But that’s about it.
At least, that’s exactly how I felt for a long time. I had no idea what stocks, bonds, or mutual funds were.
The stock market always seemed so abstract. Like something that lives up in the sky and I just couldn’t really grasp it.
I knew that I was supposed to put money into a 401k or something, and then somehow that would make me money.
I knew that some people invested in Penny stocks hoping to hit it big. And I knew others who said mutual funds were the way to go.
But I had no idea how any of it worked, much less the practical steps I needed to actually invest.
You might feel the same way.
If you’ve ever wondered how the stock market works and how you can actually invest, then keep on reading.
What is a Stock
A share of stock is a representation of ownership in a company. When you buy stock, you are buying “shares” of a specific company.
You literally own part of that company. And how much you own is based on how many shares you buy.
If you own 10 shares of stock in a company that has 1,000 outstanding shares. You own 10/1,000*100% = 1% of that company.
So what does that mean?
When you own stock in a company it entitles you to share in that companies assets. You would see this in the form of dividends which I discuss below.
You also get voting rights when you own stock. Now don’t get too excited. Your vote likely won’t count for very much.
Take Walmart for instance. As of writing this article, Walmart currently has 3.206 Billion (with a “B”) outstanding shares. And those shares are currently trading for $58.98. That means even if you invested $1,000,000 in Walmart it would only buy you 16,955 shares. Or 0.0017% of the company.
And you’re voting power is directly related to how many shares you own.
But, nonetheless, even if you own 1 share of Walmart stock, you do have a right to vote on who will be on the board of directors and other corporate policy matters.
How are Stocks Traded?
Okay, so you know what a stock is, but how are they bought and sold?
Glad you asked.
Think about what happens when you buy and sell a car. When you buy a car you typically go to a dealership or some online platform like eBay or craigslist to start looking for people who want to sell their car.
And when you sell a car you likely put it up on craigslist or maybe trade it to a dealer.
You might try to sell your car to a friend, but this is a lot harder. Think about trying to call up all your neighbors and family members to let them know that your car is for sale and they should buy it. If that was the only way to sell your car that would almost be more trouble than its worth!
Luckily there are places like eBay that allow you to reach a wide variety of buyers and sellers all in one place.
Stocks work the same way.
Instead of calling your friends and family, stock exchanges were set up to connect buyers with sellers.
Think about it like a large eBay for stocks. It is literally a marketplace for buying and selling stocks. Hence the name Stock Market 😉
You go to a stock exchange and you purchase shares of stock from a willing seller. Or you can sell shares of stock to a willing buyer.
Different Stock Exchanges
Some of these exchanges like the NYSE have physical exchanges as you can see from the picture.
You could call a broker on the phone and ask them to buy or sell stock for you. Then they would call their representative at the stock exchange who would then go and trade that stock on the floor.
Literally, on the floor.
They walk over to a specialist who is in charge of trading the stock and they help the broker trade for you.
Once a trade has been made, the broker would then notify the investor of the outcome.
Now days investing has become a whole lot easier due to the internet. Although some people still trade stocks on the floor of a physical exchange, the majority of trading has moved online.
The NASDAQ stock exchange is one example of what’s called a virtual exchange and it does not have any physical location or brokers on the floor at all. Trading on the NASDAQ is done completely via computers and telephones.
When people talk about the “stock market” they are talking about the exchanges as a whole.
For instance, you might want to buy stock in both Microsoft and McDonald’s. Microsoft is traded on the NASDAQ while McDonald’s trades on the NYSE. However, this isn’t a problem for you. When you use a broker they take care of dealing with the stock exchanges for you. So you never even notice.
Of course, there are other major stock exchanges like the American Stock Exchange (AMEX). There are even large foreign stock exchanges such as the London Stock Exchange and the Honk Kong Stock Exchange.
Although all of this about the exchanges is important to understand, you won’t have to deal with it much. So don’t get too caught up in trying to understand all of the differences.
Just having a basic knowledge of the exchanges is more than enough for the average investor.
Who Sets the Stock Price?
Stock prices change constantly throughout the day. The price is based on the supply and demand of the particular stock.
Basically, if the demand increases (more people want to buy than sell) then the stock price will increase. This also works the opposite way. So when more people want to sell than buy (supply increases) the price of the stock will decrease.
So stock prices change because people want to buy or sell them, but that doesn’t really tell you a whole lot.
The hard part isn’t understanding why it changes, it’s understanding what makes people want to buy or sell.
Basically, the stock price is a good indicator of how people feel about the value of the company.
If the stock price is rising, it means people feel like that company’s value is increasing. Conversely, if a stock price is continually falling, it means people feel that the company’s value is also going down.
But people’s perception of a company’s value can change based on all sorts of things. After all, we’re dealing with human emotions here.
A major factor that affects stock price is the earnings put out by a company each quarter. But stock prices can change drastically whenever any kind of news comes out about the company.
