Ever since your first job out of school, you’ve likely heard that you need to save for retirement. The most recommended way to do that is to invest in the stock market.
It may seem risky when you see headlines about the market’s wild swings. Even though stock prices can go up and down from one day to the next, over time the trajectory trends upward, and stocks typically outperform other investments such as bonds and interest-bearing bank accounts. That’s why stocks are considered a good option for people who have decades to invest before retirement.
The stock market—and its lingo—can be intimidating. This primer will give you the information you need to understand how the stock market works so you can get started investing to build your retirement nest egg.
What is the stock market?
The market refers to companies selling their stock—a piece of ownership in the business—to investors. It’s a way for companies to raise money without borrowing.
Company stocks are traded on an exchange. The largest is the New York Stock Exchange (NYSE) where corporations such as Citigroup, Nike and Walt Disney trade. The second biggest is NASDAQ, where many tech companies trade, including Apple and Facebook.
When you hear the market is up or down, it’s usually referring to a market index that tracks the performance of a select group of stocks. Two major indexes are the Dow Jones Industrial Average, which tracks the stocks of 30 large U.S. companies; and the S&P 500, which follows the stocks of 500 companies. Investors view indexes to gauge how well different segments of the market are doing. Many investments use an index as a benchmark to measure their own performance.
What is a share?
A share represents a unit of ownership in the company that issues it. If you invest $500 in a stock that’s selling shares at $10 each, then you own 50 shares of that company’s stock.
As a shareholder, you can vote on company issues, such as electing directors to the board. Typically, you get one vote for each share you own—although some companies have more than one share class with different voting powers.
How does the stock market work?
When you place an order to buy or sell a stock through a broker or online trading platform, you’re generally buying or selling your stock to other investors. If the stock is traded on the New York Stock Exchange, for example, your order will go to the trading floor, although technically speaking, a growing amount of trading now is done electronically and not on a floor. Intermediaries match “bid” and “offer” prices: The bid is the price the buyer is willing to pay; the offer or “ask” is what the seller is willing to accept. Once a match is made, the transaction goes through.
What factors affect stock prices?
It’s the old story of supply and demand. If lots of investors want to buy a stock, the price will be bid up, which in turn entices current stockholders to sell for a profit. But if lots of investors want to sell a stock and buyers are scarce, the price will fall.
Many factors can affect demand. Buyers may flock to a stock if the company reports better-than-expected profits, or if the company’s industry is suddenly in favor. On the other hand, sellers might get rid of shares on news of a steep loss, or if the economy here or abroad slips into a recession – or even if they simply want to cash in on some of their earnings.
How does investing work?
If you invest in strong companies, their stocks may rise in value over time. When you later sell your shares, the difference between what you originally paid and what you sold them for is your gain (or loss). Note that you may owe capital gains tax on that profit.
Another way you can make money on your stocks, without selling them, is through dividends. Well-established companies often pay out some of their earnings to shareholders through dividends. For example, if the annual dividend is $3 and you own 50 shares, you will earn $150 in dividends for the year.
You’ll owe taxes on this income too. Most dividends from companies are “qualified” and will be taxed at capital gains rates, which are often lower than regular income tax rates, depending on your income. Other dividends called “ordinary” or “unqualified” are taxed at the same rate as other earned income.
What is a mutual fund?
Everyday investors often don’t have the means to buy stock in dozens or even hundreds of companies. But buying shares in a mutual fund is an affordable way to do that.
A mutual fund pools money from many investors to buy stocks, bonds or other securities. A fund manager decides which securities to buy and sell inside the fund. One big advantage of mutual funds is diversification. If some stocks in the fund lose value, the losses may be more than offset by gains among the other fund holdings.
Mutual funds don’t trade on an exchange and can be only bought or sold once a day after the market closes.
What are index funds?
These mutual funds imitate the performance of an index by buying securities similar to those that make up the index. There are funds that mimic all sorts of indexes. For instance, you can invest in an index fund that tracks the S&P 500 for large companies or the Russell 2000 for small companies.
