The stock market a wild place. One in which makes millionaires and also takes millions from others. It is wildly complicated but is also extremely valuable to understand. This article will walk you through how to think about the stock market, whether you are new to investing or simply want to hone your skills as a seasoned investor. We’ll start our discussion with an overview of the stock market. Next, we’ll look at the effort required to pick good individual stocks. Finally, we’ll end with a discussion on the risks and leave you with some final thoughts. Okay, let’s start off by talking about the stock market!
What is the Stock Market?
A stock market is simply a centralized place where people buy and sell stuff. It’s similar to a fruit market where people come together to exchange money for delicious fruit. The difference with the stock market is in what people are buying. Instead of buying fruit, people purchase companies in the form of stock. Stock is nothing more than a piece of paper (often only digital in today’s world) that says that you own a part of the company printed on the stock certificate. Owning stock is super powerful because it provides a medium and opportunity to potentially make a lot of money while minimizing your potential losses. Stock allows companies to raise money from the general public to use that money to make even more money. When people purchase a company’s stock, they bet that the company will do well in the future. “Doing well” can mean anything like becoming more profitable, growing sales, and/or expanding operations. All of which are increases in value for the company. Understanding value is a central concept to learn if you want to better understand stock market investing. Your job as an investor is to identify companies that will create the most value in the future relative to all the other company choices available. But how do we find these companies? It depends, and the answer is complicated and subjective. Some investors rely on their intuition or mathematical models, while others simply take advice from others. However, we’re not here to tell you what stocks to buy, but rather give you a better understanding of how to think about which stocks to buy. Let’s take a look at the effort needed to pick individual stocks.
Are Picking Individual Stocks Worth the Effort?
You may have heard on the news or your friends talk about how one company is doing really fantastic and that its stock is going through the roof. These stories are all around us and often leave us wishing we would have simply bought the stock when it was at its cheapest. Looking backward is so easy, everything seems to make sense, and we frequently spend a lot of time and effort wishing we would have just bought at the “right time.” We know that feeling is hard to fight, but we suggest taking a different approach. Stay focused on the future. It’s hard, we know, but it won’t leave you feeling like crap when you watch the news, and it positions you to make better decisions. We don’t even recommend trying to find single companies poised to do well in the future. It’s really tough and requires a lot of work. We first recommend assessing your willingness to be involved in the decision-making of your investment portfolio. Are you the type of person who is willing to do the due diligence often needed to find the next successful company or the person who just wants to put money away monthly in hopes of a brighter future? Many folks think that spending time on due diligence often leads to making more money. However, that usually isn’t the case, and this is a great time to introduce the term “market.”
There are hundreds of thousands of companies around the world where people can buy stock in companies. There are also many different stock markets, just like there are many fruit markets. Financial experts and news broadcasters like to report on these markets’ overall health instead of reporting on each and every company daily. So, to help make life easier, experts created indexes, which are simply a sample of stocks within a stock market that generally assess the entire market’s overall health. Two well-known examples in the United States are the Standard & Poor’s 500 (S&P 500) and the Dow Jones Industrial Average (or the Dow). These two indexes use a set of rules to pick and track the performance of approximately 500 (SP& 500) and 30 (Dow) stocks based in the United States and serve as a benchmark. Professional investors assess their performance not against whether they made money or lost money but instead did they perform better than their benchmark index or not.
Here lies a crucial decision for investors. Do we just purchase the index stocks, or do we work really hard to try and make more money than the index? The choice is up to you, but statistically speaking, many people do not do better than the market. Many professional investors whose job it is to find great stocks don’t even do better than the market. That’s probably painful to hear, but the numbers don’t lie. And if anything, it may even eliminate some of your worries as an investor. If you are the person who just wants to put money away, consider buying the market, and don’t worry or stress about finding the next great company. Now, let’s hop over to the risks of investing in the stock market.
What are the Risks of Investing in Stocks?
Investing in the stock market often gets a bad reputation as a place where many people lose millions of dollars to greedy Wall Street people. Is this true? Let’s look at the actual risks of investing. Remember when we discussed purchasing a stock? We mentioned that you buy it from a stock market, but we didn’t say from who. You don’t usually buy stock directly from a company unless you make a direct investment or gain access to stock from an initial public offering (IPO). When you purchase stock in what’s called the secondary market, you buy it from other investors. This is weird to think about because it essentially means that one party believes the stock will go down while the other thinks it is going to go up. There are certainly other reasons why someone may buy or sell stock, but generally, we own stock because we believe it will go up in value. As we all hope the value of the stock we purchase goes up in the future, the reality is that the value can actually drop to zero. As an investor in a company, this means your investment in the company is worthless. The risk of losing your money in the stock market is always apparent, but there are ways to minimize this risk in ways such as diversification.
There’s one thing we didn’t really touch on yet but assumed as we put this piece together, and that is on you participating in the stock market. Millions of people worldwide can invest in stocks and have access to execute but don’t. This makes us really sad because the ability to own a public company is perhaps one of the most remarkable ways to build wealth. We encourage you to consider investing if you don’t already. If your goal is to build large amounts of wealth and don’t invest in companies, your journey will undoubtedly be challenging.
Thanks for Reading!
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