Basic investing concepts

We explore the basics of share market investing to equip you with the knowledge and resources needed to build a robust financial future.

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Learning the lingo

Imagine sitting at your favourite café, sipping on a latte. A conversation at the neighbouring table attracts your attention. The discussion involves stock market investment, share portfolios, and dividends. It sounds intriguing but highly complex, and you can't help but feel you're listening to a foreign language.

Well, you're not alone. The investing world can be daunting for the uninitiated, with all sorts of specialised terminology, financial concepts and economic complexities to get your head around.

But you don't need a university education to learn about investing. Whether you're a newcomer eager to understand the fundamentals or someone looking to refresh your knowledge, this article provides an essential guide to basic investing concepts.

We'll break down the core concepts, from how to invest in shares and bonds to the stock market and market indices. We'll demystify the financial jargon and provide investing definitions so you're no longer bewildered by unfamiliar terms like 'bull market' and 'dividends'.

So, join us on this journey that will equip you with the knowledge you need to navigate the investing world confidently.

Basic investing concepts

Investing is the process of acquiring assets in the hope or expectation they will grow in value or distribute funds to the investor. Assets can take various forms, but shares, bonds, and real estate are the most common.

So how does investing in these assets work?

  • Shares: When you buy a company share, you're essentially purchasing a tiny piece of the company. The more shares you own, the more of that company you own. If the company is profitable, it may distribute a proportion of profits to shareholders through dividends. Many growth-oriented companies reinvest their profits to expand and increase their stock's value over time. Investors in shares tend to be more focused on wealth accumulation and may tolerate higher short-term volatility.
  • Bonds: These are akin to loans that you provide to companies or governments. In return, they promise to repay your initial investment and periodic interest payments. Unlike shares, bonds do not give you an ownership interest in a company. However, bonds are generally considered less risky than shares. The market typically views bonds as income investments. Bondholders receive regular interest payments, which appeals to conservative investors seeking stable income and capital preservation rather than aggressive capital growth.
  • Real estate: Investing in real estate means buying properties like houses, apartments, or commercial buildings. The value of real estate can appreciate over time, and you can also generate income by renting or leasing it. Real estate investment trusts (REITs) are a popular and more accessible way to gain exposure to the real estate market without directly purchasing shares or managing physical properties.

Where does a broker come in?

Assets like shares, bonds, and REITs are traded on financial markets, such as the Australian Securities Exchange or ASX. Investors trade shares on stock markets, but there are also markets for bonds, commodities, and property. To access these markets, you will need a broker

A broker acts as an intermediary between investors and financial markets. They facilitate the buying and selling of financial assets on behalf of clients. 

Different types of brokers cater to different kinds of clients. Full-service brokers provide various services, including trade execution, investment advice, financial planning, and portfolio management. They offer personalised guidance and often have research departments that provide market analysis and investment recommendations.

Discount brokers offer essential trade execution services with minimal additional support. They may provide online trading platforms and tools for clients to execute trades independently. Online brokers are a subset of discount brokers that primarily operate online. They offer web-based trading platforms and mobile apps, allowing clients to digitally trade and manage their accounts.

How the stock market works

The stock market serves as a platform for buying and selling ownership of shares in publicly traded companies. Stock exchanges (such as the ASX) provide a centralised marketplace for trading stocks. 

You'll need to place an order with your broker to buy shares. There are a couple of types of orders you can use. A market order is an order for a certain number of shares at the market price. It guarantees execution but not a specific purchase price. A limit order allows you to specify the price at which you want to buy shares. A limit order will only execute if the cost of the selected shares reaches your specified price.

Stock markets have specific trading hours for investors to buy and sell securities. Understanding these hours and their significance is essential for anyone investing in the stock market. The ASX operates on a regular Monday-to-Friday trading schedule with five key sessions.

Trading sessions

  • Pre-opening: This session begins at 7am (Sydney time) and lasts approximately 10 minutes. During this time, orders are accepted, but no trading occurs. The purpose is to allow market participants to enter orders and establish an opening price.
  • Opening auction: This session starts at 10am and lasts approximately 10 minutes. The opening auction is the official start of trading for the day. During this time, orders are matched, and the opening prices for securities are determined.
  • Normal trading: This session begins at the end of the opening auction and continues until 4pm. It's the primary trading session during which most buying and selling of securities takes place.
  • Closing auction: The closing auction starts at 4pm and lasts for approximately 10 minutes. Similar to the opening auction, this session determines the closing prices for securities.
  • Post-closing: After the closing auction, there is a post-closing session that lasts for 10 minutes. Orders can still be entered during this time, but they are not matched or executed. The purpose is to allow investors to adjust their positions.

