I Bet You Will Understand How the Stock Market Works After This Article

Written by 
Polina Medianina
/
August 30, 2021

Answer: Samsung

Hover your cursor over the buildings and look at the connections between the companies
⬇️

what is stock market simple explanation photo

Let me explain a couple of things today. Indexes, strategy, profit… some important stuff that you need to know to start investing and become a millionaire. There are only 3 main instruments on the market and you will easily understand them. 

I know the instruments, but I need help choosing the right ones

Try GainyTry Gainy
1.Stocks
2.Bonds
3.ETFs

Stocks

What?
You buy shares of a company and own a part of their business.

Where does the money come from?
1. If a company grows, the price of its stock rises.
2. Company shares its profit with stockholders—known as dividend payments.

Example for kids
1. Your grandma produces honey for your small neighborhood. There are only 20 jars available. You have one jar of grandma’s honey. You used to sell it for $10. Suddenly, the nearby town finds out about this wonderful honey and more people are coming to buy it. The demand grows and now you can sell your jar for $15. 
2. The business is growing well, so your grandma decides to treat you and gives you one cup of honey for personal use—she’s paying you dividends.

Example for adults
6 months ago one Procter & Gamble share cost $122, now it costs $144. That’s an 18% increase! The company pays dividends 4 times a year and the annual dividend rate is 2.42%.

Bonds

What?
You act as a bank. You give a company or government money for some time to finance their activities.

Where does the money come from?
If you act like a bank, then you should get interest. So the bond issuer pays you fixed income every year until the end of the period. At the end of the period they return you the face value of the bond.

Example for kids
1. Your friend needs a lot of empty jars for his installation. He borrows an empty jar from you and from a couple of other classmates.
Every day of the week your friend gives you one candy for your kindness. At the end of the week you receive your jar. 
You got back your jar and got 7 candies.

Example for adults
A JPMorgan bond. You lend them money by buying their bond at $95. They offer you a 2% yield. The maturity date is 31 July 2033. It means that until 2033 they will pay you a 2% coupon every year and in the end return the price at offering—$100.

ETFs (Exchange Traded Funds)

What?
A portfolio of compiled securities. It can consist of just stocks or just bonds, or a mix of the two. 
You buy a share of this portfolio and it costs cheaper than if you buy all the securities individually.

Where does the money come from?
If the price of securities within the fund rises, the price of your share rises.

Example for kids
1. There is a jar with very delicious candies. And the longer it is closed, the more children want it. It has 20 candies, your friend sells a full jar for $10 (the current price of each candy is 50c). You can’t afford to buy the whole jar and your friend doesn’t sell by piece. So you agree that you buy 1/20 of the jar for 50c, meaning that if your friend sells the jar you will receive 1/20.
After one week your friend goes to school and sells the jar for $20 to a rich boy. Now you get 1/20 of this—$1.

Example for adults
Fidelity Health Care ETF. Their portfolio at $30 per share consists of the following companies, the whole portfolio grows at the annual rate of 19,78%.


So the stock market is a part of an exchange, like New York Stock Exchange,  where these instruments are being traded. You can also trade precious metals (like gold), futures, options, and currencies but it’s the next level. 

Don’t rush to buy P&G stocks yet and don’t underestimate bonds. 
One more thing you need to know is to understand what a good result is.
Do you think an 18% increase in the P&G stock price is a good result?

In the previous article I told you that Apple grew 100% in a year. That’s terrific! So in comparison to Apple, P&G is lagging. 

To understand how well your portfolio is doing, you need to compare it to a benchmark. And we’ll take an index of the broad market as a benchmark. This index is called S&P 500 after the agency that created it, Standard & Poor. The index consists of the 500 largest American companies that represent 80% of the US economy. Roughly speaking, they summarize the value of stocks and their change in prices shows general tendency. 

Here you can see how the index (and supposedly US economy) have been growing for the past 30 years.

S&P500 growth in 30 years photo

Can you name all the events (1-4) that caused the stock market to fall? (check your answers at the end)

Ideally, the prices on the stock market should reflect the fair value of an asset. But in reality expectations towards these assets drive prices far from it, and then we face declines that bring prices back to normal and cool down very optimistic investors (event 1). During the Dotcom bubble (1) many companies were overpriced and their earnings did not match their market value, as a result, the bubble burst and stock prices fell down. 

Sometimes, conflicts or global problems can cause a decline in anticipation of economic slowdown (3 and 4).

On the bright side, you can see that the economy and the stock market recover pretty fast and, as a matter of fact, it’s a big luck to buy stocks at the bottom of such a dip. Because it’s only growing after it… 

Strategy №1. Buy S&P 500 index shares and hold them. 

