Ever noticed that everyone around you seems to be fascinated by the stock market, and that everyone from your professor to your dry cleaner has a “hot tip” for you? Sure, it’s tempting to plunk down your extra pennies into the newest hot fund – but how are you supposed to pick a trustworthy one?  

Let this post take the mystery out of the world of investments by showing you how our economic system got to be the way it is today, and why it works as it does. By understanding the forces that guide the markets, you’ll start to see why markets rise and fall and what, exactly, affects stock prices. Before long, you’ll be investing like a pro. 

Investing allows you to participate in the corporate world that is all around you. 

Picture this: You wake up to your iPhone’s alarm. You brush with Colgate toothpaste, shower with Dove soap, pop in your Bausch and Lomb contacts lenses and put on your 7 for all Mankind jeans and Express shirt. You drive your Jeep to work, grabbing a latte from Starbucks on the way. 

Sound familiar? Morning to night, we interact with corporate America, consuming goods and services made by companies that range from small to gargantuan. But that involvement does not have to be passive. By owning stock in these companies, you can own your own piece of corporate America. 

But what is a corporation, exactly? Well, it’s the formal name for a company, for one. The word comes from the Latin word corpus, meaning “body,” and anyone can start a corporation. All you have to do is pay a fee and file papers in the state in which you have your legal address. Add an “Inc.” to the end of your company’s name, and voila! You’ve become an incorporated company – which means that your business is a separate entity from you, an important distinction for legal reasons.  

Most corporations in the United States are private. This means they can be owned by one person, a family, partners, or any other arrangement in which certain people call all the shots. Think of your local family-owned gyro shop or your cousin’s freelance marketing business: These are private companies, and only their owners get to make decisions about how they run. 

A public company, on the other hand, is one in which anyone can buy a share. Once you give them your money, the company sends you a stock certificate that shows that you own a piece of it. Think Nike, Disney, Coca Cola—all big public companies in which, once you’ve bought their shares, you can claim ownership proportionate to the size of your investment. 

Gender, ethnicity, and level of education don’t matter when it comes to the stock market; if you can pay, you can play. Investing in stocks might be the truest act of equality and democracy.  

The earlier you start investing, the more you can earn. But most young people lack an in-depth understanding of the stock market and how it works.  

Without capitalism, stock markets wouldn’t exist. 

Until about four centuries ago, most people in the West had no access to money. Serfs worked for food and shelter. Monarchs and landowners decided what would be planted and sold, and they passed their wealth down to their descendants. 

Then came the rise of capitalism, when private individuals began to own businesses for profit. The first of what were known as joint stock companies kicked things off around the 1600s. That’s when Dutch merchants began pooling their resources to send ships off on trade expeditions to India and beyond. When these came back loaded with goods, the merchants divided any profits from the enterprise. One of these companies was the United Dutch East India Company, which financed, among others, Peter Minuit, who negotiated the purchase of Manhattan for sixty guilders’ worth of trinkets. 

When we think of the Mayflower, we think of Pilgrims, religious freedom, and a democratic experiment. But the Mayflower was also an investment – one of the earliest examples of a joint stock project financed by British merchants. 

By the 1700s, nations were trading with each other, markets were popping up everywhere, and money was circulating around Europe. Suddenly, societies contained not just royals, priests, and serfs, but also merchants, bankers, and other businesspeople – who were often richer than those with higher social status. Capitalism was on the rise. 

A Scotsman named Adam Smith was especially fascinated by these developments. The same year that America won its independence, Smith wrote The Wealth of Nations, arguing that economics had natural laws, just like science. He wrote about an “invisible hand” that would control what was bought and sold and in what quantities. Rather than a human authority, the invisible hand that would direct these choices would be the natural laws of supply and demand. 

Smith also came up with the law of accumulation, which explains that as companies or people become more profitable, they can expand and hire more people, creating more opportunities for others. Economic freedom would, Smith argued, lead to a more just society. 

While many of these conversations took place in Europe, capitalism would really flourish across the Atlantic, in the new nation of America. In three short centuries, it would lead the world in both ingenuity and growth. 

Banks, politics, and sheer ingenuity fueled the rise of American corporations. 

Banks got off to a contentious start in the fledgling United States of America. Fearing a too-powerful central government, Andrew Jackson, the seventh president, took national bank money and put it into state banks. Each state issued its own currency, and the value varied around the country. The various banks around the country weren’t particularly stable, and their dependability varied.  

However, entrepreneurship flourished. By 1800, 295 corporations had formed. Most were private, but a few offered stock for the public to buy. Trading took place under a tree on Wall Street, and later moved to rented rooms and coffeehouses – until one of the rooms caught fire, forcing them to shift operations to a nearby hayloft. 

From the 1790s to the start of the Civil War in 1861, the economy saw explosive growth in factories, mines, railroads, ranches, insurance, and canals. Cities arose in new western states. Inventions that are now household names appeared, including Oreos, Heinz ketchup, Graham crackers, and Campbell’s soup. Supermarkets selling dry goods and mail order catalogues appeared in American life.  

