Stock Market For Dummies
Well not exactly dummies. I would say for absolute beginners. Whenever we hear the term stock market, a series of flashbacks run before our eyes.
“Stock market is bad. You will lose money”. “Stock market is for corrupt people.” “Stock market has only black money”. “It’s very risky and difficult to learn.” And many more.
While some of it may have truth but that doesn’t mean we should absolutely stay away from it. In fact, apart from real estate, the stock market is the only place where you can grow your money. So read on, if you have never ever dwelled into the share market or you have just started. Seasoned investors/traders can also learn from it. After all, the basics never change.
First, Let go of fear
We have learnt since childhood that it’s bad, risky and blah blah. Put your money in safe deposits. Its government backed. Of course, it is true that bank deposits/corporate deposits are the safest instrument, and one should keep some money there for emergencies. This you can use for emergencies. But if you want to grow your money, learning the stock market will help you in the long run.
Understand how the stock market works
Consider you and your friends have opened a shop called Hungry For Pizza. The pizza place took off and people drove from long to have your pizza. Now you guys want to make more pizza and sell to everyone and open new branches so that people don’t have to drive long.
You want to expand to another city or may be in another country. How do you arrange money? Maybe you can borrow from the bank. But that’s not going to be enough if whatever you are planning may be bigger than that. So, what do you do? You decide to sell little pieces of your Hungry For Pizza to complete strangers in exchange for money. And that’s what we call shares.
So here it going to go:
1. Valuation
Most of you have heard this term. Apple is valued at $300B approximately. What does it mean? So, you first go to the investment bank and get your company values. Banks see what your assets and liabilities are and give you a share price which you can ask from share buyers. So, let’s Say bank has come up with a number that Hungry For Pizza can have 10000 shares each valued at $50. So, your total market cap is 10000*50=$500000.
2. Listing on stock exchange
The US has the most prominent stock exchange i.e NYSE & NASDAQ. Consider this as a shop from where people can buy your shares. So, via some formalities you list your shares on this exchange. Just like your Amazon lists new products.
3. Initial public Offering (IPO)
The shares are then open to customers via IPO. This is the first time a share is bought by anyone except your friends.
4. Now trade
So now a person has shares at 50$. Now depending how HungryForPizza behaves in the coming days its demand can go up or down. If HungryForPizza is doing good business and no scam, its share prices will go up from $50 to $70. And that’s how you make profit. But if there is any bad publicity or quality issues, the share price can go down to let’s say $30. And this is a scenario your forefathers warned you about. You are at a loss now.
From this point onwards you can buy and sell shares at your free will.
From where can you buy these shares?
One can open a demat account with any of the brokers or banks. Generally going with discount brokers is a good idea as it can save you tons of commission.
Some great brokers in US are Charles Schwab, Fidelity Investments,Robinhood.
You can choose any one or more than one for your liking and open an account to get started.
Is it necessary to invest in an IPO?
NO. If you are not sure of the company’s future and you are at the beginning of your journey, you don’t need to. You can buy shares of already listed companies.
Stock market exchange
The official exchange from where you can buy and sell shares in the US is called New York Stock Exchange (NYSE).
Index
An index is a performance indicator of any segment of companies. Simply stating, if the index is moving upward, it’s a positive statement for investors.
US has 3 main indices
1. Dow Jones industrial averages (DJIA)
It tracks the top 30 prominent companies listed in the United States stock market.
2. S&P 500
As the name suggests, it tracks the top 500 companies listed in the United States stock market. It serves as a key indicator of the overall market’s health and is often used by investors to assess economic trends. By including major firms from various industries, the S&P 500 provides a broad view of the market’s performance. Whether you’re experienced in investing or just starting out, keeping an eye on the S&P 500 can help you understand market movements and make better investment choices.
3. Nasdaq composite
It includes almost all the companies listed on the US stock exchange along with Dow Jones Industrial Average and S&P 500.
Now it’s irrelevant how these indices are calculated and what formulas are applied as far as we are getting just into basics. Once you pass the beginner state, you may want to play around or go deeper into its functionality.
How to invest?
Now that you know about stock exchange and indices and have already opened an account let’s get your investment journey started.
There are two main routes to invest in the stock market.
1. Buy individual shares of a company
This space some people find intimidating as out of more than 3000 companies exactly which one to buy? Simplify it and buy the blue-chip companies if you are starting out. Blue Chip companies are the most prominent companies of a country with very less likelihood of going down. So, the stock price movement is balanced. This also means that you are not getting crazy gains like 30-40% in a year, but in case of a crash these companies will not go down much. So, it’s less risky.
Select any 5 blue chip companies. Ex. In the US it’s Apple, Walmart, Coca Cola, McDonld’s and study about them. Start putting some money into it. Make sure you park money for at least 3 years as these are less risky stocks. It needs significant time before you see any considerable gains.
After some time when you are comfortable with stock picking you can move to riskier stocks.
2. Mutual funds
This is a more user friendly and easier option. Mutual fund is a basket of the individual stocks that a mutual fund house manages. You give money to a mutual fund house and in return buy the equivalent units. Now if the value of underlying stock increases your unit value also increases.
Mutual funds are a better route for saving money every month. Suppose you have decided to invest 300$ every month, put this in a mutual fund. Every month you can buy some units, and it will keep compounding. Mutual funds are of different types for different needs. But that is a topic of another discussion. If you are just starting out, you only need one.
A. Index fund – Index funds track the index so if you are buying S&P 500 index funds. The performance of the fund is directly proportional to the S&P 500 index.
B. Flexi Cap/ Mid Cap – Every company is divided into large cap, mid cap and small cap depending on the market capitalization. Remember HungryForPizza, its market capitalization was $50000 when it started. So mid cap companies are at the middle of the pyramid and have a higher chance of growth than large cap companies. So better returns. Flexi cap is a fund which has a mix of large, mid and small cap stocks.
C. Small Cap fund – These are riskier but have highest possible growth. So do allocate some money to it. In the long run it will give you the best returns.
If you have 300$ to invest every month, make sure you invest x, y, z % in every single class of MF and stocks. The % you can decide for yourself as per your risk profile, age and occupation. If you are someone with age on your side and steady income, go for small cap stocks or funds. If you are too scared to invest in stocks, go for Index funds. The S&P 500 index rate annual return is 11% in the long term.
Now that you know how the stock market works and how you can start from absolute zero, let’s understand that growing your money more than inflation rate is mandatory. Aim for returns higher than inflation without taxes. Stock market does require patience. Do not expect results overnight. Happy investing
