The Basics of Stock Market Indexes
The rise of “meme stocks” — stocks that have gone viral with groups of investors from various online communities — during the pandemic proved it has never been easier to become an investor. Absent, in many cases, knowledge around the basics of the stock market, stay-at-homers were buying and selling — and buying more — like there was no tomorrow.
Remember the poster child of the meme stock era — AMC Entertainment? Between the end of 2020 and the first week of June 2021, AMC stock rose more than 3,300%. Between that peak and the end of 2023, the stock lost roughly 99% of its value.
As exciting as it was to watch, and maybe participate in, this is not investing — at least not investing for long-term wealth. To go down that road, you need a firm grasp of stock market basics.
Indexes are among the most important stock market basics for beginners to understand. They help explain the stock market and make it easier to become a long-term investor.
The three most-cited stock market indexes are the Dow Jones Industrial Average, known as “the Dow,” the Standard & Poor’s 500 (S&P 500 for short), and the Nasdaq Composite.
For the official definition of an index, we go to the company that maintains the Dow, S&P 500 and dozens of other indexes, S&P Dow Jones Indices, a division of S&P Global: “An index is a group or basket of securities, derivatives, or other financial instruments that represents and measures the performance of a specific market, asset class, market sector, or investment strategy.”
- The Dow Jones Industrial Average measures the performance of 30 domestic industry-leading companies, also known as “blue-chips.”
- The S&P 500 measures the performance of 500 large domestic companies, which make up roughly 80% of the value of the entire U.S. stock market.
- The Nasdaq Composite Index measures the performance of more than 2,500 stocks, including large technology firms, such as Apple, Microsoft and Nvidia.
The Dow and S&P 500 include stocks from both the New York Stock Exchange (NYSE). The Nasdaq Composite Index only includes stocks that trade on the Nasdaq Stock Exchange. The NYSE and Nasdaq are the primary marketplaces where traders and investors buy and sell stocks. They’re also the two biggest stock exchanges in the world.
For clarity, a stock exchange (NYSE, Nasdaq) is where stocks are listed, then bought and sold. An index (Dow, S&P 500, Nasdaq Composite) is a subset of stocks from one or more exchanges that represent a segment of the stock market.
Indexes give us a straightforward explainer on the basics of stock market investing and can help get you started investing as quickly and inexpensively as possible.
How and why? Because when somebody says the market was up or down today, you can usually look to these three indexes for confirmation. They’re broad stock market barometers.
And when you’ve opened an account and are ready to make an investment, you can invest in these indexes via low-cost products called exchange-traded funds (ETFs). An ideal strategy for not only beginners but all levels of investors, ETFs have no minimum investment requirements and provide a one-stop shop for investing in stocks.
How to Start Investing in Stocks
If you’ve ever opened a bank account, you should have no problem opening a brokerage account to buy and sell stocks. Opening a brokerage account has never been easier. Dozens of firms from big banks to large investment firms to online brokerages offer accounts with no or low balance requirements alongside commission-free trading.
Starting Small: Investing with Small Capital
You don’t need a lot of money to buy stocks.
Most brokerages allow you to purchase fractional shares, which just means less than one share. For example, if a stock costs $100 per share and you only have $25 to invest, you can buy 0.25 (25%) of a share of that stock, assuming the firm doesn’t charge a commission.
If you’re just starting out, it can make sense to start small. As you learn the basics, the last thing you want to do is put too much money at risk.
Using Stock Market Simulators for Practice
Some brokerages offer “paper trading” or simulated stock trading accounts. There are even stock market simulator apps that do likewise. These interfaces give you a feel for the type of environment you’ll be in when you use real money to buy and sell stocks, without the risk of using real money to buy and sell stocks.
Long-Term Strategies for Beginner Investors
Use a long-term investment strategy long enough and before you know it, you’re no longer a beginner.
The first step is to not make this process overly complicated and confusing.
There’s no one-size-fits-all strategy when it comes to long-term investing. Ultimately, it comes down to these straightforward points:
- The goals you define will dictate your specific strategy (or strategies) and the type of account (or accounts) you use.
- Long-term goals, such as retirement, might require using tax-deferred investment accounts, including individual retirement accounts and 401(k)s.
- Near-term goals, such as saving for college or simply making money and generating income in the short term, might require a college savings plan or traditional, taxable brokerage account.
- Understanding your appetite for risk is the key to sticking to a strategy. How much of a drop in the value of your stock portfolio are you willing to stomach?
A “buy-and-hold” strategy is often considered the best long-term strategy for beginning investors. This means you buy stocks or other securities and hold them for a long time, regardless of market fluctuation. It’s passive investing, as opposed to active investing, in which you attempt to “time” the stock market.
While buy-and-hold investing requires time, consistency, and patience, it tends to outperform short-term trading over time.
You can execute a buy-and-hold strategy via two main sub-strategies.
You can invest a fixed amount of money or whatever you have on hand once a year without looking at the calendar or trying to time a stock market bottom. Or you can dollar-cost average, which means investing equal amounts incrementally over time, be it weekly, monthly, or quarterly. This approach allows you to purchase more shares when prices are low and fewer shares when prices are high, building your positions and subsequent nest egg over time.
A recent study from Charles Schwab confirms that it’s “nearly impossible” to time the stock market. Schwab analyzed several different types of approaches over a 20-year period and found that the next two best options are to invest an equal amount on the first day of each year or to use a dollar-cost averaging method that splits the same amount into a dozen equal portions that are invested at the start of each month.
Both of these hypothetical strategies performed nearly as well as one that timed the market perfectly and invested an equal amount at the lowest closing point each year.
Analyst comment
This news can be evaluated as neutral. The article provides basic information about stock market indexes and emphasizes the importance of understanding them for long-term investing. It also discusses strategies for beginner investors. Overall, the news does not indicate any significant positive or negative impact on the market.