By the 1860s, banks had stabilized and had surplus cash, a new federal banking system was in place, and the US dollar was the national currency. In the 1900s, automobile manufacturers and chain stores entered the economy. Participation in the stock market grew. A man named Charles Henry Dow began calculating the average closing price of the top eleven stocks, then publishing it, helping people keep track of the stock index, which is an average of the stocks in that portfolio. 

Of course, there were stumbling blocks. A handful of super-wealthy industrialists tried to monopolize their industries with conglomerates like the Rockefellers’ Standard Oil Trust, but they were blocked by legislation.  

The great crash of 1929 also dampened enthusiasm for the markets, but the government learned over time to put cash back into the economy and lower interest rates in times of depression. In 1934, the Securities and Exchange Commission (SEC) was created. This agency would regulate and monitor all stock trading going forward, setting the stage for modern-day corporate America. 

Saving and investing make your money work for you. 

Imagine you’re browsing the electronics store and see an expensive Smart TV that you’d love to own. Should you indulge your impulse? 

Investment guru Warren Buffet would advise against it. When he’s tempted to splurge on an expensive item he doesn’t need, Buffet calculates what that amount would make for him in 20 years if he invested it instead. The answer usually saves him from the temptation of instant gratification. 

The earlier you start investing – ideally, even before you leave your parents’ home and have expenses like rent to deal with – the sooner your money will start supporting you. 

Let’s examine five basic types of investments: 

First up, we have savings accounts, which include money market funds, treasury bills, and certificates of deposit. These are backed by the US government, and you can retrieve the money whenever you want. But they also offer such low interest rates that by the time you factor in inflation and taxes, you might even lose money! 

Second, collectibles: These are things like antiques, vintage toys, or rare comic books that you think will become valuable in the future. The trick to success is to spend a lot of time researching the products, market, and pricing. 

Third, real estate: Plunking your savings into property can be very profitable. Imagine that you pay $100,000 for a house. After a year, say its value goes up 3 percent, and the house is now valued at $103,000. If you put down a $20,000 down payment, that represents a 15 percent return on your investment! 

Fourth on the list: bonds. A bond is actually an IOU. When you purchase a $100 bond from your city government, you’re actually lending that $100 with the expectation of being paid back with interest. It’s a guaranteed return, especially if offered by the government – but keep in mind that bonds can also come with a timeline for repayment of 15 to 30 years. 

Fifth and finally, there are stocks. Buying a stock means owning a share of a company. If the company is profitable, you may get a bonus or dividend. The barriers to entry are low, you don’t need a lot of money, and you don’t need to be a genius. You just need discipline and patience. If you’re looking for excitement, involvement, and high rewards, the stock market is your best bet for investments. 

Mutual funds offer a guided option to buying stocks. 

Imagine it: you’re ready to buy your first stock. You sit down, money in one hand and phone in the other, ready to purchase . . . well, actually, you’re not sure which stock to buy. That’s normal! Deciding which stocks to pick can be daunting – and that’s where mutual funds come in.  

In a mutual fund, brokers and managers do the legwork of organizing a stock portfolio for you. 

Mutual fund managers pool your money with that of other investors to offer a portfolio of stocks from many different companies. Though you don’t have to make daily decisions, it’s still smart to do some of your own research. The Investment Company Act of 1940 made it mandatory for each fund to provide detailed explanations of risk, so you can find out exactly what you’re getting into. You can also check out reputable publications like Barron’s and Forbes for a funds record, but here’s a tip: If you find one that’s been doing especially well, make sure the broker hasn’t changed. 

If you can handle the risk, a “small-cap” fund – one that invests in smaller, newer companies – can offer bigger returns. Some charge a “load” or entrance fee. Although that isn’t necessarily a marker of success, don’t not get into one because you don’t want to pay a load. If the fund does well, it will be more than worth it. 

You can also invest in an index fund such as the S&P 500 Index fund, which buys up all the stocks in that particular index. This means that no matter what, you will always earn the average of this index. 

Of course, another option is to mix it up – buy one large index fund and one small-cap fund. But don’t pick a fund that mixes stocks and bonds, and don’t jump around between funds. Most importantly, don’t sell! If you do, you lose the fees you paid to join, while if you stick it out, you’ll have a shot at future profits. 

Mutual funds are an easy, hassle-free way to invest in the stock market, but picking your own stocks offers a fun, lifelong adventure. 

Before you start investing, do your research. 

Buying stock is a big step, but to take your investment to the next level, you also need to change the way you think. 

For example, when your friend gushes about his new gym and you suddenly see ads for it pop up on social media, an investor mindset would have you rushing out to buy not just a membership, but also stock! Your playlist, your closet, your choice of cell phone – all of these take on a different meaning when you stop being just a consumer and start thinking like an investor.  

People generally pick stocks in one of five ways, some better than others. Some people go with the “darts” philosophy – as in throwing darts. They make random choices, rely on luck, and hope for the best. If you don’t want to sweat the details, then mutual funds are probably a better use of your money, because you’ll have a professional making the choices for you. 

