Why Does The Stock Market Go Up?: Everything You Should Have Been Taught About Investing In School, But Weren't

By Brian Feroldi

Have you ever heard a news reporter say "the Dow rose 300 points today" and had no clue what they meant? If the answer is yes, you're not alone! Most people are taught nothing about inve

• Language: English
• Publisher: Choose FI Media, Inc.
• Release date: Apr 5, 2022
• ISBN: 9781735066158

Book preview

CHAPTER 1

WHY SHOULD I CARE ABOUT THE STOCK MARKET?

Most people do not care about the stock market. It’s not hard to figure out why.

The stock market appears to move up and down randomly. It doesn’t seem to be linked to what’s happening in the real world at all.

The media only tends to make a big deal out of the stock market when it crashes, like it did most recently in 2000, 2008, and 2020.

The movie industry hasn’t helped, either. Popular movies like The Big Short, Margin Call, Boiler Room, and The Wolf of Wall Street all make the stock market seem like a big gambling machine.

I’ve heard people say things like:

■The stock market is rigged.

■Wall Street rips off Main Street.

■The stock market is just a playground for the wealthy.

That’s a shame, because the truth is that the stock market is the greatest wealth creation machine of all time.

Let me repeat that: The stock market is the greatest wealth creation machine of all time.

The stock market has enabled millions of ordinary people to build wealth and achieve their financial goals.

To show how, we’ll look at one example of how the stock market can help an average person realize their financial goals.

Let’s say a fictitious person named Aaron started his career in 1981, which is the same year that 401(k)s were created. His starting salary was $26,000, which was just under the average family income in the U.S. at the time.

Aaron was OK with money, but he wasn’t great. He lived paycheck-to-paycheck, but he always paid off his debt on time.

Thankfully, Aaron made one great financial decision. When he started his career, he put $400 per month into his company’s 401(k). He invested it all in funds that grew at the same rate as the overall United States stock market.

Then he completely forgot about his 401(k). He didn’t even bother to check his statements.

After 39 years of working, he finally took a look at his 401(k) balance.

How much money was in Aaron’s 401(k)?

$3,013,537

Aaron was shocked! And also confused. How had he become a multi-millionaire?

He did some quick math. His $400 per month only amounted to $191,600. Where did the extra $2.82 million come from?

The answer is the greatest wealth creation machine of all time: the stock market.

The U.S. stock market grew at a rate of about 11% per year during Aaron’s career. When that growth rate was combined with his savings of $400 per month, his investment portfolio got bigger at a faster and faster rate each year—although the growth didn’t occur in a straight line.

After the first year, Aaron had invested a total of $4,800. However, the stock market didn’t move much during the year, so his portfolio was only worth $4,823.

By the second year, Aaron had invested a total of $9,600. The stock market was up during this time, so his portfolio value was lifted to $11,383.

After five years, Aaron had invested a total of $24,000. The stock market went up a lot over those five years, which grew his portfolio to $37,594.

After a decade, Aaron had invested a total of $48,000. The stock market went up some more, so his portfolio grew to $101,208.

That’s when things started to get interesting. Since Aaron’s portfolio was now worth $101,208 and it was still growing about 11% annually, the gains from his investments were adding more value to his portfolio than his $400 per month contribution.

The stock market continued to go up during the 1990s. By the end of his second decade of investing, Aaron’s portfolio was worth $696,839.

The 2000s were a tough period for the stock market. There were two big declines in 2000 and 2008. At the end of Aaron’s third decade of investing, his portfolio only grew a little bit and was worth $793,479.

A portfolio is a collection of financial assets that are owned by an investor.

However, the stock market’s growth rate picked up in the 2010s. By the end of 2020, Aaron had invested a total of $191,600, but the portfolio was worth $3,013,537.

You might be thinking Aaron’s results were a fluke. Maybe he just got lucky and invested during a good period for the stock market.

History says otherwise.

The U.S. stock market has gone up about 10% per year dating back to 1871.

If you invested just $1 in the U.S. stock market in 1871, you’d now have more than $580,000.

And keep in mind that this period included a depression, two world wars, Presidential assassinations, pandemics, terrorist attacks, and numerous recessions.

This is why the stock market is the greatest wealth creation machine of all time. The stock market can allow anyone to turn small amounts of money into life-changing wealth over time.

And—like it or not—money affects us all.

Money determines where you live, the food that you eat, the education that your children receive, the healthcare you can access, the life experiences you can have, and much, much more.

Even if you have no interest in material possessions, building wealth is one of the best things that you can do to improve your family’s circumstances.

