It might surprise you to learn that a $10,000 investment in the S&P 500 index 50 years ago would be worth nearly $1.2 million today. Stock investing, when done well, is among the most effective ways to build long-term wealth. We are here to teach you how.
There’s quite a bit you should know before you dive in. Here’s a step-by-step guide to investing money in the stock market to help ensure you’re doing it the right way.
So how does the stock market work?
There are entire books explaining the stock market, but you don’t need to get too deep into the weeds to get a good basic understanding of the stock market. Stock markets facilitate the sale and purchase of these stocks between individual investors, institutional investors, and companies.
The vast majority of stock trades take place between investors. That means, for example, that if you want to buy shares of Microsoft (NASDAQ:MSFT) and hit the “buy” button through your broker’s website, you are buying shares that another investor has decided to sell — not from Microsoft itself. By purchasing shares of a stock, you become an investor in the underlying company.
Most people have heard the old saying, “Don’t put all your eggs in one basket.” The logic: If a farmer were to stumble while bringing the basket of eggs back from the henhouse, they could end up with a messy situation. Those words of wisdom go well beyond farming; they also perfectly encapsulate the idea of not risking all your money on a single investment.
One way investors can reduce their risk of a cracked nest egg is by diversifying their portfolio. Here’s a look at what that means, as well as three tips to help you quickly diversify your investments.
What is portfolio diversification and why does it matter?
A diversified portfolio is a collection of different investments that combine to reduce an investor’s overall risk profile. Diversification includes owning stocks from several different industries, countries, and risk profiles, as well as other investments such as bonds, commodities, and real estate. These various assets work together to reduce an investor’s risk of a permanent loss of capital and their portfolio’s overall volatility. In exchange, the returns from a diversified portfolio tend to be lower than what an investor might earn if they were able to pick a single winning stock.
Forex is a portmanteau of foreign currency and exchange. Foreign exchange is the process of changing one currency into another for a variety of reasons, usually for commerce, trading, or tourism. According to a 2019 triennial report from the Bank for International Settlements (a global bank for national central banks), the daily trading volume for forex reached $6.6 trillion in April 2019.
Pros and Cons of Trading Forex
Forex markets are the largest in terms of daily trading volume in the world and therefore offer the most liquidity. This makes it easy to enter and exit a position in any of the major currencies within a fraction of a second for a small spread in most market conditions.
The forex market is traded 24 hours a day, five and a half days a week—starting each day in Australia and ending in New York. The broad time horizon and coverage offer traders several opportunities to make profits or cover losses. The major forex market centers are Frankfurt, Hong Kong, London, New York, Paris, Singapore, Sydney, Tokyo, and Zurich.
The extensive use of leverage in forex trading means that you can start with little capital and multiply your profits.
Automation of forex markets lends itself well to rapid execution of trading strategies.
Forex trading generally follows the same rules as regular trading and requires much less initial capital; therefore, it is easier to start trading forex compared to stocks.
The forex market is more decentralized than traditional stock or bond markets. There is no centralized exchange that dominates currency trade operations, and the potential for manipulation—through insider information about a company or stock—is lower.
Pros and Cons of Trading Forex
Even though they are the most liquid markets in the world, forex trades are much more volatile than regular markets.
Extreme amounts of leverage have led to many dealers becoming insolvent unexpectedly.
Banks, brokers, and dealers in the forex markets allow a high amount of leverage, which means that traders can control large positions with relatively little money of their own. Leverage in the range of 100:1 is not uncommon in forex. A trader must understand the use of leverage and the risks that leverage introduces in an account.
Trading currencies productively requires an understanding of economic fundamentals and indicators. A currency trader needs to have a big-picture understanding of the economies of the various countries and their interconnectedness to grasp the fundamentals that drive currency values.
The decentralized nature of forex markets means that it is less accountable to regulation than other financial markets. The extent and nature of regulation in forex markets depend on the jurisdiction of trading.
Forex markets lack instruments that provide regular income, such as regular dividend payments, that might make them attractive to investors who are not interested in exponential returns.
Trading commodities is an ancient profession with a longer history than the trading of stocks and bonds. The rise of many empires can be directly linked to their ability to create complex trading systems and facilitate the exchange of commodities.
Commodities that are traded are typically sorted into four categories broad categories: metal, energy, livestock and meat, and agricultural.
Investing in commodities can provide investors with diversification, a hedge against inflation, and excess positive returns. Investors may experience volatility when their investments track a single commodity or one sector of the economy. Supply, demand, and geopolitics all affect commodity prices.