“Someone’s sitting in the shade today because someone planted a tree a long time ago.“
– Warren Buffett
Stock Market Basics
Bottom Line Up Front:
The stock market can be an amazing creator of wealth over the long run, but far too few Americans truly understand its basic concepts and mechanisms. Stocks are not gambles – rather, they should be an integral part of your retirement strategy. Yes – even you who just shrugged your shoulders.
Bottom Line Up Front:
We can’t (and don’t want to) define what financial success means or looks like to you.
Our goal is to help you define and perfect your own personal definition of financial success. Whatever that answer is, we aim to provide you with the tools, methods, and practices to achieve it. We’re here to dispel every single myth and critique that says you can’t achieve financial independence, financial stability, and your own take on financial success.
Part 2 / 7: Stock Market Basics
In the early 1600s, the Dutch East India Company became the first company to issue bonds and shares of stocks to the general public, as investments sponsoring its dangerous voyages. Then in 1773, the first stock exchange in London was officially formed, and 19 years later, the New York Stock Exchange made its home on Wall Street. Even before that, stock markets have existed, in some capacity, since the mid-1400s.
There’s an important reason for this: stocks offer tremendous growth potential, and if you’re invested for the long haul, you can likely ride out stock market downturns with little detriment. You are investing in the future success of a business, and, quite frankly, most businesses don’t begin with the idea of failing or losing money.
Honestly? We’re not Economists – and we’re guessing you’re not, either
Across the web, there are hundreds of articles written about the stock market. We like some of them*, but think many are convoluted and fail to inform the most novice of investors – those with absolutely no experience, whatsoever. What we’ll achieve in this article, in the simplest manner possible, is to:
- Explain the basics of the stock markets
- Inform why you should own stocks
- Explain how to buy & sell stocks
*Websites we recommend for continued research (and lots of other amazing, useful content):
Websites we recommend for continued research (and lots of other useful, well-written content):
1. Stock Market Basics
When you own shares of stock in a company, you own a specific fraction of the corporation. If the company profits, your investment may grow, and when the company struggles financially, your investment may decrease in value. The more stock you own, the more your stock value increases or decreases with market fluctuation.
Stock Market Tenets We Live By
- Invest in companies you know. You already follow them and are invested in their success/products.
- Learn! While emotions do impact the market, that sentiment negates a crucial realization that the markets follow companies, and companies can be broken down very mathematically.
- Investing should be long-term, unless you plan on making it your day job! It’s very unlikely that you hit a home run – run it like a marathon.
- Penny stocks & “too good to be trues” are usually just that – we stay away entirely. Again, a marathon not a sprint.
- Never panic – the market has averaged a 7.9% return since inception. Ups & downs are natural and they will occur. Weather them with confidence.
- Only invest money that you don’t need to live currently. Whether it goes up or down is irrelevant – the length of time it’s invested changes the type of tax when it’s sold.
You Don’t Lose Or Gain Until You Sell
Even if a stock has plummeted -99%, you haven’t actually lost anything until you choose to sell. One of the best, and most recent, examples of this understanding is the 2008 market crash. If, at the time, you were a 60+ year old individual looking to retire in a few years, the market crash could have been particularly painful. It may have pushed right a few years the age at which you planned to retire. However, if you weren’t that individual, the market crash should have had little bearing on your existing portfolio, and only affected – potentially – how you invested as you weathered the storm.
If you had invested $1,000 at the beginning of 2008, you would have lost 37% by year end, or $370. You’d now own stock worth $630. In 2009, the market increased 26.5%, turning your $630 into $797 – still not fully recovered. Then in 2010, the market increased by 15%, so your $797 grew to $917. 2011 only returned 2.1%, so it would have taken you until 2012, with an increase of 16% to break even at $1,008.
However, Warren Buffett famously ascribed “Be fearful when others are greedy, and greedy when others are fearful.” What would have happened if you not only weathered the 2008 market crash, but capitalized on historically low price points? Here are some low points for companies in 2008, then how high they’ve risen today.
2009 Low: $10.30
2017 High: $77.09
JPMorgan Chase & Co.
2009 Low: $15.93
2017 High: $107.79
Bank of America Corp.
2009 Low: $5.57
2017 High: $29.80
Wal-Mart Stores Inc.
2015 Low: $56.42
2017 High: $107.79
Costco Wholesale Corporation
2009 Low: $38.97
2017 High: $192.73
2009 Low: $25.65
2015 High: $84.69
As you can see, all of these companies suffered through the 2008 market crash (Wal-Mart even dipped right back down in 2015), but rebounded fairly quickly and skyrocketed during this recent bull market. We never recommend “timing the market,” but it is crucial to understand the cyclical nature of securities and capitalize when prices are at their lowest. From our earlier example, if you had continued to double your investment in these companies in March-April of 2009, you would have recouped your returns much sooner than 2012, and would have doubly enjoyed the meteoric rise from 2008-2009 lows to record highs in 2017.
Bear vs. Bull Markets
The stock market experiences trends known as bull and bear markets.
– Bull markets are categorized by generally rising prices with positive investor sentiment.
– Bear markets are categorized by declining stock prices and generally pessimism, oftentimes coupled with a weakening economy or recession.
We won’t belabor the point, but we believe in being students of history. The chart below shows cyclical bear and bull trends since 1926. Notice the bear markets are incredibly short and tame compared to their bull counterparts. So why, then, during 2008 was their such intense market panic? And in 2000? 1987? How about 1973?
Multiple reasons. For one, even a marginal decline for billionaires, managed funds and hedge funds equates to large losses, overall. When these big players begin selling their hundreds of millions of dollars worth of stock to reallocate to stabler platforms, they drive down prices sharply. Now the average investor grows understandably nervous, withdraws their money at a loss, and anyone still invested is faced with crippling low prices.
But if we review this chart below, it clearly shows that bear markets are short and manageable, and weathering the storm for the ensuing bull market is always worth it. If an investor is sticking it out until retirement, their bull market years will vastly outweigh the one or two years of a bear market.
Modern technology has made it simpler than ever to purchase stocks.
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Featured image by wikiHow.com