Exploring the stock market and the investing process
People frequently hear phrases like “the Dow” or “the S&P” on the radio, but what exactly are these terms referring to? Understanding these terms requires knowledge of the stock market. The basic idea of the stock market is straightforward: if you invest 5 dollars today, a few years later that number may multiply, generating a profit. However, to craft a successful investment portfolio, one needs to gain a more comprehensive view of the stock market and realize the risks associated with each investment.
The performance of the stock market refers to the performance of the thousands of companies listed in stock exchanges like the New York Stock Exchange or the London Stock Exchange. Tracking the performance of all these companies is unrealistic, so stock market indices, like the Dow Jones Industrial Average or the S&P 500, help track the performance of a certain industry through a group of representative stocks.
More fundamentally, the stock market serves as a place where financial assets are exchanged. By buying a company’s shares, an investor helps the company raise money, which provides them with the necessary capital to expand their business. The initial public offering, or IPO, starts this process as the company opens up to the public for the first time. People who see a positive growth for a company in the future would buy more shares, while people that see a negative growth may choose to sell existing shares. Ultimately, these fluctuations in individual opinions contribute to the volatility of the stock market. There are many factors that can shape individual opinions, like economic policies and earnings reports, making the stock market incredibly complex and unpredictable; MVHS business teacher Carl Schmidt stresses the unpredictability of the stock market: “no one has a crystal ball, even professors of finance,” Schmidt said. “If professors of finance knew how the market was going to go, they would no longer be teaching; they’d be retired billionaires.” Nevertheless, there are basic principles of investing that can help maximize success for a beginner.
Because of the stock market’s unpredictability, every transaction has a risk associated with it. Seniors Dillon Huang and Kyle Wong, both co-presidents at the Art of Investing Club at MVHS, warn about such risks. “One of the biggest risks [when making an investment] is losing the money you invest because although the market is always generally going up, that doesn’t mean the specific stocks you invest in are going to go up,” said Huang. “If you put in like $100, and the stock goes bankrupt, then there goes your money.” Wong also mentions that such abrupt losses can take a toll on one’s mental health and thus recommends investing in a more balanced way through asset diversification, which essentially refers to the process of crafting your portfolio to contain multiple types of investments.
There are a variety of different investments available, including individual stocks, bonds, and mutual funds. Mutual funds tend to remain more stable, as they take in money from multiple different investors and bring them under the management of a professional, who makes decisions in place of the buyer. Bonds are essentially loans from an investor to the company in exchange for regular payments with interest until the maturity date. Bonds tend to be more stable than stocks, but for the same reason, stocks have the potential to reap higher profits. Wong echoes the importance of diversifying by incorporating index funds or mutual funds into a portfolio. Additionally, Huang says that he usually likes to focus on two industries to make sure he thoroughly researches all aspects of a company before making an investment.
Given that the stock market is so volatile, an investor may potentially lose large sums of money in a short period of time, so why should people invest? Wong points to the power of compounding interest over time to answer this question: even though the stock market may change rapidly in the short term, over the long term, the market almost always goes up. In a similar way, Schmidt describes the importance of investing in funding one’s retirement. On average, the stock market returns around 10 percent a year. However, bonds “can be a losing proposition in times of inflation, because bonds have a fixed rate,” Schmidt said. “If you have an inflationary period, for example, [with] a bond that pays 5% and the inflation rate is 8%, you’re losing 3% a year. So investment is not really an option. It’s a requirement if you want to have a decent retirement.”
A variety of programs, including business classes at MVHS, give students early exposure to the stock market. Even though an inexperienced investor may face many losses at first, Wong claims that it’s better to face these situations in high school when one has less money and the risks stay relatively low, providing a great learning opportunity. Schmidt also sees the benefit of investing early on, saying that the investments have more time to build on themselves and recover if the market goes down.
Huang finds it beneficial to start off investing with simulated platforms like the Stock Market Game or Thinkorswim before transitioning to investing in the real market. Schmidt also suggests beginners to first use these types of simulations to both learn about the investing process and gauge their risk tolerance, suggesting that risk-averse investors can consider investing directly into an S&P 500 index fund so that they are always at the market.In general, Schmidt cautions the tendency of beginners to “follow the herd” and blindly listen to the advice of people claiming to guarantee returns. He points to a famous quote from Warren Buffet, saying that one should be “fearful when others are greedy, and greedy when others are fearful.” Thus, in some sense, the best investment advice comes from yourself, as you are ultimately the person that can best determine your risk tolerance; furthermore, by specializing in a few industries and properly researching companies that you’re looking to invest in, you can form successful investing habits early on and be much better off in the long run.