would a company want to share its wealth with the public?
To try and generate more wealth. Going public is a common way for private companies to solicit investors and raise the money it needs to expand its business. The way it works is a company launches an initial public offering (IPO), issuing shares to the public for the first time by listing on one of the world’s many stock exchanges, such as the New York Stock Exchange and Nasdaq in the U.S. and the Tokyo Stock Exchange in Japan. These exchanges are generally and collectively referred to as the stock market. And that’s where interested investors can then buy a stake in the young business, and the company can get an influx of cash to (presumably) invest back into its business and grow.
Sounds fair. Who sets the prices?
You do. Kind of. Before an IPO is issued, the company works with underwriters (read: investment banks) to figure out its own worth, as well as how many shares to sell, based on an analysis of its historic and projected revenues, profits, costs and other relevant factors.
But after that initial fair value estimate, it’s the public who dictates where the stock price goes. If a company is popular with investors, the high demand drives prices up. If it’s more of an outcast, its price goes down. And in the case of IPOs, extreme unpopularity could even convince the company to delay going public.
Beyond the IPO stage and throughout a stock’s life, the public continues to determine prices: Buyers say how much they’re willing to pay for a share, sellers say how much they’ll take, and they mix and mingle until they find a perfect price match—all of which occurs on the stock market.
Is the stock market an actual IRL marketplace?
Once upon a time, yes. You’ve probably seen some movies that show a big group of harried businessmen (yes, mainly men) waving papers in the air, shouting into phones, and anxiously watching the big board from the stock exchange floor. Such scenes are a glimpse of the literal stock market of yesteryear.
Of course, some physical exchanges are still around and buzzing with activity (like ringing the opening bell!). But actual marketplace transactions are conducted mainly online these days. And though we’ve lost the hustle and bustle of in-person bids and sells, technological advancements around trading have helped make investing more affordable and easier to access for everyday investors.
Why should an investor consider investing in the stock market?
Because investing is the best way to grow your money, and the stock market offers some of the best potential returns available.
But isn’t the stock market risky?
Yes, those big potential returns come with some risks. But avoiding the stock market can be risky, too. For example, inflation risk. Saving is where any good financial plan starts, but on its own, it may not be enough to reach all your financial goals. Even an overly defensive portfolio, laden with super-safe investments, risks falling short of the growth rate you need. That’s because inflation can rapidly eat away at your hard-earned cash, leaving you less purchasing power than you’d expect from the nominal value of your dollars. Your portfolio ought to hold at least some stocks in order to beat inflation over the long term and help ensure that your money is earning more than it’s losing.
How do investors pick stocks?
While investing in the stock market is a good idea, investing in individual stocks may not be, especially for the casual investor. Smart stock-picking requires in-depth research and plenty of dedication. And building a well-diversified portfolio out of single stocks is pretty much a full-time job, so you might as well leave it to the folks who have indeed made a career out of it.
Mutual funds and exchange-traded funds (ETFs) allow you to tap the expertise of such professionals and the investing hive mind. And they’re often the better way to go, especially for most common investors. (Acorns portfolios include a mix of exchange-traded funds with exposure to thousands of stock and bonds. Find out more.) That’s in part because these funds essentially give you the opportunity to buy into sometimes hundreds of investments in one fell swoop, giving you easy diversification. That also helps cut down your trading costs. In particular, index funds and ETFs tend to offer rock-bottom fees and a stake in a broad swath of investments, making them a prime choice for a simple investing strategy.
However you choose to get into the stock market, the most important thing is that you do get in and get comfortable. After all, stocks are a key component in every investor’s portfolio.
Investing involves risk including loss of principal. This article contains the current opinions of the author, but not necessarily those of Acorns. Such opinions are subject to change without notice. This article has been distributed for educational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.