What is the stock market?

As the name implies, the stock market (or stock exchange) is a marketplace where shares in public companies are bought and sold. Its role is to give private investors a way to become partial owners of a business to benefit from the profits it generates over time. It also helps listed companies raise capital through investors that they can use to grow their business.

Shares are listed on a particular market in a specific country, such as the Australian Securities Exchange (ASX) in Australia and the London Stock Exchange (LSE) in the UK. When a company wants to sell shares through an exchange, it has to apply to become ‘listed’. Once approved, it will have to follow the rules set out by the local financial services regulatory institution, such as the Australian Securities and Investments Commission (ASIC).

Another example is the Securities and Exchange Commission (SEC) that regulates the US market. It requires that all publicly listed companies disclose their quarterly financial results three times each year and publish an annual report in the fourth quarter.

This gives investors an overview of the company’s financial standing throughout the year, and helps them compare performance over certain periods before making any investment decisions. Buying a listed company therefore comes with certain safeguards for investors.

When an exchange is open, stock prices will fluctuate constantly as shareholders buy and sell shares based on sentiment about the company’s prospects and how investors react to economic and political events.

Shares in a company may go up or down at any time, but they usually respond directly to news about the business or the sector it’s in. If a company reports increased profits, for example, or if it promises a dividend increasing faster than inflation, then its share price is likely to rise.

How can you invest in the stock market?

As well as the prospect of your investments growing in value, you can also look to buy shares to benefit from dividends. These are portions of a company’s profits that are usually distributed among shareholders as a one-off or regular cash payment, but can also be paid in property or further shares of stock.

The 100 biggest companies listed on the LSE form the FTSE 100 index, which aggregates the share price movements of all its constituent companies.

Over the course of 2021, the FTSE 100 rose by 14.3%, its best year since 2016, and generated a further 3.37% in cumulative dividends – that’s an annual total return of more than 18%. While this gives a good indication of the returns the stock market can produce, remember that past performance is not a guarantee of future results.

If you’re investing in the stock market, you could do this by ‘buying’ a stock index like the FTSE 100. But since an index isn’t a listed entity, this would involve purchasing shares in each of its 100 constituent companies – a complex and costly process.

You could, alternatively, pool your money with other investors in a fund that offers exposure to the same companies. The cheapest way to ‘buy’ an index is with an exchange-traded fund or ETF (more on this shortly).

You’ll learn more about the different types of assets available to investors later in this course.

What is an ETF?

An ETF is a type of investment fund that’s bought and sold on stock exchanges. ETFs are designed to track the performance of a group of companies that form an index (like the FTSE 100 or ASX 200) or sectors such as energy, agriculture and healthcare. They can also track individual markets like gold, oil or the US dollar.

The price of an ETF reflects the collective value of the assets it tracks. For example, a FTSE-tracking ETF might hold shares in all of the FTSE 100’s constituent companies. Its value will be based on the share price of each company, so if one rises in value, the price of the ETF will also rise.

Like stocks, ETFs are shares that you can buy or sell on an exchange. This means you can gain exposure to the performance of an entire index or sector with just a single investment.

For instance, instead of buying shares in many individual energy companies, you could buy shares in one ETF that tracks the energy sector. From one transaction, you’d gain broad exposure to the industry’s combined performance, and subsequently have only one investment to monitor and manage.

ETFs offer a low-cost way to invest in a wide range of equities, bonds, property, commodities and other assets. However, it’s important to read an ETF’s prospectus or Key Investor Information Document (KIID) before you invest. You’ll also need to consider the relevant Target Market Determination (TMD) – available from the issuer – to determine whether the ETF is consistent with your goals, financial situation and needs.