How do Share Markets Work?
It turns out that more than 62 percent of Australians own shares and bonds in some form or another, which means that millions upon millions of people own them and are invested in the share market. However, how many of those individuals truly comprehend how the share market works? According to my estimation, the number is only a small proportion.
There are a lot of people who invest in shares because they have been proven to be a good investment, especially over the long term. Because so many people are invested, it is generally thought that there is no need to understand how it works in detail; nevertheless, this is incorrect.
Computers, smartphones and digital TV’s serve as an excellent point of comparison. Tens of millions of individuals are familiar with their use, but only a tiny percentage understand how they work.
For those who are interested in learning how the share market works, and why you should at the very least have a basic understanding, let us go through the fundamentals with you.
What Does the Share Market Do?
In order to understand why the stock market exists in the first place, this is an excellent place to begin. Just like any other market, the share market has its own set of rules and regulations. It’s a place where companies put their shares up for sale, and investors buy them.
Historically, this was accomplished solely through physical trades. In the modern era, however, most transactions are carried out electronically. There isn’t even a requirement for a physical location to house a stock exchange in order to operate it.
The term “shares” refers to the ownership stake a buyer has in a particular corporation, which is why these securities are being offered for sale.
Why Companies Issue Shares?
It’s not uncommon for businesses to raise money by issuing shares rather than taking out loans or selling bonds. Selling shares in the company is a method a company uses to raise a significant amount of money.
It’s possible that a huge sum of money will be required to launch a new product, increase production or buy out a rival firm. A bank loan may not be able to provide them with that much cash, 100% of it anyway.
There’s also interest to be paid on both bank loans and bonds which is another consideration a company has to take when looking for funds.
This is a direct expense incurred by the company. Furthermore, the loan or the bonds must be repaid at some point. Shares issued by the company are subject to dividend payments, which may or may not be made at any time after the share has been issued.
The dividend payment can be reduced or eliminated in the future if that is necessary. In addition, the company doesn’t have to pay back the money it raises through the selling of its shares. As a result, more people will be able to participate in the company’s success as shareholders.
It’s possible that the company will be prepared to accept the consequence of share dilution in exchange for the improvement in its cash situation that comes from not having to pay interest or make loan payments.
Why Investors Invest Money in Shares?
Investors purchase shares with the hopes of profiting from the current income stream, projected future growth, or a combination of the two. All this means is that you make money by buying your shares at a low price and then selling them for a higher price. This is called “capital growth” or “capital gain.”
Because of this, it is crucial to keep in mind the possibility of losing money should the share value fall below what you paid for your shares.
Income Stream on Share from Dividends
Interest on bonds and CDs (certificates of deposit) is similar in this regard. The fundamental distinction from an investor’s perspective is that interest is a contractual obligation of the corporation, whereas dividends are not.
For example, a firm may decide to increase, cut, or even altogether cancel dividends from its shareholders.
In spite of this, there are a huge number of corporations that have paid dividends continuously for a long time now. Some of these companies have a long history of growing their dividends on a year-over-year basis, as well.
These stocks are referred to as Dividend Aristocrats, and there are currently more than 50 of them in existence. ASX 200 companies that have continuously increased dividends for at least 25 years and that meet size and liquidity requirements are required to be in the index.
Price Appreciation Is Also a Benefit for Investors
Increases in firm revenues, profits, and dividends are typically the driving force behind this. The goal is for a $10 share to become a $100 share within a few years. A portfolio of growth stocks may not offer the kind of returns you’re hoping for, but it’s possible.
If you want proof that diversification pays off, consider this: the S&P 500 (the 500 largest publicly traded corporations in the United States) has returned an annual average return of 10% since 1928.
Price appreciation has accounted for at least two-thirds of the total gain. Investing in stocks for the long term is more about long-term gains than short-term dividends for the average investor.
History of the Share Market and How the Share Market Was Born.
These days, the share market is one of the most critical parts of the world’s economic system. Economies grow around the world because of equity markets. Share markets, on the other hand, are a comparatively recent development. In the history of global economies, they haven’t always played such a significant role.
The first real share markets didn’t show up until the 1500s. Yet, there were other illustrations of marketplaces that were quite similar to regular markets in the early days of trading.
France, for example, had a system in place in the 1100s where courtiers de change were responsible for managing agricultural debts on behalf of banks throughout the country. Because the men were basically trading debts, this can be considered the first important example of brokerage in history.
