Ready or not, here I come: it’s off to the “real world” with me. But, uh, about that “ready or not” — it’s definitely more of the “not” right now, and that has me a little nervous. I feel like there are still some things about adult life that are beyond me. For instance, stocks: what the heck? How do they work?
I mean, I sort of get what stocks are, but I don’t know why they’re good and how to invest in them safely and properly. Experts, can you help?
Sure we can! Stocks are incredibly useful tools for building wealth, but they can also be a bit complicated--especially when you remember that they’re just one type of “investment vehicle” to consider. Let’s break things down.
You say that you know what stocks are, but let’s recap things just in case. Stocks exist as “shares” of a company. They are not quite the same as ownership shares, but they’re similar in some ways: when the company becomes more valuable, a share of it becomes more valuable, too. Companies issue stock to raise cash, and then they use that cash to grow. If you invest in a company, you can then sell your share later on — for a profit, ideally.
Stocks are regulated in all kinds of ways, and they are publicly traded on exchanges like the New York Stock Exchange (in New York, of course) and the NASDAQ (also in New York), among other major exchanges.
Stocks help us build wealth because they can grow in value at a rate that outpaces the interest rates we’ll find in savings accounts. That’s important, because if our money is not growing, we can see our wealth erode thanks to inflation.
Valuing stocks can be tricky. Looking at the wealth and growth potential of individual companies is key, but you can also look at whole industries. For instance, the best gold stocks see substantial gains when demand for gold spikes — which can happen during a recession, meaning that tracking gold stocks can mean looking at the market somewhat counterintuitively. It can get complicated!
The key to investing in stocks is to balance risk and growth while spreading risk out through diversity. In other words, you don’t want all of your eggs in one basket, and you don’t want to make too many bets on companies that could go belly-up. While larger, more established companies may have less room for growth, they can also be less risky to invest in.
Diversity can also mean investing in things other than companies. We don’t have the room in this answer to go over every type of investment, but you should at least know about a few. Bonds are essentially a share of a company or government’s debt, to be paid back with interest on the “maturity date.” Mutual funds are collections of multiple investments that can be bought into dollar by dollar and are traded once a day. Exchange-traded funds are, like mutual funds, a collection of multiple investments--but they have a share price and are traded on the market as if they were stocks. You can use ETFs and stocks of companies that act as holding companies to trade in things like commodities (commodities, like gold and silver, can also be traded directly on some exchanges).
Finally, you should strongly consider taking advantage of tax-sheltered accounts like 401ks and IRAs in order to maximize your retirement savings. Don’t overthink it: just save steadily in retirement accounts and maintain a diverse portfolio.
“Financial fitness is not a pipe dream or a state of mind. It’s a reality if you are willing to pursue it and embrace it.” – Will Robinson