Learning about the stock market can be intimidating. There are so many terms, like dividends, capital gains, market corrections, and compound returns. Though people throw around these terms as though they were born knowing what they mean, the basics of the stock market have to be taught. Luckily, when approached slowly, stock investing is much easier to understand than it initially seems. Here are the basics.
1. What Is a Stock?
A stock represents a small ownership interest in a company. When you buy shares of a publicly traded company, you become one of its (generally thousands or millions of) shareholders. Obviously, owning a few shares doesn’t mean you get a seat at the boardroom table, but you do technically own a teeny tiny piece of the business.
2. How Can Stocks Make You Money?
There are two basic ways investors can make money from stocks. The first is through price appreciation. If you buy a stock for $50 and eventually sell it for $70, you’ve made $20 per share before taxes or fees. That $20 profit is called a capital gain.
The second way of profiting is through dividends. Some companies give a portion of their earnings to shareholders. Not every company pays dividends. Returns can include both changes in the stock’s price and any dividends you receive.
3. What Exactly Is the Stock Market?
The stock market is essentially a giant marketplace where investors buy and sell shares in companies, so long as they’re publicly traded. Instead of walking all the way to Wall Street, most investors now sell and buy electronically through brokerage accounts. Prices are always in a state of fluctuation as buyers and sellers are continually changing what they’re willing to pay for shares.
4. Why Do Stock Prices Go Up?
There isn’t one single reason. High or low profits, popular new products (or lack thereof), economic conditions, and expectations about the future can all influence a company’s share price. There are also countless other factors that can contribute.
Sometimes just excitement alone can push a stock higher for a bit of time. If investors collectively think a particular company is going to be extremely successful, demand for its shares can go up fast. But following the crowd can be risky, since popularity doesn’t always mean a stock is worth its price.
5. How Can Investing Build Wealth?
Compounding is one of the biggest reasons people invest over long periods of time. It can be very powerful. This works when your investments generate returns, and those gains remain invested, generating additional returns of their own.
Compounding doesn’t look too impressive over a few months. Over decades, however, the difference can be massive. That’s why long-term investing isn’t about finding one magical stock. Time, diversification (spreading your money across many investments), regular contributions, and patience are an effective combination and can be much more important than one fantastic stock.
6. What Is an Index Fund?
Buying individual stocks isn’t the only way to invest in the stock market. Funds allow investors to buy small pieces of several companies at the same time. An index fund follows a particular market index, like the S&P 500, instead of requiring you to pick individual companies. This is a good way to spread your money across hundreds or even thousands of companies with a single investment. For beginners, understanding funds is important because investing in the stock market doesn’t always mean choosing individual stocks.
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