7 Stock Market Facts You Need to Know Before Investing
Stock market facts
If you’re a newbie investor, understanding the stock market is crucial to make the best investing decisions for you and build long-term wealth.
But with all the content now online (and terms like “securities” and “issuance of shares”), it can be difficult sifting through the jargon to make sense of this often misunderstood market.
Skip the noise. Here are seven key stock market facts to help you truly understand the market before jumping into investing.
- The stock market is an overall public system that allows you to buy and sell company stocks (as well as other types of financial investments).
- A bear market shows when stock prices are down and a bull market shows when stock prices are up.
- A stock index (e.g. S&P 500) measures changes in the stock market while a stock exchange is a place where you can buy and sell stocks.
- Historically, the stock market has an average return of 7% each year after inflation (aka prices rising over time).
- Stock market volatility (prices going up and down) are part of investing and shouldn’t cause panic.
- There are 11 different stock market sectors which helps you avoid putting all your eggs in one basket and lowers your risk of losing money when investing.
- Start investing in the stock market through DIY methods, robo-advisors, or an employer’s 401K.
1. The stock market refers to a system for investors to buy and sell stocks with one another.
The stock market is a public marketplace designed to buy and sell types of financial investments like stocks.
It’s not a new concept. The first stock market began in the 1600s when the Dutch East India Company needed money to fund its expensive voyages of trading gold, porcelain, and other valuables around the world.
Private citizens began investing money in the company in exchange for shares of voyage profits. The more they invested, the more voyages the Dutch East India Company was able to afford, generating even more profits.
The modern stock market runs very much the same way (although slightly more complicated and also electronic). Publicly listed companies sell shares of their profits. Investors then buy and sell these shares in the form of stocks.
Think of it this way…to grow successfully, companies need a large amount of money or some type of financing (i.e. capital). A company can borrow this money and go into debt OR sell shares through the stock market to raise funds. A startup can start by selling shares through an initial public offering (IPO). By making this move, the startup successfully goes from private firm to publicly traded company on the stock market.
When you buy stocks, you’re a partial owner of the company. If the company is successful, more and more people buy the stocks. Thanks to the increased demand, the stock prices go up, raising the value of the stock you already own.
The opposite can also happen. If the company does poorly (or even appears to do poorly), investors might begin to sell their shares, dropping the stock prices. It’s a beautiful balance of supply and demand.
Note: The stock market doesn’t just contain stocks. It’s made up of three types of securities (aka types of financial investments): equities, bonds, and derivatives. Stocks fall under equities and have proven time and again to generate higher profits than other financial investments.
2. Bear and bull markets describe stock market performance.
One of the most important stock market facts, a bear market describes the constant falling of stock market prices (normally by 20% or more) over months or years and indicates a struggling economy.
A bull market is the exact opposite. It refers to the constant rising of stock market prices (normally by 20%) and indicates a prosperous economy.
No one knows exactly how these terms exactly originated, but it’s usually agreed that it’s because of the stance bears and bulls take when fighting. Bulls move their horns upward while bears swipe their paws downward.
A good rule of thumb to remember these terms? Bull = positive. Bear = negative.
If the economy is bullish, investors typically have more confidence in the market which helps prices go up as there’s a strong demand for stocks. If the economy is bearish, investors are wary and stock prices go down.
Both types of markets are unavoidable; we just don’t know when they will happen. However, the bear market shouldn’t cause you too much concern.
There were 10 bull markets and 10 bear markets between 1957 and 2018. Bull markets normally last 55 months while bear markets last under a year.
This is why long-term investing – buying stocks and waiting years to sell – can be a safer option than trying to “time” the market (aka guessing when to buy and sell). Good times inevitably are followed by hard times, but long-term investing helps you ride out the storms.
Note: A bear and bull market can also refer to the performance of other investments like real estate. But typically, both terms refer to the stock market.
3. The stock market, stock index, and stock exchange are not the same thing.
These three terms are sometimes used interchangeably. But though part of the same puzzle, they are not the same pieces.
As discussed, the stock market is the overall public system of investors buying and selling stocks (and other types of financial investments). A stock index measures changes in the whole market or a sector of the market (check out Fact #6 to view stock market sectors).
Below are just a few well-known stock indexes. However, there are 5,000 U.S. indexes!
- S&P 500. As you might guess from the name, this index is made up of 500 of the largest companies in the U.S. This index makes up 80% of the entire stock market value.
- Dow Jones Industrial Average (DOW). This includes 30 of the largest U.S. companies.
- NASDAQ. This index is tech-focused and comprised of stocks of more than 3,200 companies.
To show how stocks in a particular index are doing, a final number is presented based on a weight from a mathematical equation that is specific to that index.