Even as far back as the 13th century, the merchants of Venice were credited with trading in government securities. Many bankers in nearby Italian cities, like Pisa, Verona and Genovese in Italy, also bought and sold government bonds soon afterwards.
As a general rule, Belgium is where the world’s first stock markets are thought to have come from. They seem to have their own “share” market systems in the 1400s and 1500s. Bruges, Flanders, Ghent, and Rotterdam in the Netherlands all seem to have their own share market systems.
According to most historians, Antwerp was the site of the world’s first stock exchange system. In Antwerp, Belgium, the Van der Beurze family was very important, and it was the place where they lived. So, early stock markets were called “Beurzen.”
There was one thing missing from all of these early stock markets: shares. Even though the infrastructure and institutions looked like share markets today, no one was actually buying or selling shares in any company.
As a result, markets dealt with the issues of the federal government, corporations, and individual debt holders. Although the real properties being traded were different, the structure and organisation were the same.
Most major economies in the world now have a stock market that you can buy and sell shares on. Many people talk about the “share market” as a single thing, even though there are a lot of different share markets. When it comes to investing in stocks, a well-diversified portfolio will have positions in a number of different markets at any given moment.
There are at least 21 major share exchanges in the world. The largest top 10 exchanges are (with recent market capitalization) listed below:
- New York Share Exchange: $26.64 trillion
- NASDAQ: $23.46 trillion
- Shanghai Share Exchange: $7.63 trillion
- Euronext (European Union): $7.33 trillion
- Japan Exchange Group (Tokyo): $6.79 trillion
- Hong Kong Share Exchange: $6.13 trillion
- Shenzhen Share Market (China): $5.74 trillion
- London Share Exchange Group: $4.05 trillion
- Bombay Share Exchange (India): $3.96 trillion
- National Stock Exchange (India) $3.77 trillion
How Does the Share Market Work?
Share trading is a rather straightforward process. Prices are negotiated and trades are made on the stock market by buyers and sellers.
For example, you may have heard of the New York Stock Exchange (NYSE) or the NASDAQ. Initial public offerings, or IPOs, are when companies sell shares of their stock to the public for the first time on an exchange.
These shares are bought by people who want to invest in the company and allow it to grow its business. The exchange keeps track of the supply and demand of each stock listed, allowing investors to purchase and sell amongst themselves.
When it comes to stock prices, supply and demand play a major role in determining how much investors and traders are ready to pay for any individual share.
“Bid,” or the maximum amount buyers are ready to pay, is typically lower than the amount sellers “ask” for in exchange. The bid-ask spread refers to this discrepancy. A buyer must raise his price or a seller must lower theirs in order for a trade to take place.
However, although it may appear sophisticated, the majority of price-setting computations are typically performed by computer algorithms.
Even though you’ll be able to see your broker’s price quotes, you shouldn’t be alarmed if the difference between their asking price and your purchase price is just a few cents. For long-term investors, this won’t matter much.
What is a Share Buy Backs?
This is a subject that we won’t spend a lot of time on, but we’ll go over it a little because you’ve likely heard about it. The majority of a company’s stock is owned by its shareholders, although many companies also purchase back their own stock. In recent years, share buybacks have become a frequent practise.
Basically, when a business buys its own stock, it reduces the number of outstanding shares. As a result, the earnings per share rise, and the stock’s valuation often rises as well.
What are the Differences between Shares vs. Bonds?
Shares and bonds are two terms that are frequently used simultaneously in the financial world. Possibly because a well-balanced portfolio includes both sorts of assets.
However, how much do they share in common? ‘In actuality, not much. Every year, in order to keep their obligations to investors, companies are required by law to make interest payments on the bonds they issue. Typically, the bonds are issued for a period of 20 years.
At the conclusion of that time period, the corporation is responsible for repaying the bonds that it has issued. To put it another way, the corporation serves as a sort of Bailee for the debt in that arrangement.
Most bond purchases are made with the intention of caching interest. Due to the company’s assurance of principal payments, bonds are seen as less risky than shares.
As a result, both stocks and bonds are included in a well-diversified portfolio. Bonds, on the other hand, have a set value that will not fluctuate, even if you don’t hold them to maturity. The value or payment of dividends on shares, in contrast, is unguaranteed. In order for the investor to make a profit, either the value of the share or the company’s dividend must rise.
