Updated: Jan 30
One way to effectively utilize a portion of your income is to invest it in the stock market. The stock market is comprised of large indices, like the S&P 500 and the Nasdaq, where stocks of public companies are traded.
Stocks refer to partial ownership of a public company. Through the stock market, individuals are able to buy and sell shares of these companies under a set of regulations, which are mainly provided by the SEC(Securities and Exchange Commission) and FINRA(Financial Industry Regulatory Authority).
The stock market allows companies to receive capital from investors which allows them to expand and pursue new endeavors. When the company performs better, the stock price increases which would benefit the investors. Investors can also benefit through dividends, additional payments that are given to investors to thank them for their investment in the company.
IPO & Market Cap - To access this capital, companies go through a process called IPO, or the initial public offering. For example, let's discuss Robinhood, a financial services company that had a fairly large IPO this past August. When Robinhood went public, its IPO price was $38. Since then, the share price has dropped to around 20 dollars (as of December 29th). To get the market value of Robinhood, we need to find their market capitalization. To do this, we can multiply the share price by the number of shares outstanding, which is all the shares of the company. By understanding this concept, we get closer to being able to evaluate whether a company is under/overvalued.
Bull vs Bear -
In trading, there is a concept of a bull market and a bear market. A bull market is a terminology given to a market that is rising rapidly or is expected to rise by at least 20%. Conversely, a bear market refers to a market that is falling rapidly or expected to fall by at least 20%.
Advantages of the Stock Market -
Investment Growth - The primary benefit of investing in stocks is the ability to gain money through company growth. As companies grow, the stock does better and investors are able to profit. Though individual stocks fluctuate throughout the year, the stock market tends to have an average annual return rate of 10%.
Liquidity - Liquidity refers to the ability to quickly turn our financial assets into cash. Compared to financial assets like a house or a car, stocks have more liquidity which is important in case of financial emergencies.
Diversification - Investors can invest in different types of asset classes such as real estate, bonds, and crypto. By investing a portion of your money into stocks, you diversify your portfolio and are financially protected against large losses within these other asset classes.