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What is the Stock Market? How to Start Investing in Stocks
Charles Schwab
Overview
This video explains the fundamentals of the stock market for new investors. It defines what a stock is, how investors can make money through price appreciation and dividends, and why companies issue stock. The video also covers how stock prices are determined by supply and demand, the role of brokerage firms and stock exchanges, and the function of stock indexes like the S&P 500. Finally, it outlines common ways to start investing, such as through retirement plans and brokerage accounts, emphasizing the long-term nature of stock investing and the importance of understanding risks and fees.
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Chapters
- A stock represents a share of ownership in a company, making the owner a shareholder.
- Shareholders have a claim on a company's earnings and assets, meaning their investment's value fluctuates with the company's success.
- Investors can profit from stocks through price appreciation (when the stock price increases) or dividends (a portion of company earnings distributed to shareholders).
- Owning stock also grants voting rights in the election of the company's board of directors.
Understanding what a stock is and the basic ways to profit from it is the foundational knowledge required before considering any investment.
Buying 50 shares at $25 each ($1,250 total) and selling them later at $27 per share results in a $100 profit due to price appreciation.
- Companies issue stock primarily to raise capital for business expansion or product development.
- The first time a company sells stock to the public is called an Initial Public Offering (IPO).
- Both individual retail investors and large institutions (like banks, mutual funds, and pension funds) buy and sell stocks.
- Many people are already invested in stocks through employer-sponsored retirement plans without realizing it.
Knowing why companies offer stock and who the major players in the market are helps demystify the market's structure and participants.
A company might sell shares through an IPO to fund the development of a new product line.
- Stock prices are initially set during an IPO based on financial metrics and investor interest.
- After the IPO, prices are driven by supply and demand, similar to other goods and services.
- Brokerage firms facilitate the buying and selling of shares by executing orders on behalf of investors.
- Stock exchanges, like the NYSE and Nasdaq, are the marketplaces where these trades occur, though most trading is now electronic.
Understanding price determination and the trading process clarifies how market forces influence stock values and how transactions are executed.
If many investors want to buy a stock and few are selling, the price will likely increase to match buyers with available sellers.
- Stock indexes, such as the S&P 500 and Dow Jones Industrial Average, are tools that measure the performance of a group of stocks.
- Indexes track various market segments, like large companies (S&P 500) or smaller companies (Russell 2000).
- Historically, stocks have offered higher potential returns than bonds or cash over the long term, but with significant year-to-year volatility.
- Past performance is not indicative of future results, and stock investing involves periods of both gains and losses.
Stock indexes provide a benchmark for understanding overall market trends and the historical performance and risks associated with stock investments.
The S&P 500 index tracks the performance of 500 of the largest U.S. companies across different industries.
- Many begin investing through employer retirement plans (401(k), 403(b)), which offer tax benefits and potential employer matching.
- Mutual funds pool investor money to buy a diversified basket of securities, including stocks, which can reduce risk compared to single stocks.
- Mutual funds can be actively managed (stock picking) or passively managed (tracking an index), with differing fee structures.
- Brokerage accounts offer direct access to buy individual stocks or mutual funds, requiring more personal research for individual stocks.
This chapter provides actionable steps and common entry points for individuals looking to begin their stock investing journey, highlighting different investment vehicles and their characteristics.
A 401(k) plan often allows employees to invest in various mutual funds, diversifying their retirement savings automatically.
Key takeaways
- Investing in stocks means owning a piece of a company, with your investment's value tied to its success.
- Profit from stocks comes from the stock price increasing or through dividends paid out by the company.
- Companies sell stock to raise money, and stock prices are ultimately determined by the forces of supply and demand.
- Stock exchanges are the regulated markets where buyers and sellers trade shares, facilitated by brokerage firms.
- Stock indexes are useful for tracking market performance, but past returns do not guarantee future results.
- Stock investing is generally considered a long-term strategy due to inherent market volatility.
- Retirement plans and brokerage accounts are common avenues for individuals to start investing in stocks and diversified funds.
Key terms
StockShareholderPrice AppreciationDividendInitial Public Offering (IPO)Brokerage FirmStock ExchangeStock IndexMutual FundRetirement Plan
Test your understanding
- What is the fundamental difference between owning a stock and simply holding cash?
- How can an investor profit from owning a stock, and what are the risks associated with each method?
- Why do companies decide to sell shares to the public, and how does this process begin?
- What role do supply and demand play in determining the price of a stock after its IPO?
- How can stock indexes help an investor understand the broader stock market, and what is a key limitation of relying solely on them?