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Investing for beginners: How does the stock market work?

Perhaps you already know that you can start putting money towards that financial goal. Maybe now you want to start buying stocks or other securities. But what does that entail? More importantly, how does the stock market work? Don’t worry, we’re here to take the mystery out of investing for beginners so that you can get your financial health in order.

What is stock?

First things first; what is a stock? A stock is a share or imaginary “slice” of a company which is assigned a proportional value according to the company’s overall value. Companies are interested in getting involved in the stock exchange because when they sell stocks, they can use the money they get in return from stockholders. Individual businesses might use this money to expand their business or invest in something else to bring in greater profits. 

How does the stock market work?

Imagine that the stock market is a giant, global auction house. In an auction house, objects like art or antiques are auctioned off to the highest bidders. In the stock market, investors and traders negotiate to buy and sell stocks.

However, unlike those at the auction house interested in beefing up antique collections, investors and traders playing the stock market are interested in turning a profit. They do so by trying to buy stocks for less than they will ultimately sell them. 

Read also: A simple guide to start investing in stocks

Companies involved in a stock exchange begin the process by listing shares in their stock with an exchange at a particular IPO (initial public offering). An IPO is the first price of stock when a company first becomes involved in the stock market. Once the company has “debuted,” its stocks are then bought up on the stock market and successively sold and rebought amongst investors.

As the company grows in value (or is projected to grow in value), the price of those stocks may increase, thus allowing the investors to turn a profit through future resales. The opposite may also happen. 

Investing for beginners 

Now that you understand how the stock market works, consider some of these tips for investing for beginners to get you on track for financial success. 

Diversify your investments

Stocks are riskier than many other securities because they can fluctuate greatly. This means that stockholders can lose or earn a lot of money. It’s like putting all of your eggs into one proverbial, very unstable basket. Given how difficult it is to predict the fluctuation of an individual stock, many advise investing in exchange-traded funds or index funds because they contain a diversity of stocks and other securities.

Diversifying your portfolio with these types of mutual funds and other types of investments can help protect you from risk and improve your long-term returns. Portfolio diversification is a great tip for beginner investors and foundational for seasoned pros.

Practice long-term thinking

Another key investing-for-beginners tip revolves around long-term thinking. Long-term investing can have tax benefits, can be built up gradually over time, and is generally more stable. While investors may experience dips and peaks over the short term, generally long-term investment results in gains because long-term investments tend to yield greater returns, despite short-term volatility.

Plus, a long-term orientation to investing lets you build on the power of compound interest and grow your investments over time. 

To develop a long-term orientation towards your investment strategy, avoid making emotional decisions when investing. It can be easy to sell your stocks when you see a gut-wrenching drop, imagining that you are avoiding a bigger loss down the line. However, many factors trigger volatility in the market and short-term losses may not be indicative of future trends.

Prioritize investing

A key tip is to make investing a priority. One way you can do this is by employing the Pay Yourself First (PYF) principle. PYF means that you allocate a part of your monthly income to a particular financial goal like investing before paying for other things, including essential bills and fun stuff. The PYF principle turns your investment goals from an end-of-the-month option into your top financial priority.

Some experts believe that this rule is the best way to accumulate money and that it can “help you develop tremendous wealth” over the long-haul. Some recommend automatizing a monthly transfer of up to 10-20% of your monthly income and funneling it into your investment fund, emergency fund, or savings accounts. PYF makes investing a priority, not a luxury. 

Investing for beginners may seem difficult if you don’t have previous investing knowledge. However, once you know how the stock market works and a few tips for smart investors, you’ll be well on your way to getting your financial health in check. For more financial and investment education, check out the rest of the Academy library!

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