Funds charge an annual fee—or expense ratio—to cover management and other operating expenses. (Other fees may apply, too.) Index funds passively track an index—meaning a professional money manager isn’t researching and hand-picking the securities—so their expense ratios tend to be low.
What is a target-date fund?
Found in many workplace retirement plans, target-date mutual funds are designed for people who want to put their investing on autopilot.
You simply choose a fund with a target year that’s closest to when you expect to retire—say, Retirement 2050 or 2060. Those fund managers invest your money more aggressively when you’re young, and gradually shift to a more conservative portfolio as your retirement nears.
What is an exchange-traded fund?
ETFs share characteristics of an index fund and a stock. They typically invest in a basket of securities similar to those making up an index. And they’re listed on an exchange, like individual stocks, and can be traded throughout the day.
Annual fees may be lower in ETFs than other mutual funds, including index funds. You may pay a commission each time you trade an ETF, though.
What are bonds?
Bonds are basically IOUs. You lend a company—or government—money, and in exchange you receive your original investment plus interest when the bond matures at some future date.
Some bonds are riskier than others. The more risk there is that investors may not be paid back, the higher rate of interest is promised. To guide investors, rating agencies report on the ability of a bond issuer to repay the debt.
Buying shares in a bond fund is different. The fund may own bonds from hundreds of issuers and sell them before the maturity date. Unlike an individual bond you hold to maturity, bond funds don’t promise the return of your original investment.
Why should I invest in the stock market?
If you’re investing for the long term, say you’re planning to retire several decades from now, then stocks make sense. Stocks historically have outperformed other traditional investments. The average annual return of the stock market over decades, as measured by the S&P 500 index, is around 10%. That’s higher than returns on bonds and interest-bearing bank accounts.
Stocks are riskier and can swing wildly in price in the short term, however. That’s why stocks are suited for younger retirement savers who have the time to weather these ups and downs. As investors get nearer to retirement, it’s recommended that they shift some money out of stocks and into more stable investments. But even retirees typically hold some stocks to keep up with inflation in the years ahead.
How do I get started in the stock market?
The easiest way to begin investing is through your workplace retirement plans, such as a 403(b), 457 or 401(k). Plans usually offer a variety of stock and bond mutual funds.
If you want to buy individual stocks or mutual funds on your own outside of a retirement plan, you will need to open a brokerage account. You can open one online. (Check fees. Some online firms have no account minimums or trading commissions.) Once you fund the account, you can start investing. Regular brokerage accounts and investing within a tax-deferred retirement plan have different tax implications. Consult an accountant or tax advisor to understand the differences and how they may affect your personal financial situation.
How do I find good companies to invest in?
Do some research first on companies you want to invest in. Start by looking at publicly traded companies whose products or services you like. If you’re a fan, it’s likely that others are, too, and the company has a strong customer base. Look for companies that have a competitive advantage and a history of increased earnings.
Read information about the company posted on its website, as well as news about the business in the financial press. You can review a public company’s annual report (known as a 10-K), available at SEC.gov. Brokerage firms also offer analysts’ reports on stocks. You can research the performance of mutual funds at Morningstar.com.
Be wary of “hot” stock tips that may be too good to be true.
Make sure your overall stock portfolio is well-diversified with shares in a variety of companies in different sectors. If you’re too heavily concentrated in one stock or sector, your entire portfolio can take a severe hit if that one stock or sector tumbles.
You can also work with a financial adviser who can recommend suitable stocks or mutual funds for you.
Where can I find more information about investing?
NEA Member Benefits offers a variety of online resources and tools to help new investors. This includes a retirement glossary, information about the right mix of stocks and bonds based on your age, and how to manage your portfolio and investment options outside a 403(b).
Plus, as an NEA member, you have access to the NEA Retirement Program, which provides plans that can help you supplement your retirement income, along with information to help educators plan for retirement. Work with a local NEA retirement specialist or self-manage your investment accounts online.
For a quick look on your current retirement savings, try this 5-Minute Retirement Checkup. Or get a personalized projection based on your state pension and personal accounts using the Retirement Income Calculator.
NOTE: This article is for general informational purposes only and is not financial advice. Everyone’s financial situation is different. Seek advice from a professional before making any investment decisions.