There’s been a lot of talk recently regarding the market and investments. But what exactly does “the market” mean and what are the “investments” everyone’s talking about? This month, we’re going to get back to basics and review some investing fundamentals.
What is “the market”?
The market is a general term used to refer to a centralized system of buyers and sellers of investments. Because there are always two sides to a transaction, the market pairs those who want to sell an investment with those who want to buy the same investment. In order to create trust in the system as a whole, there are market makers whose job it is to ensure there is a buyer for every seller and vice versa.
There are many markets depending on the type of investment. Bond markets are dedicated to trading fixed income and stock markets are dedicated to trading equities. Different countries have their own markets, such as the London or Shanghai Stock Exchanges. The New York Stock Exchange (NYSE) and Nasdaq are the most accepted and popular in the world and are located in the US.
When someone refers to “the market”, generally it’s in reference to one of two popular indices: the Dow Jones and the S&P 500. The Dow measures the stock performance of 30 large companies listed on US stock exchanges and the S&P 500 measures the stock performance of 500 large companies listed on US stock exchanges. Each of these indices represent a different basket of stocks and there are thousands of investments that attempt to mimic the indexes since it is impossible to directly invest in an index.
What are “investments”?
There are many types of investments but the main opportunities for typical investors include four: stocks, bonds, mutual funds, and exchange-traded funds.
Stock – a stock represents partial ownership of a corporation. It’s possible to purchase individual (and sometimes partial) shares in a publicly traded company on an exchange.
Bond – a bond is a unit of debt issued by a corporation. It’s possible to purchase municipal and corporate bonds directly, or through a mutual fund or exchange-traded fund on an exchange.
Mutual Fund – a mutual fund is a pool of money that is professionally managed and invests based on a set of established criteria. Because of the pooled money, a mutual fund can invest in many different investments which offers some diversification. For example, a small cap stock mutual fund might invest in thousands of different publicly traded small cap company stocks while the investor only sees the one small cap stock mutual fund as a holding. Because the mutual fund is comprised of thousands of individually traded investments, the Net Asset Value (NAV) of the mutual fund (similar to a stock’s share price) is determined after the market closes each day. Any buy or sell transactions occur after the market closes when the NAV is determined and appropriate shares are allocated.
Exchange-traded Fund (ETF) – an ETF is similar to a mutual fund except that it can trade intra-day. This allows an investor more control over the price of the trade since real time pricing is involved instead of after the market closes. In this way, an ETF trades like a stock but has the diversification of a mutual fund.
There you have it! A brief explanation of the catchy words floating around these days, which will hopefully help you better understand and participate in investment-related discussions.