All Articles,  Finance

Welcome to the Market!

Nowadays’ capitalistic society is driven by the economy, and every job contributes to its development. In general, employees produce a product or provide a service, for which they are paid a wage that they usually spent for living expenses. Basically, most people follow a “work to get money” system. But what if you could save some of your income, set it aside for a while, and let it grow in value by itself in a few years?

It is possible not only to work for money, but to also make the money work for you. How? By becoming an investor. The earlier you start, the better, and it is definitely not true that it is only for the wealthy. Most investors begin with savings of around a thousand dollars, but I believe that even a smaller amount can be totally enough – it is always quality over quantity, so rather invest a few tens or hundreds of bucks wisely, than put thousands into whatever seems good at first sight.

Another false myth is that investing is just like gambling. But the truth is, earning money at a casino is only a matter of luck, and in a very short term, you can lose it all. On the other hand, although the market is very unpredictable, investors are able to do a lot of research, calculate possibilities and really maximize the chance of not only getting their invested money back, but also make a profit. In addition, they can’t lose more money than an amount they have invested. You don’t have to risk it all, which makes investing a really safe choice. The world of financial markets brings so many opportunities, but still, they can only be beneficial if you know what you’re doing, which is also why I’m writing this article. So, welcome to the market!

There are many types of financial markets, on which you can invest in various of different things, from stocks and bonds, to real estate, certain funds, and other tradeable assets. Although “money markets” exist for short-term investments, investing is typically a long-term process. The investments that can take years, or even decades to complete, are usually made on “capital markets” which cover the two most well-known markets: the equity or stock market, on which stocks are traded, and the debt market, on which bonds are traded.

A stock is a share of a company, which can be bought on a stock market for a certain amount of money. In a case of buying, an investor becomes an owner of a certain piece of a company. As opposed to a stock, a bond is a form of debt, with which an investor lends money to a company or a government. A purpose of a company issuing shares or a government borrowing money is to collect a greater amount of capital, and therefore have enough resources to execute bigger, expensive projects, like building new factories, opening new stores, or anything else that would be very beneficial for a growth or development of an organization or a society in general.

In addition to doing specific research to help us predict whether an investment into a certain asset is a good idea or not, you can also use indexes to measure how well the market is performing as a whole. Many bigger cities, regions, or countries have their own index for their markets, but the most famous and broadly-used is the United States’ one called the Standard and Poor’s 500 (S&P 500), which compiles from the 500 “biggest” stocks there are in the marketplace to indicate how well the United States’ stock market is doing in general. Therefore, when prices go high, so does the S&P 500, and vice versa.

But don’t panic if a price of your stock has dropped a bit from yesterday. Smaller ups and downs are totally normal in the market. So, when deciding whether to invest into something or not, don’t pay attention to day-to-day rises and falls, but look at the long-term picture.

In financial markets, the higher the risk, the higher the return. So, if you want to get a really good investment, you also have to take on risks. But, it is important to keep in mind to never put all your eggs in one basket! To manage your risk properly, you need to create a diversified portfolio (collection of your financial investments), which you can achieve by investing in different assets rather than just one. Every investor wins and loses money, so it is crucial not to risk to lose it all at once. It’s not a big deal if some investments don’t succeed from time to time – what matters is how your portfolio does as a whole, so what is its average return and how uncertain its total return is.

For a long time, what people saw in financial markets was only statistics and numbers. But, as economics professor and Nobel prize winner Robert Shiller teaches in his classes, the market has always been much more tied to human psychology than we would have thought. As a part of evolution, people have developed a need to always follow the tribe, as a way to avoid dangers. Nowadays, when some of investors invests in a certain asset, everybody else gets a feeling that they should invest in it too, just because others have done it. With such high demand, the price of the asset can grow rapidly and enormously over its real value. In economics, this phenomenon is called a bubble. As every bubble in reality bursts at some point, so does the price of the asset suddenly fall staggeringly low. That usually happens when investors finally realise that the amount they have paid highly exceeded a real worth of the asset.

Psychology in finance is so powerful, that it even caused a house-buying mania in the early 2000s. At that time, banks were approving mortgage loans (loans that are ensured with a real estate) way overoptimistically. It sounded like a great deal to borrow money to buy or build a house, and again, everyone was doing it because others did it as well. It turned out to be a bubble again. Then, the prices of homes suddenly collapsed, and owners couldn’t sell a house for enough money to pay out their mortgage loan. This time, the bubble was so severe, that it resulted in the 2008 financial crisis, the greatest crisis of all time, from which we are still recovering today.

This overall introduction of the financial markets shows that investing has a great potential and can be a very good choice when managing your finances. Nevertheless, the best advice is to do it wisely. Calculate possibilities, check the statistics and don’t follow the tribe.

For the end, keep in mind what Warren Buffett – one of the wealthiest and most famous investors of all time, who is probably right – has said: “Be fearful when others are greedy and greedy when others are fearful.”