Once shares are listed on a public exchange, investors can then buy and sell them amongst themselves with the exchange tracking the supply and demand of each listed stock. The stock market acts as an auction house between buyers and sellers. In other words, a stock’s price is reflected by what a buyer is willing to pay and a seller is willing to accept.

Stock tickers, also known as ticker symbols, are used by exchanges to facilitate orders every day and make it easier for investors to identify individual companies - for example Apple’s ticker is AAPL, Walmart’s ticker is WMT, and Microsoft’s ticker is MSFT.

How the Stock Market is Tracked

The stock market’s performance is often tracked through the price of a broad market index, which is a specific group of stocks that represents a portion of the overall market. The three most commonly referenced U.S. stock market indexes are: Standard & Poor’s 500 Index (“S&P 500”), Nasdaq Composite Index (“Nasdaq”), and Dow Jones Industrial Average (the “Dow” or “DJIA”). 

• S&P 500: Established in 1957, the S&P 500 includes 500 of the largest publicly traded companies in the U.S. It is often considered the best representation of the U.S. stock market and a leader for the U.S. economy. The index is “market-cap weighted” which means companies that are worth more are given greater weight in the index and vice versa. 

• Nasdaq: Launched in 1971, the Nasdaq Composite Index includes both domestic and international stocks listed on the Nasdaq exchange. The index is heavily weighted towards technology companies and is particularly useful in evaluating the health of the technology sector. Similar to the S&P, the Nasdaq is market-cap weighted.

• The Dow: Composed of 30 large U.S.-based (“blue-chip”) companies across various industries except utilities and transportation, the Dow was first calculated in 1896. Unlike the S&P and Nasdaq, the Dow is price-weighted, meaning stocks with higher share prices are given greater weight in the index.

Companies are added and removed from these indexes based on a variety of factors. As of the writing of this article (July 2023), an example of a company in each Index: Johnson & Johnson (S&P 500), Amazon (Nasdaq), and Apple (DJIA). Some companies are included in more than one index - for example, Apple is a member of all three of these indexes.

How To Measure Stock Market Performance

Index prices are calculated based on the prices of the stocks that make up that specific index. Based on its weighting in the index, each stock contributes to the index's price. As the prices of stocks change, the price of the index will change as well. For example, if the price of the S&P 500 index was 3,000 one day and 3,030 the next, that would indicate that the total market value of the 500 companies in the index (weighted according to their market capitalizations) had increased by 1% over that period. 

When it comes to tracking performance, investors usually measure the change in the price of the index over a specific period of time (e.g., daily, year-to-date, 1 year, 3 year, 5 year, etc.). You should look at both the percentage change in the price of an index as well as the absolute change. However, percentage change can provide a more intuitive sense for how much the overall value of the companies in the index has increased or decreased. 

By comparing the performance of their own stock portfolio to that of the indexes, investors can get a sense of how well their investments are doing in relation to the broader market. 

Navigating the Trade-off Between Risk and Reward

While the stock market has historically generated attractive returns, it’s important to understand that past performance isn’t indicative of future results. Investing always comes with some degree of risk. In order to achieve higher potential returns, you must be willing to accept a higher level of risk.

Higher-risk investments are generally those with a higher degree of volatility. This means they can experience significant price fluctuations in a short period. Stocks are typically considered to be higher-risk investments. While they can provide substantial returns, they can also lead to significant losses. 

Lower-risk investments on the other hand are those that have less volatility and more predictability. Bonds, for instance, are often seen as lower-risk investments. Bonds provide regular interest payments and return the principal amount at maturity. However, their potential returns are typically lower than those of stocks.

The key to navigating the risk-reward trade-off is to align it with your personal risk tolerance and financial goals. You should establish a balance of high-risk and low-risk investments in your portfolio that align with your long-term goals, financial needs, and ability to tolerate market fluctuations. By spreading your investments across a variety of assets, you can aim for higher potential returns while also protecting yourself from potential losses.

Understanding the Importance of Diversification

Imagine putting all your savings into the stock of a single company. Now, what happens if that company's stock price tanks? Your entire investment goes down with it. That's why one of the fundamental principles of investing is diversification. Diversification in investing means spreading your investments across a variety of assets to reduce risk.

In the context of a stock market portfolio, diversification involves investing in a mix of companies and sectors. If one stock or sector performs poorly, you may be able to balance out your losses if other stocks in your portfolio perform well.

Remember, while diversification can reduce risk, it doesn't eliminate it. It's still possible to lose money when investing in the stock market. However, a diversified portfolio can help protect you against the volatility of the market.

Time in the Market Beats Timing the Market

Many inexperienced investors fall into the trap of trying to time the market — that is, attempting to buy stocks at their lowest prices and sell at their highest. However, even the most seasoned financial experts struggle to consistently predict market highs and lows accurately. This is why one of the most respected philosophies in investing is that "time in the market beats timing the market."

What does this mean? Simply put, it means that long-term investing is typically more beneficial than short-term trading. The stock market tends to increase in value over time, despite its short-term fluctuations.

It's also worth noting that some of the stock market's best days often follow some of the worst. If you're not consistently invested, you could miss these valuable days of recovery and growth. Therefore, consistently investing and holding your investments for the long term, regardless of market conditions, is often the most effective strategy. This approach requires patience and discipline. It may be tempting to sell when the market is down, but this could lock in your losses and leave you out of the market during a potential recovery.

