How the Stock Market Works

Historically, the stock market has generated superior returns above nearly every investment out there—although historical returns may not always translate to personal returns. There have been very few investments that can beat the stock market for 10 years.

In order to invest in the stock market, you have to understand how it works, from the consumer to the stock owner. I encourage both new and seasoned investors to know what happens behind the scenes.

So How Does It Work?

Let’s use the Starbucks down the street as an example.

• Consumers are the customers who buy coffee in the cafe, and Starbucks exchanges services or goods for money. They get their expensive latte with an extra shot and call it a done deal.
• The next tier is employees. Unlike consumers, employees exchange their time for money.
• Then you have people who own the stock, known as stockholders or shareholders. They are at the top tier because they exchange their money for an ownership stake in Starbucks. The stock owners don’t have to do anything. While they’re sleeping, Starbucks is working hard to return their money to them with extra.

As the company grows and more and more people go through the drive through line for that expensive latte, the company’s stock is worth more and increases in value, so the stockholder gets a greater return. The contrast is also true, however—if the company goes downhill, so does the stock. This is why it’s important to ride out the inevitable ups and downs in the stock market. Follow that timeless advice, “Buy low, sell high.”

How Do Stockholders Earn Money?

Investment growth comes in two ways: appreciation and dividend.

• Appreciation: When you own stock, price appreciation means that when the stock goes up, you can sell it for a profit. It’s as simple as that.
• Dividends: The other way to earn income on stock is through dividends. Dividends are payments that the company makes to the stockholder for owning the stock. The stock stays in your hands, but you get consistent returns. Keep in mind, though, that not all stocks pay a dividend.

Check out our blog How to Make Money in the Stock Market for more info.