The Lexicon Series: The Stock Market
If you’re thinking about how you can up your investment game in 2017–the Stock Market might be among the options that you consider. To many, investing in the stock market feels overwhelming, because of the inherent risk involved with investing in companies who might grow their profits…or might not. And, while the rewards can be many, (you might grow your money at a far faster rate than the average % a year that a savings account can deliver,) the stakes are most certainly higher since you can suffer losses, including principal. With that said, as a potential investor, the most important thing that you can do is understand the landscape, be honest about your risk tolerance and make informed choices.
First, let’s review a little Stock Market 101. In the most basic of layman’s terms, this is how the stock market works:
If you buy a share of stock, you – quite literally – have a share in the ownership of the company. That entitles you to a share in the company’s earnings, proportional to the number of shares that you own in the company. You also have a residual claim to the company’s assets. Assets include the company’s buildings, their trademarks and patents, among many others. However, stock is the most junior security in the event of a liquidation.
The company that sells stock, is selling shares in their company to public investors as a way to raise capital. Rather than take out a loan with a high interest rate to grow their company, they would rather sell a share of the company to you – take the money that you give them to invest in their growth – and then give you a return on your investment when their growth strategies succeed. (This is more appealing to them than paying back a high interest rate to a bank that they will owe whether or not they succeed at growing their company and their profits.)
There are two ways that your investment in a company’s stock will pay out.
a) The stock price goes up if a company that you have invested in, succeeds in growing their profits. If they make money, then the strength and value of their company increases, and so do the price of their shares of stock. This is valuable to you. If you bought the share of stock at $10 and then the price increases to $12, that means that you will make a profit when you sell your shares, at the higher price. (Conversely, if you bought a share at $10 and then the company does not do well, the price of the share could drop to, let’s say, $8 and you will lose $2 when you go to sell your shares, at the lower price.)
b) Some companies pay quarterly or annual dividends. A dividend is – literally – your share in the profits. As an owner of a share of stock, you are entitled to a (small) percentage of the profits and you will receive a check on a quarterly or annual basis when the company you invest in is profitable. However, note that the payment of dividends is not guaranteed and may be reduced or eliminated any given time.
Now. The Stock Market. We all have visions of a crowded room of brokers yelling at one another…it’s noisy and full of numbers and can feel overwhelming and confusing for any investor. Instead, think of it this way: the stock market is just a market where shares of stock are traded. If you want to sell a share of your stock, you don’t have to go out into the world and find your own buyer. Instead, you can buy/sell stocks through an advisor, hire a money manager to do it for you or do your own trades online.
There are a few stock markets in the United States, such as:
NYSE – New York Stock Exchange
NASDAQ – National Association of Securities Dealers Automated Quotation system
Different companies are available on different stock market exchanges. If you want to buy Amazon stock, for instance, it is listed on the NASDAQ, while General Electric is available through the NYSE. Again, because you have an advisor or money manager, that person will handle buying or selling through the appropriate stock market.
And finally…because I know you hear the news media report The Dow Jones, S&P 500 and NASDAQ daily, you should know that The Dow Jones Industrial Average is a predicative tool that measures the 30 of the most influential stocks on the NYSE and NASDAQ. The S&P 500 is an index of 500 leading American companies and the NASDAQ composite is an index that measures all NASDAQ domestic and non- U.S. based common stocks listed on the NASDAQ Stock Market. These three indices are most common in providing the public information. All indices are unmanaged and may not be invested into directly.
Now. If you started this post knowing very little about the stock market, you know so much more now! And, if you were merely looking to fill in a couple of holes in your understanding of how the stock market works – then I hope you found what you were looking for here.
In closing, I thought that I would share some of my top 5 insights for any stock market investor – from newbies to old pros.
Do your research and invest in companies that you truly believe in.
It will be much easier to ride out the ups and downs of a stock’s value if you have faith in the business model, the product, and the leadership of the company in which you have invested.
Limit your exposure to “the noise”.
“The noise,” as I call it, is the bluster of marketplace media, and the gossip that you come across at cocktail parties. The 24-hour media needs a story – and so they have lots of opinions to share – only some of them contain weight. And, beware of braggarts at cocktail parties. Anyone who is talking about their triumphs on the stock market wants to make themselves sound smart. Take their brags with a grain of salt.
The stock market isn’t down….it’s “on sale”.
When the stock market loses value, it tends to make shareholders feel fearful and reluctant. But, when your favorite clothing brand goes on sale, you tend to double down and purchase more. I encourage you to consider that approach with the stock market too. See tip #1 above. If you believe in the direction of the company overall, then when the market goes down, the opportunity to get some real bang for your buck presents itself for your consideration. Note that share prices may continue to drop, and may not return to previous levels.
Prepare yourself for the long haul.
Investing in the stock market is a long-term investment strategy. The longer you hold onto a stock, the less risky it becomes. Too often, investors buy into the illusion that buying stock with the intention of selling it in a quick turn-around is a great way to make fast money. But instead, it can be an appropriate way to increase your risk. And, even if you succeed in selling it for more than you bought it, you can trigger a different set of tax consequences if the buy and sell date fall within a year of one another.
It’s best to work with a trusted advisor that can help you assess your risk tolerance and educate you on your choices to make sure they fit with your overall strategy.
Companies listed are for informational purposes only, and are not a recommendation or advice to trade their securities.