You might hear, for example, the DOW is “up today” or vice versa. On Google, the number looks something like this:
A stock exchange is an actual place or online location (e.g. M1 Finance and Robinhood) where you buy and sell different types of financial investments like stocks that are tracked on stock indexes. Company stocks are listed on a stock exchange for investors to buy.
An example of a stock exchange is the New York Stock Exchange (NYSE) which is headquartered on Wall Street in New York. Another example is the NASDAQ exchange where you can buy and sell stocks that are tracked on the NASDAQ index.
4. The stock market has an average return of 7% each year after inflation.
Based on S&P 500 data, the stock market had an average annualized return of 7% over a 50-year period between 1971 and 2020.
To put this into perspective, $1 fifty years ago would now be worth over $27 (adjusted for inflation or spending power) if invested in the stock market.
With this 7% average in mind, let’s say you invest $1,000 in the stock market today. You then contribute $500 every month for fifty years. With an average return of 7% each year, you’ll have $1.8 million dollars at the end of fifty years, even after taxes and inflation.
In short, if you’re investing in the stock market for longer than 10 years, you can expect to earn a lot more money than you invested.
Note: This 7% return doesn’t apply to investing in one or a few stocks.
5. Stock market ups and downs (aka volatility) aren’t cause for alarm.
The stock market is a lot like a roller coaster. Prices go up and down. Stock market volatility measures how big the price swings are over a given period of time for the overall market.
If prices rise or fall by more than 1% over a sustained period, the market is considered volatile. Market volatility is caused by many factors including
- Political upheaval
- Global pandemic
- Interest rate changes
- New policies
- Investors’ attitude toward the market
Whatever the reason, stock market volatility often strikes fear in the hearts of new and experienced investors alike. If you watch the news or check social media, you might see headlines like “The DOW dropped 500 points today!”
This type of news can cause panic and uncertainty. Investors start selling their stocks of a company. The stock prices then drop.
The trick with market volatility is to manage your emotions as rash decisions can end up costing you. Instead, consider the facts. There are always risks involved with investing, but historical returns show that the stock market eventually recovers from dips.
Stock market volatility is also an opportunity to buy stocks at a low price and sell later when prices have increased again.
Note: Stock volatility is also a thing. This means that the price of a stock is rising and falling dramatically. Cryptocurrency stocks are one example of extreme stock volatility as prices fluctuate every day.
6. There are 11 different stock market sectors.
A stock market sector is a group of similar stocks (normally from the same industry). Stock market sectors make it easier to compare companies and decide which stocks you want to invest in.
Sectors are according to the most commonly used classification system: the Global Industry Classification Standard (GICS).
There are 11 GICS stock market sectors in the stock market:
- Consumer Discretionary
- Consumer Staples
- Information Technology
- Communication Services
- Real Estate
The size of each market sector differs, but having different market sectors allows you to diversify your investments. This means you don’t put all your eggs in one basket such as all of your money in energy stocks or all in healthcare stocks.
You then lower your risk of losing money. If one market sector takes a hit, another market sector could do well. You can also easily choose investments that interest you based on these sectors.
7. You have multiple ways to invest in the stock market.
You now have six stock market facts. This next fact is actionable and all about investing in the stock market yourself.
You’re not limited on options when it comes to investing in the stock market. Here are three ways to get involved:
CHOOSE INVESTMENTS ON YOUR OWN
Open an online brokerage account such as through Fidelity or Vanguard. You can then easily open a retirement account such as an IRA. Or you can choose to open a taxable brokerage account if your retirement plan is already set.
Once you’ve got an account, choose between different investment types including stock mutual funds (basket-like investments that are typically actively managed) or exchange-traded funds (ETFs – basket-like investments that are typically passively managed).
You can also invest in individual stocks that you’ve researched like NIKE or APPLE.
ALLOW A ROBO-ADVISOR TO MANAGE YOUR PORTFOLIO FOR YOU
Robo-advisors like E-Trade and M1 Finance are great options if you want to be a hands-off investor with the stock market. You fund the account and then robo-advisors manage your investments through a computer algorithm.
INVEST IN A 401K
If your employer offers a 401K, take advantage of it (especially if they will match your plan contributions). Set up a plan through your employer and select what type of investments you want (stock mutual funds is a common option). You can then make monthly contributions to the account.
Use these stock market facts to start investing
Investing in the stock market doesn’t have to be complicated. Take these stock market facts to begin making solid investment decisions.
And whether you have $100 or $1,000+ to invest, here are action items to get started with the stock market:
- Set up an investment account with an online brokerage or robo-advisor.
- Choose whether you’re going to invest in stock mutual funds or exchange-traded funds, or individual stocks (you can do a combination).
- Create a budget for how much you’ll invest in the stock market.
- Fund your account and set up monthly automatic contributions.
- Check your investments every month or quarter (depending on the type of investment).
Do any of these stock market facts surprise you? How do you plan to start investing in the stock market?
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