In its simplest form, a stock represents ownership in a company. As you own more shares of a company, your equity is greater in that particular corporation. You can make money on a stock based on its appreciation and the amount of a dividend the stock pays out to its holder. Conversely, there may be no dividends and a stock can drop in value below what you paid for it.
Stocks might be one of the more complicated investments we have. Without clear guidance or putting the time into learning about stocks, it is easy to make a wrong decision. Very often, you might think you are looking at two stocks that seem similar, but you are actually comparing apples and oranges.
Stock typically takes the form of shares that are either common stock or preferred stock. Common stock typically carries voting rights exercised in corporate decisions. Preferred stock does not possess such rights, but it is legally entitled to receive a certain amount of dividends before any can go to other shareholders. You can purchase stocks as individual shares in a particular company, or you can buy shares in a fund. A stock fund consists of individual stocks. The concept behind them is that you are spreading your money out over a variety of companies so that no one poorly performing stock can flush all of your money down the drain.
The appeal of the stock market is that it is the major financial investment talked about the most. The media uses it as a barometer of how the economy is doing. Investment advisors tout its overall growth and sustainability as a place to put your money. When compared to what banks offer in interest these days, it seems like a no-brainer to jump into the stock market where you can make “real money.”
However, it is important to look at actual statistics and the story behind them to separate fact from propaganda. According to MeasuringWorth.com, is a nonprofit organization and represent some of the finest universities in the United States and Great Britain such as Harvard, Stanford, New York, Vanderbilt, Oxford and Northwestern; here is a chart showing the actual growth rate of the stock market from 1885 through 2018 of the Dow Jones Industrial Average (DJIA). The “S&P 500” was first reported daily on March 4, 1957, and the “NASDAQ” started on February 5, 1971. Both have produced similar annual growth rates.
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From the 1940’s through the 80’s, the stock market did reflect the American economy. The growth of the market in the post-World War II years matched the stupendous expansion of manufacturing in America during that time. The market almost ground to a halt in the turbulent 60’s and 70’s where corporations were rather anemic.
However, the boom in the last two decades of the 20th century did not have as much to do with the economy improving as it did with the amount of money dumped into the stock market. You see, financial thinkers tried to figure out how to infuse the stock market with large influxes of cash. When you got past institutional investors and the few people who had more money than they knew what to do with (the usual investors in the market), all you had left were the common folk. They never really had any means to get into the stock market. This was the target group that those running the markets wanted.
What ended up happening was that the government passed several laws that allowed the development of products that we take for granted today. The IRA, 401K, and other qualified investment programs came into existence. These allowed the establishment of different financial vehicles that allowed investment in stocks. For the most part, this happened through stock mutual funds, and massive amounts of cash poured into the stock market.
This completed the transition from the stock market being a somewhat accurate barometer of the corporate strength of the nation’s companies to becoming an artificial entity. Its gains and losses had more to do with the proliferation of money available to invest in the stock market, rather than the performance of the companies on the stock exchange. You often hear financial and political commentators say there is a disconnect between Wall Street and Main Street (meaning how well the stock market is doing compared to the average American’s income.) This is where that disconnect began.
This artificial stock market boom lasted for a good twenty years. It is arguably one of the longest periods of prosperity in stock market history. It came to a grinding halt during the first decade of the 21st century. America had the tragedy of 9/11, the wars in Iraq and Afghanistan, and uncertainty throughout all facets of the country. Then the recession of 2008 hit, and people discovered many of our financial institutions were built on a foundation of sand.
Now and in the future, the stock market has its own internal economics with almost no bearing on the actual strength of its underlying companies. Keep these historical lessons in mind as you look to invest in the stock market. It offers the potential for a good return, but it has its own particular volatility that can flare up and consume your investment.