Other people are all about hot tips, like “My uncle says that Drexel Drugs is an awesome bet right now!” Unverified information isn’t a safe bet for your money, of course, so many people prefer educated tips from experts. But there can be a downside to that, too: Experts might change their minds in a volatile market and not write a follow-up article or reappear on a television show to update you.  

Other investors like the security of working with brokers buy lists, which are put together by professional analysts.  

But the most fun and potentially the most rewarding way to pick stocks is by doing your own research. Visit the business – is it clean and organized? Are the employees enthusiastic? Observe what people you know are into – a new skincare product? A suddenly popular energy drink? Keep an eye on your own industry, and an even closer eye on the competition. Now look at the numbers. How much debt does the company carry? Does it pay good dividends often? If the company looks like it’s well-run and the numbers match that story, it’s probably a wise investment. When you think like an investor, you won’t just consume goods and products; you’ll evaluate them for investment potential. You don’t need a special degree to choose stocks. With some work and research, you may even manage a “triple,” which occurs when your stock value increases threefold over what you paid. 

Once you’ve done the legwork and chosen companies you feel are doing a good job, it’s time to take a closer look at the numbers.  

To choose stocks, follow both the numbers and the stories. 

Stocks are traded on exchanges, like the New York Stock Exchange (NYSE), which is the oldest in the world. You’ve probably also heard of the NASDAQ, the National Association of Securities Dealers Automated Quotations System.  

Traders often look at the closing price of a stock when making buy or sell decisions. The closing price is the last trade of the day, which occurs at 4 p.m. 

To truly understand whether a company is a good bet, look beyond the company’s trading price and check out its balance sheet. See how much debt the company carries, and whether it pays good dividends often. 

Look for big companies that show about 10 to 15 percent growth per year, and small ones that show 25 to 30 percent. Then look at their earnings. Here’s how those work: Imagine that you finance a friend’s gardening venture, giving her $1,000 to buy tools in exchange for a 10 percent share in her company. So when your friend is hired to landscape a family’s front yard for $400, you get $40 of that. In a corporation, if earnings rise, the stock price goes up. On average, you should see companies increase earnings by about 8 percent. 

Now look at the price-to-earnings ratio. For example, if IBM stock earns $10 a share and you buy a share for $100, the p/e ratio is 10 – which is a good deal. But if IBM earns $1 a share, p/e is 100, which makes that same stock expensive. To get a sense of what the number should be, compare your company’s p/e ratio to the average (or index) of a large group of companies. 

Investigate what the company does with its profit. Does it use it to grow the company or spend it on extravagant corporate bonuses? Some buy back stocks to raise the value of stocks left on the market; others pay stockholders dividends. 

Follow the story, not just the numbers. Read the news and understand the industry. Stockholders will also get quarterly reports, plus a fancy annual report that looks like a magazine and tells you all about the company’s performance.  

Doing your research and reading thoroughly about a company can help you get a complete picture for a long-term investment. 

Stock markets are born, live, and die within their own environment. 

Just like people, corporations and the economic climates they live in have their own life cycles. These have distinct phases. 

The first stage – let’s call it “birth” – is when the company goes public; that is, it makes its initial public offering. Usually, only big-time investors get in on this stage. 

Next, the company offers shares to be traded on the stock exchange. Now everyone can get in on the action. Before you buy, wait a few weeks or months until the initial excitement dies down and prices fall. Young companies have rapid growth spurts, but they can also fail, especially in competitive economies. 

Middle-aged companies are reliable, but must evolve to keep up. Even outrageously successful Apple has made mistakes – remember the Lisa computer, the model that flopped back in 1982? Some companies “marry” by merging with other companies, and some “divorce” via divestiture, which occurs when part of a company is sold off. “Old age” companies, which have withstood the test of time, are generally safe investments and will probably pay dividends. 

Now, corporate lifecycles don’t exist in a vacuum. They happen in certain economic climates. There are different kinds of climates: a hot one, for example, is booming. That means that people want more things, driving up prices. When things eventually become unaffordable, the economy slides into a cold climate – also known as a recession.  

To recession-proof your portfolio, include “consumer growth” stocks that will continue doing well no matter the climate – fast food and medicine, for example. The Federal Reserve System, known as the Fed, increases and decreases the flow of money to the system to keep it at an ideal temperature. 

When stocks climb, that’s a bull market – prices are rising and everyone wants to buy. If stock prices fall 10 percent from their most recent peak, that’s known as a correction. If they fall 25 percent, it’s a bear market. 

It’s tempting to skip participating in the stock market because you’re afraid of bear markets, but remember this: If you miss out on the bear, you also miss out on the bull when it happens – as it inevitably will. When it comes to the stock market, patience and an iron will will lead you to worthwhile rewards. 

Investing in the stock market is an enjoyable and profitable lifelong venture that will help your money work for you. With multiple environments driving the prices of stocks, the game is sure to stay interesting as long as you play it. 

 

Action plan: Before you plunk down real money, practice with a fantasy investment portfolio. 

Just as sports enthusiasts put together a roster of Fantasy Football players and keep track of their statistics and points for the season, you can put together a list of stocks. Use real numbers from the markets and track their highs and lows. Doing this can help you understand which ones are winners in which to invest real money.