Investing in the stock market is more often than not depicted as the preserve of a financial elite, where exceptionally well-read or intelligent individuals in tailored suits (or increasingly t-shits and trainers) can predict market fluctuations to make it big. The reality of the stock market however is far less complicated and a lot less glamorous. That said, if you are investing, a basic understanding of what the stock market is, and how it works is helpful to anyone. So let’s dispel some of those ‘elitist’ myths and get started.
What are "stocks"?
At its most basic, the term “stock,” or “shares,” refers to an ownership stake in a company. As a company grows, it will almost inevitably need to raise cash, or ‘capital’, which it can use to reinvest to increase productivity. One of the most effective ways to raise capital is to sell a share in the company’s ownership.
Small-scale start-ups do this often through angel investors, crowdfunding, or venture capitalists. There comes a point for companies however, where the amount of capital needed will far surpass the amounts they can generate from these early-stage investors. It is then that companies will announce their intention to become a publicly traded company, in a move called an initial public offering, or IPO.
At an IPO, owners of a company will agree upon a number of shares (representing some portion of the company) to be offered publicly. The initial price for that company’s stock price will be determined by a complicated consideration of industry comparables, growth prospects, and the company’s performance to date, usually calculated by experienced firms that underwrite the initial placement of the shares at a target price range. The issue of new shares in the initial placement is referred to as a primary market, as the company is directly selling its own shares. If an initial public investor wants to sell their stocks, or if another investor becomes interested in acquiring shares in a company after its IPO, they will need to trade amongst themselves. Trading between investors is facilitated by the secondary market, more commonly known as the stock market.
Understanding the stock market
“The stock market” is technically a misnomer: there is no one marketplace for every stock in the world, but rather a number of stock exchanges that facilitate the buying and selling of company shares: “stock market” refers to the collective trade. Arguably the most famous of these, not to mention the most valuable, is the New York Stock Exchange, founded in 1792, whose listed companies shares have a capital value of over $30 trillion. In total, there are 60 or so major stock exchanges, 16 of which list stocks valued at over $1 trillion.
In order for a company to list its shares on a major exchange, it must comply with a the information disclosure standards of that stock exchange, both its initial listing requirements and annual maintenance obligations. Each exchange has its specific set of standards, usually relating to company size, amount of business generated, and the like.
As we mentioned earlier, stock exchanges facilitate the buying and selling of company shares. They do this through licensed middlemen—or brokers—who match sellers to buyers and negotiate a trade. Today, rather than the images conjured of pinstripe suits and braces, most brokers are online entities, who will service a buy or sell order for a small—and sometimes even zero-fee—commission.
When it comes to making a trade, interested brokers will offer a “bid,” otherwise known as the price they are willing to pay for a stock and an “ask,” or the price at which they’re willing to sell their stock for. The difference between the bid and ask is known as the “bid-ask” or “bid-offer” spread, which is typically captured by the broker when they execute a trade for a buyer or seller.
In order to gauge the general health of a market, many investors will look to stock indexes. These are groupings of company stocks that have an index value based on the component stocks making up the index, each company’s stock making a contribution to the index value based on its own stock price and number of shares in issue.
More often than not, indexes group together the largest companies listed on a broader stock exchange. Such is the case for the Dow Jones Industrial Average, which is a list of the US’s 30 largest public corporations. Another example is the S&P 500, which is comprised of the largest 500 US companies by value, or the UKs FTSE 100 index. Other categories of index include the Nasdaq Composite, which centres around the Nasdaq exchange’s most prominent technology companies.
Since the 1970s, more and more investors have been convinced of the benefits of investing in indexes as a whole—that is to say investing in the companies that comprise an index in the exact ratio that those companies’ values contribute to the value of the whole index. Initially derided, this method of investing has become exceptionally popular as more and more data show that funds which selectively pick stocks are often outperformed by the index as a whole. A fund that tracks an index is called an “index tracker fund.”
When it comes to Silo, our team of investment professionals combine these passively managed index tracker funds with actively managed portfolios, comprised of stocks handpicked by experienced fund managers. This approach minimises exposure to risk, given the diversity of the investments across different companies and geographies, while maximising the potential for growth, leveraging the experience of the world’s foremost asset managers.
Academics and industry professionals will continue to disagree about the ‘best’ ways to invest for decades to come, but one thing we can all agree on is that investing is the best way to make your money work harder, and to take control of your financial future. And the good news for you is it’s never been easier.
Please note this article is for information purposes only and is not personal advice. As is the nature of investing, your capital is at risk.