Since it would cost a fortune to buy stocks of 500 companies, there are special funds that buy them for you and you just own a share of this fund. In professional language, you buy an S&P 500 ETF. 

S&P 500 ETFs that you can buy:

- iShares Core S&P 500 ETF (IVV)
- Vanguard S&P 500 ETF (VOO) 
- Fidelity 500 Index Fund (FXAIX)

It would be very useful if you also read about two other major indexes NASDAQ and DOW JONES. You can buy ETFs for these indexes, too. 

Buying index funds is a safe and conservative way to invest. The risk is very low because the fund holds stocks of companies that are very diversified across industries.  

Expected annual yield: 15-20%
Level: Easy
Risk: Low


Strategy №2. Pick individual stocks

In the last year the following stocks grew considerably:

good performing companies photo

Thus, their yield is higher than that of the S&P 500. 

At the same time, some stocks did not perform as well: 

poor performing companies photo

These stocks rose less than the S&P did in the last year. Even though all these companies are absolutely fine, if you had invested in them a year ago, you would have lost to the broad market. 

As you can see, investing in individual stocks gives you more potential for profit but is also riskier than investing in the stock market as a whole through indexes or ETFs.

Expected annual yield: 0-100%
Level: Moderate
Risk: High

Remember the last time I asked you to pick any stock?
Let’s go to the Gainy app and see how well you did. Enter your stock name and choose a 1-week timeframe. 

stock chart timeframe performance photo

What does it show? 

Now type the ticker “SPY” into search and check the growth in the last week. 

If your company’s result is higher than that of S&P 500, you outperformed the market. If not, you underperformed. 


🌚 Is it possible to choose companies that will always outperform the market?

‍The short answer it no, 
but 
when we talk about the stock market we always talk about probability. You CAN learn how to choose companies that are more LIKELY to outperform the market. 

Or if you are not willing to risk, you can learn how to fill your portfolio with assets that will give you stable and moderate growth.

I am going to share with you the steps that will help you build a system of decision-making and increase your chances of picking the perfect stock for your portfolio. 

Next time we will start discussing portfolio compilation.

But first, please pick at least 2 new stocks and monitor them for a week. This way, you’ll start creating your portfolio.

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Answers:

1 - Dotcom bubble
2 - Global financial crisis 
3 - Trade war with China
4 - COVID-19 breakout

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because I want to check what my friend has just sent me
The company developed and maintains technological products and services, namely Snapchat, Spectacles, and Bitmoji. Snapchat is the third most popular app among millennials and gets high profits from ads on the platform. Since TikTok is not available to invest in yet, Facebook is boring, we see Snap as a good choice to diversify your portfolio. We don’t know what keeps those kids so glued to screens in Snapchat but if companies profit from it, we can get a share thanks to investing in their stocks.
because xBox brings us together with friends
Microsoft is the second biggest company on the market in terms of capitalization. Xbox, Skype, Windows Office 365 are all part of Microsoft business as well as it develops, licenses, and supports a wide range of software products and services, as well as designs and sells hardware. The company’s future is as bright as it’s past with all the money the company invests in disruptive tools like AI. Next time you plan to buy another game for the Xbox console, you might also consider buying a Microsoft stock which is not very expensive.
because we want schools to be cooler
So we packed peanut butter and jelly sandwiches for the kids, now it’s time to go to school. The K12 Inc. is an educational technology company. The company offers a private education program, software and education services built to teach online for preschool students up to grade 12 or K-12. The company’s earnings soared up after the pandemic because we came to realise that online learning is not far in the future and may continue the trend.
because we like to treat our pets and ourselves, too
The American manufacturer of supermarket food JM Smucker Co also operates a pet food business including brands such as Milk-Bone and Meow Mix. It’s also the producer of the peanut butter JIF, kid’s all-time favorite filling. The company offers a 2.96% dividend yield and in the third quarter reported a 7% increase in net sales.
because we love playing games
If there is one game to teach you financial literacy - it’s Monopoly, which belongs to Hasbro, as well as unparalleled portfolio of approximately 1,500 brands including MAGIC: THE GATHERING, NERF, MY LITTLE PONY, TRANSFORMERS, PLAY-DOH, BABY ALIVE, DUNGEONS & DRAGONS, POWER RANGERS, PEPPA PIG and PJ MASKS, as well as premier partner brands. The company generates strong cash flows and pays regular dividends. The company’s business moves along the online trend and develops digital content in the form of TV shows, films, computer games.
because everyone has a favorite childhood hero
Disney is a widely diversified company which owns everything from toys to apparel, and books to video games: Disney Parks, ESPN channel, Pixar, Hulu and so much more. And now it bets on streaming services with Disney+ and threatens Netflix’s market share. The company revenue suffered a major drop last year due to closure of Disneylands, but has opened them in October and foresees a strong comeback.
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