The opening and closing auctions play a crucial role in establishing the daily opening and closing prices for shares. These prices are used as reference points for valuing investments and calculating returns. The first few minutes of the trading day, especially during the opening auction, can be more volatile as supply and demand forces come into play.

Market liquidity

The market has the highest level of liquidity during market hours. Liquidity refers to the ease with which you can buy or sell an asset without significantly affecting its price. Higher liquidity generally leads to more efficient trading. 

While the main trading session occurs during regular ASX hours, some brokers and exchanges offer after-hours and pre-market trading. These extended hours allow trading outside the regular session but often come with lower liquidity and different rules.

What are stock market indices?

A stock market index is a statistical measure that represents the performance of a specific group of stocks or securities within a financial market. 

Stock market indices serve as benchmarks, allowing investors to assess the overall market's performance and track specific market segments. An index comprises a selected group of individual stocks, bonds, or other financial assets based on specific criteria. These criteria may include market capitalisation, sector classification, or trading volume.

For example, the S&P/ASX 200 Index (ASX: XJO) is one of Australia's most widely followed stock market indices. It is a benchmark index representing the performance of the 200 largest companies listed on the ASX by market capitalisation. The ASX 200 is used to gauge the overall health and direction of the Australian stock market and serves as a reference point for investors and fund managers.

Many other indices track the Australian stock market or components of it. These include the ASX All Ordinaries Index (ASX: XAO), which represents the performance of all companies listed on the ASX. It has more companies than the ASX 200 and is considered a broader market indicator. 

The Small Ordinaries Index (ASX: AXSO) includes small-cap companies listed on the ASX. These companies are typically outside the top 300 by market capitalisation. The Small Ords offers insight into the performance of smaller, growth-oriented companies.

Other indices monitor the performance of different segments of the ASX, such as resources, financials, health care, information technology, and utilities. 

Basic terminology and definitions

To operate effectively as an investor, you will need to understand some basic terms and investing definitions. 

The Motley Fool's comprehensive glossary of investing definitions is a helpful reference guide explaining the meaning of the financial terminology you will encounter on your investment journey.

We have outlined a few common terms below: 

  • Bull and bear markets: A bull market is characterised by rising asset prices over an extended period. It's a period of optimism where investors are confident in the market's future performance. The name reflects the upward motion of a bull's horns as it charges. In contrast, a bear market is marked by declining asset prices over an extended period – the opposite of a bull market. It's a period of pessimism, where investors are cautious and may sell off assets to avoid losses. The name comes from how a bear attacks, swiping downward with its claws. 
  • Dividends: Dividends are payments made by companies to their shareholders. They represent a portion of a company's profits distributed to its shareholders as a return on their investment. Dividends are a way for companies to share their financial success with investors and reward them for holding shares in the company. Dividends provide shareholders with a source of income from their investments. Shareholders, especially those seeking regular income, appreciate dividends as a steady cash flow stream.
  • Portfolio: A portfolio is a collection of various investment assets, primarily shares, but it can also include other financial instruments like bonds, exchange-traded funds (ETFs), REITs, and more. An investor creates a portfolio to diversify investments across various assets to achieve specific financial goals while managing risk. Determining the composition of your portfolio will depend on your financial goals and risk tolerance. More risk-averse investors may allocate a larger portion of their portfolio to bonds or cash, while those with a higher risk tolerance may favour equities such as shares.

Foolish takeaway 

Learning the fundamental concepts of investing is akin to having a compass for your financial journey. An understanding of this knowledge is essential to success. 

Investing is not just about multiplying your wealth – it's about securing your financial future, achieving goals, and building a more stable tomorrow. By understanding the essentials, you're better equipped to make informed decisions about where to put your hard-earned money.

But it doesn't end here. Your journey into the world of investing has just begun. You can expand your financial IQ and discover new avenues for growing your wealth by exploring our education pages, including: 

Remember, financial empowerment starts with knowledge. So, continue your quest for financial literacy, explore various investment opportunities, and take charge of your financial future. 

These tools will help you chart your course towards a more prosperous tomorrow.

This article contains general educational content only and does not take into account your personal financial situation. Before investing, your individual circumstances should be considered, and you may need to seek independent financial advice.

To the best of our knowledge, all information in this article is accurate as of time of posting. In our educational articles, a 'top share' is always defined by the largest market cap at the time of last update. On this page, neither the author nor The Motley Fool have chosen a 'top share' by personal opinion.

As always, remember that when investing, the value of your investment may rise or fall, and your capital is at risk.

The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.