The Stock Market: All You Really Need To Know … For Now!

Your Very Simple Guide To Investing

This post is really for the absolute beginner investor. Beginner or not, we all need to know how the stock market works.

I was watching a tv program recently about managing money and increasing wealth. One scene showed a person who was terrified of investing money. He had the money to invest but just couldn’t commit for fear of the unknown.

And it dawned upon me that there must be thousands of people who literally feel exactly the same. They are so overawed with the information that is out there and it just seems so complicated.

I’m not sure why I was surprised though. After all, that was me not so long ago. But I’m happy to say that I’m much more well-informed these days and that if I can understand it then you can too.

I’m here to make it super simple.

If you have money that you want to save or invest, you need to know a few of the options. For the purpose of simplicity, I will just address 2 options here as the purpose of this post is really just to explain the stock market and how I think you should use it to grow your wealth.

Where can you put your money?

Option 1: The bank

You can put your money into a savings account which will earn a very small amount of interest. Interest is great because it helps our money grow. When we deposit money into our bank accounts we are basically lending money to the bank. They use our money to lend to other people.

As interest is the cost of borrowing money, the bank pays us interest. The downside? This could be as little as 1% per year.

If we deposit $10000 and leave it in the bank for one year then that’s $100 that the bank pays us. Yahoo!

But the problem is that during that year, the prices of things may have gone up by 2%, 3% or even more. This is called inflation. If prices go up by 3% then we needed to get $300 just to break even as it will cost us more to buy things

That 1% interest doesn’t sound so good anymore does it? Our savings are completely safe in a bank account. But they can fall behind and actually lose us money in terms of purchasing power when prices rise.

Fixed deposit savings accounts

If we are prepared to lock our money away for a long period of time such as 5 or 10 years we can receive a higher interest rate. But this still may only be 3% or 4% if we are lucky.

Option 2: The stock market – This is why you’re here right?

Just like the bank option, there are a few different ways to invest in the stock market. We will get to those. But first things first.

What is a stock and what is the stock market?

Some companies are structured in a way that allows regular people like you and me to buy a tiny part of their company. This tiny share is what we call stocks. And these stocks are purchased in the stock market. It’s just like buying from any market.

For example, if you buy 1 share in Apple, at the time of writing, this would cost $168. In 2010 its price was $46. Now like anything that has a price, this price can go up or down. Lots of factors are involved. But nobody can really predict which company’s stocks will rise and which ones will fall. Although lots of people will tell you that they can. Don’t listen!

Obviously, if you buy a stock for a certain price and it goes up in value, then you’ve made a gain. If it falls then you have lost. Now, that’s pretty simple. Some companies pay what is called a dividend, which is a small share of their profits. This can add to your potential gains.

So, to recap. You can buy shares (stocks) in a company and your total value of, shares can go up or down over time. Using our Apple example, it seems like a pretty safe bet that it will be around for a while and continue to perform well. But you never know.

Some companies, like Kodak, for example completely crashed and shareholders lost their investments.

So how do you decide which stocks to buy?

Lots of people will try to advise you here. My advice is to ignore anyone who tries to tell you what stocks to buy.

As far as I’m concerned it’s too risky to just buy individual stocks which could just as easily fall as they can rise. This kind of investment is ok if you are happy to lose but with the hope that you may have guessed correctly. Unless you are an expert, this is pretty much like gambling.

So what should you do?

Well, we should work with what we know. We definitely don’t know which stocks will rise and fall. But we do know that over the history of the stock market (that’s around a hundred years) that the average annual returns have been 10.33%.

So if you could just buy stocks that fairly represent the average of the stock market then you are on the right track. You will know that over the long term (very important) that your investment should earn around 10% per annum. Now that’s more like it.

Index funds

Luckily this is possible when you buy what’s called an index fund which contains shares in the largest 500 companies in the US stock market. It’s called the S&P 500. Just like all stocks there will be times when the S&P 500 falls. But history tells us that it always rises again and over time the rises beat the falls for a 10% per year gain.

Compounding rules

This post is a simple explanation, so I won’t really go into compounding here. But I will just say that for our 10% example, you would get 10% each year and then 10% on the new balance. This means that even without adding to your investment that it will double every 7 years.

Adding small amounts every month will accelerate your returns and over the long term really can make you rich. But don’t take my word for it. This is the advice of the guru of investing himself, Warren Buffett.

I hope that helps you to understand just a little about the stock market. It really is a pretty safe option to buy index funds as long as you are prepared to ride out the falls and invest for the long term.

In times when inflation is rising, just putting your money in a regular savings account is actually losing you money. Index funds allow you to beat inflation and compound your wealth over time.

It doesn’t have to be complicated. Sticking to a plan, investing small amounts regularly and leaving it alone until you retire is a proven path to wealth.