When I first started investing I imagined the stock market as a jungle.
I envisioned I stood at the edge of the jungle, thinking there was absolutely no way to get in there without getting lost (or at least seriously hurt, haha).
Investing to me meant a couple of things. Here are some of the opinions that came to my mind when thinking of finance and the stock market:
- finance is boring
- necessary to read difficult financial newspapers (the kind where you read a piece 5 times and still don’t understand)
- white men in suits talking gibberish
- putting money into schemes I didn’t understand
- locking your money away for a long time, not being able to reach it when you need to
There’s a good chance you might be nodding now.
“Yes Valerie, that’s exactly what I think!”
Well, in that case I have some good news for you: it doesn’t have to be this complicated.
In order to understand investing you should take it step by step. And the first step is to understand what kind of products you can buy on the stock market.
The stock market and its products
First of all: what is the stock market?
The stock market is just like any other market: a place where buyers and sellers meet. Only here they don’t sell fruit or vegetables, they sell a variety of financial instruments.
In order to see the forest through the trees as a beginner there are 4 products you need to learn about. Get a good understanding of these before you do anything else.
Stocks
A stock is a fraction of a company. Whenever a company goes public (i.e. offers itself on the stock market) it virtually splits itself up into pieces that are valued at a certain price. Those pieces are the stocks. The goal? Raising capital the company can use for further growth, product development etc…
Stocks are considered the purest form of investing because you have a direct link with the issuing company. You get to share in both wins and losses, so there is quite a large risk attached to investing in stocks. As a stock holder you own a piece of the company, which also comes with voting rights.
Bonds
A bond is a financial instrument that represents a loan between a borrower and an investor. The borrower – for example: the government – needs money and issues bonds that investors can buy at a set price.
The bond is a proof of the loan and has a fixed due date after which the investor is reimbursed. Usually a set interest rate is communicated upon issuing the bonds, so the investor knows how much the profit will be. Bonds are considered fairly safe investments.
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Mutual funds
A mutual fund is a basket of securities and consists most commonly of bonds and stocks. Multiple investors put money into the fund through a broker, and the fund managers will actively follow up on the fund’s structure with the goal of optimizing the returns. For this active management investors pay a fee.
Mutual funds offer diversification, so that you – the investor – don’t have to purchase each of the underlying financial instruments individually.
ETF’s
ETF stands for “exchange traded fund”. They are similar to mutual funds because ETF’s too are baskets of securities. The difference? They are not actively managed which means they have lower fees.
ETF’s are freely available and are traded all day long on the stock market (whereas the price of mutual funds is only determined once a day or even once a week). They are in fact traded like stocks.
My opinion? They are the ultimate beginner product because of the simplicity, diversification and low fees. Investing in ETF’s will give you the opportunity to get to know the market in a low effort way.
Side note
A lot of ETF’s are index funds, meaning they track a particular index.
What is an index?
A list of securities to measure the performance of a certain market.
For example: the S&P500 index measures the performance of the largest US listed companies. An ETF that tracks the S&P500 buys all stocks in that index, so if you buy a unit of the ETF you have a tiny part of each and every one of those stocks.
Recap
- The stock market is a place where buyers and sellers meet to trade in financial instruments.
- There are 4 products you need to know and understand as a beginner:
– stocks
– bonds
– mutual funds
– ETF’s - ETF’s are great beginner products as they are simple, diversified and relatively cheap.
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