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The stock market allows investors to buy and sell shares of publicly traded companies. If you own stock shares of a company that increases in value, you could turn a profit. The opposite is also true: You could lose money if the company's value decreases.
Risk comes with the territory, but stock investing often plays a key role in long-term saving, especially where retirement is concerned. Understanding the ins and outs can help you move forward with confidence. Let's unpack how it all works and how to invest in the stock market.
What Is the Stock Market?
Hollywood usually depicts the stock market as a high-energy, fast-paced trading floor. In reality, the term "stock market" is a broad concept that refers to the way investors buy and sell stock shares. Just like the housing market or auto market, there are buyers, sellers and fluctuating prices. The end goal is to buy low, sell high and score a profit. Let's start with the basics.
What Are Stocks?
Stocks are a type of security that represent a share of ownership in a company. When you buy a share of stock, you have a claim on that company's performance. That's a good thing if they do well and their value increases.
You can also consider buying fractional shares, which allow you to invest based on how much you want to spend. If you have $100 to invest and a stock trades at $500, a fractional share would allow you to buy 20% of one share.
You'll score an investment return, also known as a capital gain, if you eventually sell your shares for more than you paid for them. Just be aware that capital gains tax applies. The amount you owe will depend on your income, tax-filing status and how long you held the stock.
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Which Companies Are on the Stock Market?
Private companies are not allowed to sell shares of their stock on public stock exchanges. To do so, they must go public through an initial public offering (IPO). Why do companies sell stock? By selling slices of ownership, the company generates cash to support its business operations and fuel growth. In exchange, they give up a portion of their own equity.
Learn more >> What Are the Different Types of Stocks?
What Affects Stock Prices?
Stock market volatility is a real thing, which means that values are constantly moving up and down. Stock prices can be influenced by:
- A company's financial performance, for better or worse
- News and trends within a specific industry
- Economic conditions (rumors of a recession, for example, can cause a dip in stock prices)
- A company experiencing good or bad press
- U.S. and global political issues
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How Does the Stock Market Work?
The stock market allows individual investors to become partial owners of companies big and small. These shares are held in investment accounts like:
- Employer-sponsored 401(k)s
- Individual retirement accounts (IRAs)
- Regular brokerage accounts
- Health savings accounts (HSAs)
- 529 savings plans
Again, gains are considered taxable income. The same goes for stock dividends. These are income payments some companies dole out to stockholders as a way of sharing their profits. Dividends are usually paid in cash at regular intervals, though some companies offer one-off dividends. Others provide stock dividends or dividend reinvestment programs (DRIPs) instead of cash. Both of these options give shareholders more access to company stock.
Tip: While the stock market controls the investment accounts listed above, there are also other markets for other assets, like cryptocurrency, treasuries and commodities.
Learn more >> Can Anyone Invest in Stocks?
Who Regulates the Stock Market?
The stock market is regulated by the U.S. Securities and Exchange Commission (SEC). This government organization oversees stock exchanges, brokers, investment advisors and mutual funds. When a private company is going through the IPO process, they'll have to file a registration statement with the SEC before going public. The SEC then needs to approve it and declare it effective. All companies that trade on the stock market must also stay in compliance with the SEC. That means filing regular reports that are certified by the company's CEO and CFO.
Stock Market vs. Stock Exchange
"Stock market" is a catch-all term that refers to the way investors can buy and sell shares of publicly traded companies. Stock exchanges are actual marketplaces where trades happen.
The two dominant stock exchanges in the U.S. are the New York Stock Exchange (NYSE) and the Nasdaq.
Each exchange has its own requirements that companies must meet if they want to list their stock. These mandates are usually around minimum share prices, pretax earnings and the market value of a company's publicly held shares, among other things.
If you want to begin investing in stocks, you won't contact a stock exchange directly. Instead, you'll partner with an investment broker who's licensed to trade on the exchange. This may be a stockbroker or online brokerage firm. Think of the broker as the connector between you and the stock market. You'll likely pay a fee, though automated robo-advisors allow you to invest without a human advisor and are known for their more reasonable price points.
What Is a Stock Market Index?
Stock market indexes track the performance of specific groups of stocks. One may focus on stocks that are within a certain industry or at a specific price point. Others may zero in on market capitalization (or market cap), which is the total value of a company's outstanding stock. The three main stock market indexes are:
| S&P 500 | Dow Jones Industrial Average | Nasdaq Composite |
|---|---|---|
Prioritizes: Market cap Tracks: Around 500 of the largest, most stable companies in the U.S. | Prioritizes: Stock price Tracks: 30 large, well-known U.S.-based companies with strong earnings records | Prioritizes: Market cap Tracks: All of the common stocks listed on the Nasdaq stock exchange; there's a heavy focus on tech companies |
You can't invest directly in a stock market index, but index funds contain portfolios of stocks or bonds that track a specific index. These types of funds stand out for their low cost, simple maintenance and low risk. However, growth tends to be slower when compared to riskier investments.
Learn more >> Pros and Cons of Buying Stocks
How to Invest in the Stock Market
- Open an investment account. If you're contributing to a 401(k) or IRA, you're already investing in the stock market. You can also invest through a brokerage account. You won't get the tax benefits of those retirement accounts, but you can easily fund your account and make trades.
- Know your options. Individual stock-picking is a highly risky strategy—it's impossible to consistently predict price changes and to know which stocks will be successful. Exchange-traded funds (ETFs) and mutual funds allow you to invest in groups of stocks. That can help mitigate risk.
- Set your investment target. Look at your budget and decide how much you can reasonably invest each month. From there, you can set it and forget it with automatic contributions. Dollar-cost averaging is when you invest a set amount at regular intervals, regardless of what's happening in the markets. You could also invest lump sums if you come into a cash windfall like a tax refund or work bonus.
- Start making trades. If you have a brokerage account, you can likely make trades online or through your broker's app. You can also contact your 401(k) administrator to better understand your investment options. Either way, diversification is the name of the game. This involves holding a healthy mix of different assets, which can help spread out investment risk.
Learn more >> How to Start Investing
Frequently Asked Questions
You can make a profit if you sell stock shares for more than you paid for them. Just keep in mind that you'll have to pay capital gains tax on these earnings, which could eat into your returns. When it comes to long-term gains, the rule of thumb is to consistently stay invested—even during periods of market volatility. Over the past century, average annual returns for the stock market have been about 10%.
A brokerage firm acts as an intermediary between investors and the stock market. You can trade stocks through an individual stockbroker, online investment brokerage or robo-advisor—and fees apply. Robo-advisors are usually the most cost-effective, but won't give you personalized investment advice.
The Nasdaq and the New York Stock Exchange are open from 9:30 a.m. to 4 p.m. Eastern time Monday through Friday, but some brokerage firms may offer extended trading hours. Stock exchanges are closed for most major U.S. holidays.
The Bottom Line
Thanks to the stock market, individual investors can buy and sell shares of stock from publicly traded companies. That can be an important strategy in your long-term savings plan, especially when it comes to building your nest egg—but it isn't without risk. Diversifying your portfolio can help soften the blow of market swings and investment losses.
Investing in the stock market will not affect your credit score, but it's always wise to prioritize your credit. The good news is that it's possible to invest and pay off debt at the same time. You can check your FICO® Score☉ and credit report for free with Experian.