Stockology

Things you can invest in are sometimes called investment vehicles or financial instruments. Normally, when you think about the market, you think stocks or mutual funds. A stock is a share of a company that you can buy or sell. A mutual fund, and there are many types, is typically a basket of stocks that you can buy or sell.

A quick bit: People buy mutual funds for several reasons. The two more prevalent ones are 1) because they don’t have time to track a group of companies, instead electing a professional fund manager to manage their money for them, and 2) to diversify their holdings, diminishing risk, since mutual funds include a bunch of companies (and if one company went bankrupt, it won’t completely wipe you out).

There are a whole lot of other things you can invest in, namely bonds, options, index funds, and exchange traded funds (ETFs). And while becoming an expert on each of these will literally explode your brain, you should have an idea of what each of these are. Ignorance and obliviousness is not rewarded in investing.

Bonds, and there are many types of these as well, are debts. Treasury bonds are issued by the government. Municipal bonds are issued by a municipality. Corporate bonds are the debts issued by a company. When you buy a bond, you’ll get paid interest. Bonds are less risky than stocks in general. The government isn’t going to collapse, so you don’t have to worry about your interest payments not coming through. I don’t want to get too into detail for now. So just know that investing in bonds can be an alternative or a complement to investing in stocks. Bonds are also known as fixed income securities because they pay out a fixed interest rate to their investors.

You can visit http://www.investopedia.com for more detailed explanations of each.

Moving on…

Options are part of a more general group of securities called derivatives. These aren’t the derivatives you learned you in your high school calculus class, but there is a correlation. Options are called derivatives because their price is derived from something else. I’m sure there will be a future post on how options work and all that good stuff. But for now, just know that options are contracts that give you the right to buy or sell a stock at a given price. The concept is actually really simple, but there’s a lot of ground to cover and I’m still learning it myself.

We kind of touched on mutual funds earlier, so now we’ll briefly touch on index funds and exchange traded funds (commonly known as ETFs). Index funds, as the name might suggest, track an index. I wrote about indices in an earlier post. So we know that the Dow Jones Industrial Average (DJIA), and there’s a fund that tracks that index. Likewise for the S&P 500 and Nasdaq indices. There are also indices that track a particular industry (like oil, technology, financials), or track a particular region (like Europe, emerging markets, etc.).

Exchange traded funds are essentially mutual funds that trade like a stock. For a conventional mutual fund, say the Fidelity Real Estate Fund, you’d have to have an account with Fidelity Investments to buy it. But for exchange traded funds, you buy shares just like you would for a stock. Nowadays, a lot of companies offer exchange traded funds. The more popular ones include iShares, PowerShares, and ProShares.

There have been volumes of books and tons of articles written on each of these instruments. And there are new bonds, options, and funds (especially) created every single day. So this is just a little recap of what each of them are.

If you’ve ever cracked open the Business section of your local newspaper, or clicked on the Finance link on Yahoo!’s front page, or simply not been living in a cave for the last y years, you’ve undoubtedly heard of the Dow Jones. Dow Jones is the publisher of The Wall Street Journal and Barron’s (a weekly business journal). Yeah, it’s those things too. But that’s not the Dow Jones I’m talking about. I’m talking about the Dow Jones Industrial Average, or the Dow, for short.

The Dow is an index of 30 companies. Some smart people sat in a room and decided to create an index of 30 companies that would best reflect the United States. These 30 companies in the Dow are known as the Dow components. Like… the components that make up something… Anyway, the Dow components are usually big companies, big household name brands that you’ve heard of. You’ve got your Bank of America, Disney, McDonald’s, General Electric, Boeing, Verizon, Home Depot, etc. Usually when people say, “The market’s up 200 points today,” they’re refering to the Dow.

There are two other main indices that you’ll want to know: The S&P 500 and the Nasdaq Composite Index. I’ll save the Nasdaq for last because it’s more confusing.

The Standard & Poor 500, or S&P 500, is kind of like the Dow. But instead of tracking 30 companies, it’s an index that tracks 500 companies. A lot of the S&P 500 components are still companies you’ve probably heard of, like UPS, or Wells Fargo, E*Trade, eBay, Gap, etc. The two indices (the Dow and the S&P) overlap. The 30 Dow components are probably also components in the S&P. I haven’t confirmed this, and I’m not going to because I’m lazy. But just think about it. If you’re going to make a list of 30 really big companies, then make another list of 500 really big companies, some of those companies are going to be the same companies, right?

Before moving on to the rest of the indices, I’m going to talk about exchanges. Trust me, I’m not deliberately trying to confuse you. It’s just better to know these things in this order.

In the United States, there are no less than 10 stock exchanges, or bourses (a word I picked up from reading The Wall Street Journal and looked up on Dictionary.com). The good news is you don’t have to know all 10, just 3 of them. The bad news is, it’s confusing. So the 3 you should know: the New York Stock Exchange (NYSE), the National Association of Securities Dealers Automated Quotations (NASDAQ), and the American Stock Exchange (AMEX). The way exchanges work is this: When a company becomes public, it lists its shares on an exchange so that its shareholders can trade its stock.

The NYSE is the largest stock exchange in the world in terms of dollar volume. That means, more money exchanges hands on the NYSE than any other stock exchange. Then you have the Nasdaq, which is an electronic exchange. Most of the companies that trade on the Nasdaq are companies with smaller market capitalizations; smaller companies, if you will. That’s not to say there aren’t any big ones that trade on the Nasdaq. Microsoft, Intel, and Cisco are some of the biggest companies in the world that trade on the Nasdaq. It’s just that a lot of smaller companies, namely technology and biotechnology companies, tend to list on the Nasdaq rather than the NYSE.

I’m going to leave the AMEX out of this discussion because frankly, it’s not that important. 

Here’s where it gets confusing. We’ve established that the NYSE and the Nasdaq are exchanges. But they’re also indices! The NYSE Composite is an index that covers all the stocks listed on the NYSE. Likewise, the Nasdaq Composite tracks all stocks listed on the Nasdaq exchange. But wait! There’s more. There’s a Nasdaq-100 Index, which tracks the 100 largest domestic and foreign non-financial companies.

Is your head spinning yet? 

So while indices and exchanges are completely different things, there really is a fine line in distinguishing them when you hear them in the media. You’ll hear people say, ”The Nasdaq is up today,” in which case, they’re refering to the index. Or if you hear, “Apple was among the Nasdaq’s most active today,” they’re refering to the exchange that Apple is listed on. Conversely, you’ll probably never hear anyone say, “The NYSE was up today.” I don’t know why. It just doesn’t happen.