However, the value of a share might fall for a variety of reasons, including a decrease in sales or earnings, as well as legislative changes and international volatility. This is especially true if the company has a sudden or regular drop in revenues or earnings, or if it is obliged to either lower or discontinue its dividends.
Is there Interest Rate Risk in Holding Bonds?
Even with bonds, there is now the possibility of losing the value of your investment. Long-term bonds are susceptible to the risk of interest rate fluctuations.
A rise in interest rates presents this problem. The value of a bond will decrease if interest rates climb above the rate at which the bond is paying. Suppose you buy $20,000 worth of corporate bonds paying 4% (or $800) and interest rates go up to 5%. The bond’s market value could drop to $18,000 as a result.
For a total investment of $18,000, the company will earn a 5% return on its $800 in interest payments. You’ll lose money if you sell the bonds at that point. Similarly, the other way around is also true. In the event that you buy the same bond at 5% (or $1000) and rates decrease to 4%, the bond’s value rises.
If you sell the bonds for their current market value and receive an annual interest payment of $1000, you’ll earn a 4% yield and a profit. The numbers above are just examples for illustration purposes.
How to Invest in the Share Market?
At this point, we’ve arrived at the most significant part of this conversation. Now that you understand what shares are, let’s talk about how to make a share investment.
In the past, investors participated in the share market by purchasing individual shares of the company. A lot of the time, these were shares of well-known corporations. It was common for these firms to pay out substantial dividends to shareholders because of their size and track records of increasing revenues and earnings.
With rising markets, they performed well and resisted falling markets. However, given today’s increasingly complicated economic environment, as well as the rapid advancement of technology, owning a small number of shares in specific companies isn’t always the most advantageous option.
Aside from that, investing in particular companies is not recommended for first-time investors. There is a lot of research that needs to be done into the company including reading and understanding profit and loss statements and company quarterlies.
The more prudent approach is to invest in stock portfolios. Mutual funds and exchange-traded funds (ETFs) are examples of this type of investment vehicles.
Investing in the best-performing firms is a common strategy for actively managed mutual funds, which aim to outperform the overall market. They are index funds, which means that they invest in a wide range of markets and asset classes.
An example of a common ETF is one that invests in the S&P 500 index of large U.S. corporations. That means it has a portfolio that is reflective of every share in that index. ETFs mimic the market, but they don’t outperform it in terms of performance.
Surprisingly, over the long term, exchange-traded funds (ETFs) tend to outperform mutual funds since the great majority of mutual funds fail to beat the market.
For those who have little or no experience in the stock market or just have a little sum of money to invest, the best course of action is to use mutual funds. As your portfolio develops in size and your investment in knowledge and confidence increases, you will eventually be able to trade individual shares on the stock market.
How to Start Investing in the Share Market?
Now that it has been explained How do Share Markets Work, in the event that you decide to invest in Exchange Traded Funds, where can you go about doing so? Investing with a diverse online investment broker is the best option if you are comfortable selecting the funds in which you will put your money – and if you want to have the option of eventually exchanging individual shares.
If you’re unsure about picking your own investments, a robo-advisor may be a better alternative for you. A robo-advisor is a financial technology platform that provides professional investment advice at a surprisingly low price point.
They build a diverse investment portfolio that includes, at a bare minimum, stocks and bonds, but may also include real estate, sector funds, and other alternative investments as well.
Your portfolio is handled for you on an ongoing basis once it has been established. Additionally, dividends can be reinvested to keep the asset allocations on track.
In Conclusion
Now that you have a better idea on How do Share Markets Work, you don’t have to do anything but fund your account while investing with a robo-advisor. No need to be concerned about any of the technicalities because the robo-advisor will take care of everything for you!
Betterment and M1 Finance are two instances of Robo advisers that are worth your time to investigate further.
Another significant advantage of using a robo adviser is that it is cost-effective. You can start investing with as little as $50 or as much as $1,000. Even if you only have a few dollars to invest, a robo-advisor can build you a well-diversified portfolio.
Having learned all you need to about the stock market, you are now ready to begin your trading journey. Coming from experience, I would also suggest always do your own research and if in doubt at any stage, seek professional investment advice form a licenced professional.
I sincerely hope in reading this article, you are more aware of the advantages of investing in the stock market as well as the reasons for doing so.
