Some essential insights to stocks and the stock market can help you better navigate the complexities of finance that may affect your goals.
Quick takeaways
Plenty of people have heard of stocks and the stock market; even more are invested in stocks through retirement savings. But how do you better understand these financial fundamentals so you can make decisions that are best for you and your financial goals? Here are some basics.
A stock is a share of a company. Companies issue, or sell, stocks to generate money; investors buy and sell stocks primarily because they hope to tap into the potential for gains in the value of a stock. Here's how it works?
- Company Z wants to build a new factory. → To raise money, Company Z sells 1,000 shares of stock. → You buy 100 of those shares. → You now own 100 shares out of 1,000, or 10% of the Company Z. That ownership is known as equity; if the company grows and becomes more valuable, those shares may benefit you.
The type of stock determines a couple of things: if you can vote at shareholder meetings, receive dividends, and get your money back if the business fails.
- Common stock makes up most of the stock bought and sold. A single common stock equals a single vote at an annual meeting, and, in general, the right to receive dividends, if paid. If the company fails, you’re unlikely to receive payments.
- Preferred stock has no voting rights but guaranteed dividends in perpetuity. If the company fails, you may still receive payments.
You may also hear stock referred to as:
- class A, B, or C, which indicates voting rights or ownership control
- blue chip, which refers to stock in well-known, relatively stable companies
- large-cap, mid-cap, small-cap, and microcap, which indicates company size
- U.S. stocks versus international stocks
Many Americans are already invested in stocks, whether or not they know it. They’ve made indirect stock purchases when they saved in retirement accounts, which are typically invested in part in stocks. You can buy stock:
- through your retirement account in transactions made by the investment manager
- directly from a company, which is often reserved for employees or existing shareholders
- by reinvesting dividends, which is typically for existing stock owners
- through a financial professional who does the research on your behalf and may charge a fee
A few stock markets (also referred to as exchanges) such as the New York Stock Exchange and NASDAQ, are very well known. But economic centers around the world have stock markets, which are simply centralized places where buyers and sellers of shares of company stocks trade their holdings with one another.
What’s not a stock market? Probably the most famous stock-related number of them all, the Dow Jones Industrial Average. It’s an index, or a slice that represents a broader market.
Think of an index like a benchmark: How well did this grouping of companies do today compared to another moment in time? If the Dow, or another index, goes up in one month, that means the average stock prices of those companies in that average went up.
From day-to-day, prices of securities (both stocks and bonds) fluctuate based on supply and demand from buyers and sellers. When you see that a market or index had a positive day, that means there were more buyers than sellers.
Supply and demand demand is driven by a number of things, including the health (or lack thereof) of a company. And a company’s stock price isn’t static; it changes all the time based on a number of things including how well the company is doing or a stock’s popularity or value, for example.
Sometimes the day’s news is good or bad, and markets react; other times they don’t. That’s because the professionals managing funds and indexes on these markets spend all day, every day, assessing the health of companies, sectors, and the like. They’re not reacting to one-day news; they track and analyze data over extended periods, not just days or weeks, but months and years.
Most would counsel: Nothing. Instead, focus on the long term, especially for retirement. Quick, daily moves in (and out) of investments and savings plans can disrupt your financial goals; it’s not timing the market, it’s time in the market. Over the long run, market swings tend to even out. That's why remaining calm, even in those down markets, can make a real impact.