Reducing Market Timing Risk through Dollar-Cost Averaging

One way that investors can reduce the risk of market timing and volatility is through a strategy known as dollar-cost averaging (DCA). DCA involves investing a fixed amount of money into a specific investment, such as a stock, on a regular schedule, regardless of the asset’s price. To help put DCA into simpler terms, let’s use a practical example with the stock market. Suppose you decide to invest $100 every month in Company X's stock.

1. In the first month, the price of Company X’s stock is $10, so with your $100 you buy 10 shares. 

2. In the second month, the price of Company X’s stock goes up to $20.You still spend $100, but now you only get 5 shares because the price has increased.

3. In the third month, let’s say the price drops to $5. With your $100, you now buy 20 shares.

So over three months, you’ve invested a total of $300 ($100 each month), and you have 35 shares. The average price of the shares you bought is $300/35 or $8.57 per share. This is lower than the $10 or $20 price you would’ve paid if you bought all the shares in the first or second month. It’s also higher than the $5 price in the third month, but you reduce your risk by not trying to time the market.

This strategy can help you avoid making a large investment when the price is at its peak, and it also removes the stress of trying to time the market perfectly. It's a long-term strategy that focuses on consistency and discipline rather than trying to predict market movements.

Capitalizing on the Magic of Compounding Interest

One of the most powerful forces in investing is compounding interest, often dubbed the 'eighth wonder of the world'. But what exactly is it? Compounding interest is the process where the interest or return on your investment earns more interest over time. When you invest in the stock market, any returns you earn will compound over longer periods of time. This dynamic creates a snowball effect, where the size of your investment can grow faster and faster.

For example, let's say you invest $5,000 into the stock market and it has an average annual return of 7%. After the first year, your investment grows by 7%, which is $350. Now you now have $5,350. After the second year, you earn another 7%, but this time it’s on the total amount of $5,350, which results in $374.50. So your total investment is now $5,724.50. After the third year, your 7% return is now on the amount of $5,724.50, generating $400.71 in returns.

This process continues for as long as you leave your money invested. If you leave your money in this investment for 30 years, your initial $5,000 investment would grow to over $38,000. This increase is due to the power of compounding interest. 

Taking the First Steps To Investing

Now that we’ve covered the fundamentals, you’re probably wondering, “How do I actually start investing in the stock market?” Before you start investing, it's crucial to understand your financial goals. Are you saving for a down payment on a house, funding your retirement, or building an emergency fund? The duration and purpose of your investment will help guide your strategy.

Next you’ll want to assess your risk tolerance. This is a personal assessment of how much risk you're comfortable taking on. If the thought of your investments losing value keeps you up at night, you might want to lean towards more conservative investments. Conversely, if you're comfortable with ups and downs in the pursuit of higher returns, you might be okay with riskier investments.

If you’re comfortable with the relatively higher risk-return tradeoff of stocks and want to start investing in the stock market, you'll need to open an investment account with a financial institution. Some reputable institutions that offer these sorts of accounts include Fidelity Investments, Vanguard, and Charles Schwab. Each of these institutions provide online platforms that make the process of opening an account very simple and straightforward.

An investment account can take the form of a standard brokerage account, or a tax-advantaged account like an Individual Retirement Account (IRA) or a 401(k) through your employer. These accounts have different benefits and rules. It is important to understand the differences between account types before opening an account. 

Once you open an investment account, you’ll need to determine how you want to invest in the  stock market. Some common ways that people invest in the stock market include: Individual Stocks, Mutual Funds, Exchange-Traded Funds (ETFs), and Index Funds.

• Individual Stocks: Buying individual stocks allows you to own a piece of a company. You make money when the stock's price goes up and you sell it for more than you paid. You might also receive dividends, which are a portion of the company's profits distributed to shareholders.

• Mutual Funds: These are investment vehicles that pool money from many investors to purchase a diversified portfolio of stocks, bonds, or other assets. They're managed by professional fund managers. Mutual funds can be a good option if you're looking for diversification and professional management.

• ETFs: Similar to mutual funds, these vehicles pool investor money to purchase a diversified portfolio of assets. ETFs trade on an exchange like individual stocks, offer diversification, and are often designed to track specific indexes. One of the most well-known examples of an ETF is the SPDR S&P 500 ETF Trust, which trades under the ticker symbol SPY.

• Index Funds: These are a type of mutual fund or ETFs that aims to replicate the performance of a specific index like the S&P 500, Nasdaq, and DJIA. These funds offer a way to invest in a large segment of the market, providing broad diversification.

A good starting point for beginner investors is a broad market fund, like an index fund or ETF. These funds provide instant diversification and are often recommended for beginners due to their simplicity and low fees.

After you start investing in the stock market, it can be helpful to remember to continue to add to your investments. Consistently adding money to your investments can significantly boost your returns over time thanks to compounding interest.

The world of investing is complex and ever-changing. Keep educating yourself about different investment strategies, asset types, and financial news.

Ride The Wave To Better Destinations

That's a quick guide on how to start investing in the stock market. Remember, investing isn't about quick wins; it's about patiently growing wealth over time. Hiatus will keep track of your net worth all in one place. As you begin your investing journey, keep these principles in mind, continue learning, and never be afraid to ask questions.