If you are a beginner investor or interested in becoming one, then you first need to understand what the stock market really is and learns the basics of how the stock market works.
Simply put, the stock market, also known as the stock exchange, refers to the different marketplaces around the world where any investors, including you and me, can buy and sell shares in publicly held companies (=Stocks).
In addition to company shares, you can invest in several other types of investments (=financial securities) such as:
Exchange-Traded Funds (ETFs): An ETF is a type of investment fund that invests in securities traded on the stock market. The portfolio is constructed to match or track the components of a market index, such as the Standard & Poor’s 500 Index (a basket which represents the 500 largest publicly-traded companies in the US). Instead of having a portfolio manager buying and selling shares or bonds on behalf of the fund, the portfolio is automatically invested to reflect the composition of the index it is tracking.
Government and corporate bonds: A bond represents a loan made by an investor (you) to either a company or the government, which pays interest to the lender (you).
Derivatives: derivatives are more complex stock market ‘creations’ that are also traded on the stock market. They allow investors to make bets on the stock market or can also function as some sort of insurance against stock market losses.
Now that we covered the basics, let’s look at why it makes so much sense to start investing in the stock market:
One of the great things about the stock market is that it is widely accessible. You don’t have to be ultra-wealthy, you don’t even have to be an adult. For example, I have recently taken steps to open investment accounts for my two kids with Interactive Brokers (which I should have done as soon as they were born!).
In fact, there are no laws that forbid people to start investing in the stock market, unlike for many other investment alternatives such as hedge funds and private equity investments, which are only legally available to the ultra-rich and institutions such as pension funds and insurance companies.
As long as you have a valid ID and can give a recent proof of address, you are able to open an account with an online trading platform such as Interactive Brokers and start investing in shares, bonds, and the likes.
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Unlike what Irene thought, it is possible to invest in the stock market with little money, say EUR 1,000.
Once you have opened an account on an online trading platform, you could invest in one or a couple of ETFs which track the world economy to have a well-diversified portfolio of thousands of companies around the world.
You would then have a low-cost, well-diversified, and balanced portfolio that would serve you well over the long run, even as you transition from a beginner to an experienced investor.
(Note: you could technically start investing with less than EUR 1,000. But because online trading platforms typically have minimum transaction fees, it would not be very economical to do so with smaller amounts).
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I was once talking with my hairdresser about investing (because yes, I am sooo into investing that I can’t stop talking about it, even when I am getting a haircut!)
She told me about an investment she had made about ten years ago. It was a long-term investment and life insurance policy, such as the products typically offered by Zurich Insurance and the likes.
Because some unscrupulous and/or ignorant sales guy (always a guy!) had made her sign into this investment, she not only had been paying the required contributions for the last 10 years, there was also no way out for her. She is forced to continue paying for the next 15 years.
Even if she now realizes that such investments are just TERRIBLE! They are crippled with fees and using active investment strategies, the combination of which results in a terrible performance.
(Side note: Never ever ever EVER invest in such a product. This is one of the worst financial decisions you could ever make. The only people who make money with this is the insurance company and the person who makes the commission selling it to you. Even the insurance component is not worth it. You can insure yourself differently if you really need or wish that)
The story is very different when you start investing directly in the stock market.
Of course, to maximize performance, you should let your money invested for at least ten years (or even better: until you retire!).
But if for whatever reason you would want to access your money and stop investing, you would be free to do so in just a few clicks, without even having to ask anyone.
Here is another reason why I truly believe investing in the stock market is great for beginners.
My sister, Johanne, is great at managing her money. And she also likes to invest: she owns a couple of apartments near her home, which she rents out to other people. But one of the disadvantages of investing in owned property is the difficulty in diversifying.
Because of the high purchase price of a property, chances are that you can only invest in a handful of properties at most. This means that all your money (or at least large chunks of it) is concentrated in a couple of objects.
And what if the leading employers in the area where your properties are located move to another location? You would then have to lower the rent to keep attracting tenants to your property, or worse; your property may become vacant. In any case, you would lose income, and your real estate would also lose value.
On the other hand, when you invest in the stock market, you can invest in a highly diversified portfolio of companies (and bonds). Big and small companies active in different industries and that are located in different regions of the world.
This means that even if one company in your portfolio goes bankrupt, your portfolio is so diversified that chances are you would not even notice.
Probably one of the best things about the stock market is that investing in the stock markets yields good returns, even for beginners (when done right, of course).
If every year you had invested your savings in an ETF tracking the S&P 500 index (which represents the 500 largest US companies listed on the stock exchange) for the last 10, 20, 30 or even 100 years:
1) regardless of stock market conditions 2) without knowing much more than just stock markets basics; and 3) without doing anything else, and importantly, without selling anything
… then you would very likely have a return of approximately 6-8% per year, beating most investors out there, professionals and amateurs alike.
Let’s say you save USD 1,000 per month and invest all of that (USD 12,000) at the end of each year in an ETF tracking the S&P 500 index. After 25 years, you should end up with just over USD 1 million, instead of the USD 300,000 you would have saved if you had never invested.
