In Part 1, I discussed the “why” behind investing and addressed some of the fears that come with investing. I will continue this discussion by going into the basics of the stock market.
“WHAT’S A STOCK?”
Here is a conversation I overheard recently:
Boy 1: What would you do with a million dollars?
Boy 2: I’d buy a lot of stocks.
Boy 1: Huh? Why would you buy socks?
Boy 2: Not socks!! Stocks!!
Boy 1: Oh. (Long pause) What’s a stock?
Boy 2: It’s a piece of a company!
Unfortuantely, I was unable to catch the rest of the conversation. I was pretty impressed that a 10 year old would be talking about stocks with his friend. How many kids are taught about the stock market and how it works? Probably not very many.
So here’s a quick primer on how one gets to own a piece of a company: you have a private company that decides to go public. This process is called an IPO (initial public offering), and this is how the company raises more money so that it can grow beyond its current capabilities. This usually gets a lot of press if it’s a large, well-known company (think Facebook). This turns the company into a public entity, open to anyone and everyone that wants a little piece of the pie. The pie represents the company stock while the piece of the pie is a share. When you buy shares, you’re hoping that the company is going to be worth more than what you initially paid.
HOW ARE THE MARKETS DOING?
So the stock market is where stocks get bought and sold, which includes both public and private entities. When people want to know how the markets are doing, they are usually referring to a large stock market index. An index is a way to measure a certain segment of the stock market. The Dow Jones Industrial Average is a stock market index comprised of 30 large, publicly traded companies based in the US. Other examples include the S&P 500 (made up of 500 US stocks, therefore a more diversified look at the US economy), the NASDAQ Composite (mostly technology stocks), the Nikkei (index for the Tokyo stock exchange), and the FTSE (pronounced “footsie”, tracks stocks that are on the London stock exchange).
As of this writing (August, 2018), the markets look fantastic. In fact, it has gotten to the point where a whole new generation of investors have no idea what it feels like to experience a bear market, which is a 20% drop in these major indices. I will count myself in that group since we had so little invested during the Great Recession and the financial crisis 10 years ago. Frankly, at that point in my life, I was more interested in getting settled as a family, not what was going on in my (paltry) retirement account. Too bad, because if I had decided to pay more attention back then, I’d have a lot more in my retirement account right now.
If you look back over the past 100 years , the markets have gone through many ups and downs. In other words, the stock market is pretty volatile. Our current bull market is actually an anomaly in terms of its length- by some measures, it is currently the longest bull market on record. And there is no reason to think that this is permanent. Volatility is inherent in the stock market, and in some ways, it’s a reflection of the volatility of human nature. When we think the markets are doing great, we tend to put more money into it. When we think it’s going south, we tend to pull money out of fear. We act out of emotion because, well, humans are emotional beings.
To make money in investing, you have to do the opposite- otherwise known as buy low and sell high. The maddening thing is we don’t know when or for how long these peaks and valleys will occur. All the while, you’re constantly trying to weigh risks versus rewards.
So yes, investing is risky because guess what….none of us can predict the future. We can analyze the past in great detail, but even the brightest minds in finance can’t say with certainty how the markets will react to domestic and geopolitical forces in the future. Casual and professional investors alike make their choices based on what they think is going to happen in the future.
What’s the overall trend of all this “guessing”? Despite the lowest lows, it turns out we’re a pretty optimistic bunch, because the markets have always recovered and show an overall upward trajectory. Always. This is an important point for long term investors- they need to have faith that their investments will go up over time, despite the inevitable downturns.
So how does one become a more confident, successful investor? Understand that the stock market has a cyclical nature and expect to take a bit of a roller coaster ride as an investor. Understand that although the stock market is volatile, the markets have always recovered and surpassed previous highs, showing an overall upward trend. Combine this knowledge with your own personal investing goals, timeline, and risk tolerance levels. Then find the investment strategy that makes the most sense to you.
Why did I bother going over some entry-level, 101 material?
Because to me, the stock market was always mysterious, outside of my comfort zone. Investing was never discussed in my circle of family and friends. At some point, it was something that I thought I was supposed to just know as an adult.
Which is completely ridiculous, now that I think about it. I mean, how does one magically attain knowledge? Turning 18 or graduating from vet school certainly doesn’t make one an investing guru just because you’ve arrived at some level of adulthood. Opening up a 401(k) or an IRA doesn’t automatically make you a confident investor.
What made me want to learn? Well, I now have a goal, a “why” when it comes to my money. If we’re going to be putting a significant chunk of our assets in investments that are tied to the stock market, then I wanted to make sure I understood exactly what we were getting ourselves into. I wanted to understand the risks and what we could reasonably expect going forward. This has completely changed my outlook on what was previously an intimidating topic. This level 101 material was exactly what I needed to boost my own confidence, and I have a feeling that some of you may need that boost as well.
Turns out that books are a great way to learn about investing- go figure! You can check out my Resources page for some book recommendations.
Chances are you can go to your local library and find these titles as well. Or stop by your local bookstore and take a peek. If you have any interest at all, taking the time out to learn will be a guaranteed positive investment!
Are you new to investing or a veteran? What are some resources that you have found useful? Comment below!