Now that people have access to the internet and an essentially infinite number of opinions, stock prices change constantly and often times it seems without any rhyme or reason.
Stock prices change so rapidly that often it is extremely difficult to understand why.
Even Investopedia says
So, why do stock prices change? The best answer is nobody really knows for sure.
No matter what anyone tells you, no one has been proven to be able to consistently predict the future of stock prices.
You’re better off not to worry about the day to day prices of stocks. Understand what the stock price means, and then don’t worry about what it’s doing throughout the day.
How Do You Make Money With Stocks?
You can make money with stocks in 2 different ways.
The first is through dividends.
A dividend is just a payout by a company to the shareholders. This happens when a company takes part of the profits and gives it to its shareholders.
This is very common for older more established companies but not very common for new startups.
Not all companies pay dividends. But those who do typically pay them on a set schedule, such as monthly, quarterly, or yearly.
The second way you can make money in the stock market is by selling your stock after it has gone up.
If you buy 10 shares of a stock for $50 per share, that’s $500. Let’s say at the end of the year, the stock price has increased to $60 per share. Then your stocks would be worth $600, and you would have $100 of unrealized gains.
“Unrealized gains” is just fancy for, you would make money if you sold, but you haven’t sold yet.
If you decide to sell your shares for $60 each, you would then “realize” that $100 gain.
You may have heard of a stock market index. Like stock exchanges, there are all sorts of indexes out there.
Two of the popular indexes are the S&P 500 (Standard and Poor’s 500) and the Dow Jones Industrial Average (DJIA). The S&P 500 is a group of 500 of the largest companies in America while the DJIA tracks only 30 large U.S. companies.
These two indexes have been around for a long time and have become benchmarks in the industry.
Another popular index is the Wilshire 5000, which attempts to include almost all of the publicly traded stocks in America. Because of this, it is often referred to as a total stock market index.
A stock market index is essentially a grouping of stocks based on some commonality. The index uses the stock prices of each company to measures the value of that section of stocks as a whole.
For this reason, the S&P 500 has become known as one of the best benchmarks for the U.S. stock market. The logic is that since the S&P 500 tracks the performance of 500 of the largest companies in the country, it provides a pretty good gauge of how the overall U.S. economy is doing.
Although there are different ways that these indexes can be calculated, don’t make it more complicated than it is. It’s enough to know that there are many different indexes out there and their whole purpose is to help you understand how a specific group of stocks is performing.
But if you’re interested here is a great list that compiles the most popular indexes.
How Do You Actually Invest in the Stock Market?
So now that you understand how the stock market works, you’re probably curious on how you can actually invest.
Well, the easiest way is through an employer-sponsored retirement plan, like a 401k or 403b. If your employer offers a retirement plan, you can specify the mutual funds you would like to invest in.
But if you don’t have access to an employer retirement plan, you can either open your own retirement account such as a Roth IRA, or you can open a regular brokerage account.
You simply open a regular brokerage account which is very similar to setting up a checking account at your bank. Then you can search stocks based on their ticker symbol and purchase as many shares as you would like. Typically you can expect to pay a fee for each transaction on the range of $7 – $15 per trade for these lower cost online brokerage firms.
As you will likely learn if you spend any time on my blog, I am a huge fan of mutual funds through Vanguard.
Specifically, index funds.
There’s a good shot that you have no idea what you are doing when it comes to investing. The majority of the professionals out there can’t consistently beat the S&P 500, so why in the world do I think that I could?
Here’s the thing. I don’t.
So I take a very hands-off approach by investing through a Vanguard Index Fund, and I think you should too.
You can set it all up online through Vanguard’s website and easily transfer money to your investment account from your bank.
I promise it’s not as hard as it sounds.
Don’t Invest In Anything You Don’t Understand
I want to stress this point.
When it comes to investing you can really lose your shirt. So be patient.
Don’t be in a rush to throw your money into something you don’t really understand.
Do some research. Spend some time on google trying to understand what it is your wanting to invest in. If you’ve got questions, don’t be afraid to comment below or send me an email. I want to help you in any way that I can.
Just promise me that you won’t jump in feet first. Investing is one area where you don’t want to learn by doing, that’s a quick way to lose more money than you ever thought possible.
You Really Can Do It
I truly believe this.
You don’t have to be an expert. You don’t need a degree in finance. You don’t even need to understand all of the different types of investment transactions.
If you’ll put in some time on the front end you really can invest for yourself and your future.
You’re a lot smarter than you give yourself credit for. And investing is a lot easier than you think.
I really believe that anyone can invest well and retire wealthy on their own if they truly want it.
If you want to continue learning more about how you can invest for yourself, shoot me an email and subscribe to my newsletter below where you’ll get updates on new blog posts and extra tips sent right to your inbox.
Good luck on your investing Journey!
Free Email Course On Choosing Financial Freedom
5 lessons that will teach you how to choose financial freedom and the necessary mindset to reach it.