Stock Market 101

I want to go over some finance basics for those who are unfamiliar with some of the basic terms that are used in finance discussions.  Again, I often find in my work that many people (especially women) tend to feel they “can’t understand money stuff”.  This is an example of one of the “stories we tell” ourselves about money.  As women, many of us were not taught about finance or business.  Even in this supposedly gender-neutral world we live in, many girls (myself included) felt they were terrible at math in school.  However, women are often times the keeper of the family purse.  When I work with clients that are couples, the wife is usually my point of contact.  This may have to do with the fact that I am also female, but more often than not it is because she is the one in charge of paying the bills, she is the one wanting to plan for the children’s education, and also the driving force in purchasing life insurance.  I find it interesting and disheartening that so many women are saddled with these financial issues, while feeling completely lost and confused.  This next chapter is an overview of Financial Planning, with a portion on Investing 101.  These are topics you really should understand before beginning to invest your money, so I encourage you to read it thoroughly unless you have a high level of expertise or experience in the field.

The phrases “financial planning”, “family finance” and “estate planning” are ones we hear often in the media.  There always seems to be one expert or another touting their wisdom or promoting an idea or product.  Much of the information out there seems to be contradictory.  However, there are some basic truisms in finance, and that is what I will focus on in this chapter.  

Basics of Stock Market

To fully understand the power of investing and compounding interest, we need to take a step back and talk about the markets themselves.  In my practice as a financial advisor, it is common that in a first meeting with a new client they will sheepishly admit they don’t know the difference between a stock and a bond, much less how a mutual fund works.  They often tell me they’ve been embarrassed to make this confession their entire adult lives, and have therefore been blindly accepting investment ideas and advice that they didn’t understand in the slightest.  As a result of this happening so often in my office, I now preface every first appointment with “I know this may be elementary for you, but lets start with going over the basics of the stock market if you don’t mind.”  So far, no one has rejected my offer.  Even experienced investors generally have questions or confusion about some aspect of the market.  I certainly don’t have every answer to every question that might come my way, but I do feel like I know what I don’t know, and ask for clarification when I need it.  

Companies that are publicly traded go through an initial IPO (Initial Public Offering).  During this process, an investment banking firm values the company through a complex valuation process.  From there, it is decided how many shares will be issued, and what type of stocks these shares will be (common stock being the most common).  The price per share is calculated by dividing the entire valuation of the business by the number of shares issued.  Once the shares are listed on one of the major stock market exchanges (NYSE being the primary example in the US), they can be bought and sold.  Each stock is a sliver of ownership in the company.  Once you are are stockholder, you are entitled to attend shareholders meetings, receive company financials and participate in voting on company matters, though most investors don’t get that involved in their investments.  The stock value goes up and down throughout the day, in real time.  At any point during the day when the Exchange is open (EST), you can instantly buy or sell stock.

Stock Market Sectors

The Stock Market is divided into Sectors, both Economic Sectors and Capitalization Sectors.  Economic Sectors include industries such as Consumer Products, Banking, Transportation and more.  Capitalization Sectors reference the size of the company issuing the stock, and include Small Cap, Mid Cap and Large Cap.  When purchasing individual stocks, diversification is the most important risk management strategy.  A well-balanced stock portfolio include companies from each major Economic Sector, and companies from the Large Cap, Mid Cap and Small Cap valuation sectors.

Low Cost Investing

When you purchase stocks, you can either go through a financial advisor or purchase them yourself on a fee based transaction model online.  The commission paid to the financial advisor is generally a percentage of the total investment, and you can end up paying hundreds if not thousands of dollars in commission for the same investment you can make online for as low as $4.95 a trade.  The primary difficulty with online trading is that you are likely not an expert financial analyst, and might not know where to start in picking your stock investments, knowing when to diversify, and deciding when to sell.  Resources are available online for this information, though it takes time and commitment on the part of the individual investor to stay engaged in their portfolio management.

Other articles about Investing on Investor Sage that you may be interested in include Creating Financial Freedom, ETF’s, 401k, Roth IRA, Budgeting, Socially Responsible Investing and Stock Market Basics.