This is because you would have experienced good average returns over time, paid low fees, while also, very importantly, benefiting from compounding.
‘Compounding’ means that investments earn a return not only on the amount initially invested but also on the accumulated earnings of previous periods (for more information on how compounding works, then read my article: “Why I am NOT Afraid to Lose Money”).
Well, actually, the vast majority of investors, beginners, and experienced investors alike, pay outrageous fees for investing in the stock market. This is because they are investing the traditional way.
That means that either they are either investing in actively managed funds from traditional banks (with high annual fees of 1.5% to 2.5% or more) or they are actively trading single stocks themselves (incurring lots of transaction fees).
But when you invest the right way, investing in the stock market is actually VERY affordable!
The right way means through a passive investment strategy and only selecting a handful of well-diversified low-cost ETFs or index funds to build your portfolio, which will typically only cost you between 0.04% to 0.30% per year.
Or you could invest through an online robo advisor, which for a low fee of 0.30% – 1.00% will do all the work for you!
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There is this widespread belief that investing in the stock market is something very complicated. And that beginner investors should absolutely rely on the (very costly) help of financially educated and experienced professionals at established financial institutions.
This is also the way the world of investing is depicted on TV in movies like the Wolf of Wall Street starring Leonardo di Caprio (who is such a good actor!).
Unfortunately, movies could not be further from the truth when it comes to investing successfully. And that is probably because the way to invest successfully, as demonstrated by one study after the other, is waaayyyy too boring to make a movie out of it.
Because there is nothing very exciting about buying the same couple of index funds or ETFs year after year for decades.
And there is nothing very hard about it that would require anyone to have a degree in finance or years of work experience with a financial institution.
All you need to know are stock markets basics.
So even if the world out there, including your boyfriend or husband, parents, television and the press seem determined to make you feel otherwise, successful investing is something YOU can (and absolutely must) do yourself to create your financial security and that of your loved ones.
For millennials like you and me and even more so for younger generations, there can be something very dull and old-fashioned about the stock market.
Nowadays, there are way cooler and user-friendly ways to invest money, including buying and selling cryptocurrencies on cool exchanges, or crowdfunding and peer-to-peer lending platforms.
But despite the uncool factor, good old stock market investing has a lot going for it when compared with modern alternatives:
Regulations: To be listed on the stock exchange, companies have to meet an endless list of requirements. And then, once they are listed, they have to comply with very stringent regulations and reporting requirements. The same applies to market participants such as exchanges and online trading platforms: they are all highly regulated. This makes it very hard for fraudsters to take your money and run. On the other alternative investing platforms such as peer-to-peer lending are just starting to get regulated, leaving room for abuses.
Transparency: The pricing of shares, bonds, and other listed securities is widely available on the internet and updated every minute. Similarly, there is a lot of research available on shares, ETFs, bonds, etc. Not so much so with the modern alternatives to investing. Try getting some reliable research about cryptocurrencies. Or try getting a fair market price for a crowdfunding investment. You may have to keep looking for a while!
Track record: The stock market has been around for a long time, dating back to 1602, when the first company became publicly listed on the Amsterdam Stock Exchange. And such a long history has permitted an enormous amount of research and testing on best practices for investing successfully in the stock market. And we are able to learn from the findings of such research. On the other hand, since cryptocurrencies and crowdfunding and peer-to-peer platforms are barely ten years old, it’s hard to get much research nor insights on what works best on them!
When you invest in the stock market, your return comes from two components:
(1) the rise in the value of your investments in company shares (=growth) as well as (2) the regular dividends or interest payments (=income) that are generated by your investments.
Typically, when you are young and earning money, you want to build a portfolio oriented towards ‘growth.’ This means that the majority of your portfolio should be invested in company shares, using ETFs.
When you retire, you will typically want to revamp your portfolio to have the majority of it invested for income, so that you can use the dividends and interest you portfolio generates to fund all or part of your daily expenses.
As a single mother of two working full-time, I can barely manage my day-to-day workload. Which is why I certainly don’t have time to manage my investments on a daily or weekly basis.
And if I were investing in owned property like my sister Johanne, I would have to get to know the local market, maintain the property, hire contractors for repairs, deal with local authorities to obtain permits, tax documents, etc.
That is too much work for my busy lifestyle.
This is why I choose instead to invest in the stock market instead.
Most of the work is done upfront when you open a trading account and define your investment strategy. Then you need to invest your current savings in your selected ETFs or index funds.
You should also define how often and how much you will invest going forward, ideally through an automated transfer from your salary account.
Once you set this up, you will need an hour or two to invest your new savings and rebalance your portfolio once or twice a year.
And this can be further streamlined by investing through an online robo advisor.
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This was my plaidoyer for the stock market. And I hope that going over these stock markets basics will help you get you closer to start investing!
So learn to invest the right way, and start as early as possible, with whatever amount you have.
Ready to get started with investing in the stock market?