Stock Market Basics

Posted June 2016.

Unless you majored in economics or finance in college, you probably didn’t learn much about the stock market growing up. And, if you’re like many people, your eyes glaze over when you hear stock market news. Nonetheless, despite the economic turmoil of recent years, the stock market remains among the most important options for Americans to build their wealth and secure a comfortable retirement. So, while you may still choose to work with a financial advisor to guide your investment strategy, here are some stock market basics every investor should know.

What is the stock market?
Simply put, the stock market is where ownership in companies is bought and sold – this is also called trading. When you buy stock – also known as shares — in a company, you’re buying a piece of that company, and that makes you a shareholder. When you hear talk about “equities,” remember that’s just another word for stocks. The “stock market” is, however, a general term. Companies actually list their stock on one of several different stock exchanges, such as the New York Stock Exchange (NYSE), the American Stock Exchange (AMEX) and the National Association of Securities Dealers Quotation System, which is commonly referred to as the NASDAQ.

How do you make money in the stock market?
There are two basic ways to make money in the stock market. The first is to buy a stock, and then sell it after it increases in value – the profit you make is referred to as a capital gain. The other way to make money is to buy a stock that pays dividends to shareholders; dividends are a company’s earnings, which it pays out to its owners. Companies that pay dividends are often older or well-established firms. Often, newer companies aren’t yet making enough money to issue dividends because they’re reinvesting their earnings back into the company.

What’s the difference between a stock and bond?
Stocks are ownership investments – you’re buying a piece of a company. Bonds, on the other hand, are a lending investment. You give the bond issuer money, and they pay you interest in return, just like you pay interest to a creditor. In general, bonds are considered safer than stocks since the bond issuer has a legal obligation to pay them. They are not, however, risk-free.

What is diversification, and why is it important?
Diversification simply refers to the practice of spreading your money among a variety of investments to balance risk. It’s important because nobody can know for sure exactly how different types of investments will perform at any given time. A diversified investment portfolio has lower risk because if one type of investment is down, it can be balanced by others that may be doing better.

What is a mutual fund?
A mutual fund is a collection of stocks or bonds, in which investors pool their money. Mutual funds can be a great way for smaller investors, and those who don’t have the time or expertise to research and purchase individual stocks and bonds, to diversify their investments. Shares in a mutual fund are purchased in the same way that individual stocks are purchased.

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