And there’s no better tool for building wealth than the stock market.

If you’re still not convinced, consider this: you might already have money in the stock market, even if you don’t know it. Gallup estimates that more than half of Americans currently own stocks, mostly through retirement plans.

If you have a:

■401(k)

■403(b)

■457 Plan

■Brokerage Account

■Employee Stock Purchase Plan (ESPP)

■Financial Advisor

■Index Fund

■Individual Retirement Arrangement (IRA)

■Mutual Fund

■Pension

■ROTH IRA

■ROTH 401(k)

■SARSEP Plan

■SEP Plan

■Simple IRA

■Thrift Savings Plan

…the odds are good that you are already invested in the stock market.

You have this amazing, wealth-creating tool at your disposal, but you may not know how it works or how to use it.

Once you understand the basics, you will learn how to harness the stock market’s awesome wealth-building power.

And don’t be intimated; the basics are not complicated. If you can understand 5th grade math, you can understand how the stock market works. You can also learn how to turn small amounts of money into life-changing amounts of wealth.

That is why you should care about it.

PART 1

STOCK MARKET BASICS

CHAPTER 2

WHAT IS A STOCK?

Let’s say three friends named Natalie, Ethan, and Lauren decide to open up a coffee shop together. They name their new business Best Coffee Company and estimate that it will cost $10,000 to get the coffee shop up and running.

Natalie has $6,000 to invest. Ethan has $3,000. Lauren only has $1,000.

■How much of Best Coffee Company will Natalie, Ethan, and Lauren own?

■How will Natalie, Ethan, and Lauren protect themselves from being sued if one of their customers spills hot coffee on themself?

Business owners have been dealing with questions like these for centuries. This is why corporations were invented.

Corporations make it easy for businesses to raise money from investors. They also offer legal protection to the investors in case the business gets sued or goes bankrupt.

One way that corporations raise money is by selling stock, which is also called ‘equity’ or ‘shares’. A stock represents partial ownership of a corporation. The owners of the stock are called ‘stockholders’ or ‘shareholders’.

A corporation is a legal entity that is separate from its owners. Corporations are owned by shareholders. The shareholders have a legal claim on the corporation’s assets and profits but are not personally liable for the company’s debts or actions.

The shareholders have a claim on a portion of the company’s assets (what it owns) and its profits. Shareholders also get to vote on how the business is managed.

A stock (which is also known as equity) is a financial security that represents the ownership of a fraction of a corporation.

Natalie, Ethan, and Lauren decide to turn Best Coffee Shop into a corporation. They decide to sell stock in the new business for $1 per share.

Stocks make it easy for investors to figure out how much of the company they own. To find this out, the owners simply divide the number of shares that they own by the total number of shares.

For example, Natalie, who contributed 60% of the start-up funding, owns 60% equity in the company. If there are 10,000 shares, then she owns 6,000 of them:

Here’s what the ownership looks like on a pie chart:

This is one reason stocks were invented. Stocks help investors understand how much of a corporation they own.

CHAPTER 3

WHY DO STOCKS HAVE VALUE?

Let’s continue with the example from the last chapter. Let’s say that Best Coffee Company is successful. It makes $5,000 in profit during its first year.

Natalie, Ethan, and Lauren decide to take the $5,000 in profit and pay it to themselves. In corporation speak, this is called paying a dividend.

A dividend is when a company gives some of its profits—which are also called ‘earnings’ or ‘net income’—back to its shareholders.

A dividend is a portion of a company’s profits that are paid out to its shareholders.

How much of that $5,000 should go to Natalie, Ethan, and Lauren? To find out, we divide the total dividend payment by the total number of shares.

Next, we multiply the dividend payment per share by the number of shares that each of the shareholders own.

Natalie would receive a $3,000 payment. Ethan would receive a $1,500 payment. Lauren would receive a $500 payment.

Would you like to own shares of Best Coffee Company?

You should! It’s a successful business that paid each of its investors $0.50 for every share of stock that they own in just one year. That can be very valuable to you as a shareholder.

What if Best Coffee Company makes another $5,000 in profit next year? What if it makes $10,000 in profit the year after that?

Would you even be willing to pay Natalie, Ethan, or Lauren to buy some of their stock? If yes, then the stock has value.

That is why stocks have value. When you

Reviews for Why Does The Stock Market Go Up?

[Suresh Unni · Rating: 5 out of 5 stars]

Excellent Book written in simple English . Author has tried to educate people with low level of financial literacy.

[Mostafa Fouad · Rating: 4 out of 5 stars]

Instructive, easy and straight forward
Just I awaited for more deep tactics and details