When understanding something new it’s best to make an analogy to your everyday life, learning about the stock market is no different and I find the best analogy to the stock market is to a supermarket. Your local supermarket is open to the public meaning anyone can buy goods from the store. Some supermarkets are private for example Costco and Sam’s where you have to have a membership fee which is paid annually; in order to shop at these supermarkets, you have to meet certain qualifications. Additionally, these supermarkets are hard to access because they are not open to the public. This is what makes the stock market so amazing with its easy access for anyone to start investing.
Examples of Public Companies: Morgan Stanley (MS), Tesla (TSLA), and Lowes (LOW)
Examples of Private Companies: IKEA, LEGO, and SpaceX
What is a stock?
Going back to the supermarket analogy let’s say you go to the supermarket because you want to buy a banana, you think the banana will add some nutritional value to your diet and you also just really like eating bananas. You go to the cashier and purchase the banana and in exchange, the supermarket receives some form of payment, and you go home with your banana. An example in the stock market would be if someone is trying to sell one share of Amazon stock and you are looking to buy one share of Amazon stock. You could purchase the share and exchange would give the seller the cash value of whatever the market value of Amazon stock. When buying shares of a company you are buying a very small piece of the business.
How is this price determined?
Now I am sure you are wondering how the price of banana (stock) is determined: similar to the banana the price of a stock is determined by supply and demand and how much value the owner believes it has. If I am trying to buy a banana at a supermarket where the next closest supermarket is twenty-five miles away the owner of the banana has all the power because there is a much higher demand for the banana than there is supply. On the flip side if the supermarket is surrounded by twenty other supermarkets in a five-mile radius then the buyer has the power when purchasing the banana. In the stock market, the price of the stock is like the banana if a lot of people want to buy the stock, then it will drive the price of the stock up and if a lot of people want to sell the stock it will drive the price of the stock down.
Examples of Technology Stocks Known as FAANG: Facebook (FB), Apple (AAPL), Amazon
(AMZN), Netflix (NFLX), Google (GOOGL)
Examples of Non-Technology Stocks: Goldman Sachs (GS), The Kroger Company (KR),
Kirkland’s Inc. (KIRK)
What is an ETF? (Exchange-Traded Fund)
If I go to the supermarket and I don’t feel like just eating bananas so instead I buy a fruit platter that consists of some banana, melon, strawberries, cantaloupe, and oranges. Like a fruit platter, an ETF is similar because it takes a group of stocks typically in the same sector so buyers can get a wide variety of companies for the price of one just like a fruit platter where the buyer can get a lot of different types of fruit. Let’s look at an ETF called ARKK, some of their largest holdings are Tesla, Roku, Teladoc Health, Square, Zoom, and Shopify as you can clearly see their holdings primarily consist of technology stocks with a small portion of their holdings in healthcare. ETFs have become popular because it allows for people to invest in a specific sector, saves time because you don’t have to research individual companies, and the ability to mitigate risks and still produce good returns.
What are indexes?
For my third trip to the supermarket, I want to start eating some protein. I still want to have some fruit, so I get a prepared meal that consists of steak, fruit, tortilla, and vegetables. In the stock market, this would be an example of an index because the meal consists of a balanced diet with protein, carbohydrates, fruit, and vegetables. An index takes a group of companies from varying industries that typically have something in common with them. For example, the S&P 500 index is a wide range of sectors that consists of the 500 largest companies in the United States. Another example of an index is the Russel 2000 which is made up of 2000 companies that are small-cap meaning their market share is under 1 billion dollars.
Some ETFs are formed in order mimic indexes; for example, Vanguard 500 Index Fund ETF is representative of the S&P 500 and offers a cheaper price where investors can get into the S&P 500.
Some examples of ETFs: Invesco QQQ ETF (QQQ), Schwab U.S. Small-Cap ETF (SCHA), ARK Genomic Revolution ETF (ARKG)
Examples of ETFs that mimic Indexes: iShares Core S&P 500 ETF (IVV) and Fidelity Zero Large Cap Index (FNILX)
What are bonds?
While the price of bonds correlates to the stock markets they are quite different. In the supermarket analogy it would be like: if my friend wanted to start farming bananas but he can’t afford to buy the seeds. I buy him seeds from the supermarket and in turn, he takes those banana seeds grows them pays me interest of one banana a year for thirty years and at the end of the thirty years I get back what I originally gave him.
Some types of bonds that are issued are government and corporate bonds. In the same instance if the government is looking for money to start a new project, they would issue bonds to where people could buy into and receive yearly interest, and once the bond has matured the purchaser of the bond receives what they initially purchased for the bond. The same goes for corporate bonds. Although similar government bonds are typically seen as lower risk than corporate bonds as it is more likely that a corporation goes bankrupt and can’t repay the bond than the government is in repaying the bond.
Stocks, ETFs, indexes, and bonds allow for a diverse portfolio that most prudent investors have in their portfolios. Before starting to invest in stocks, ETFs, indexes, and bonds or the options markets which was not covered it’s best to research as much as you can about these topics. After researching there are many simulation games that offer great practice before one starts to invest with real money.