When it comes to investing, the common terminology says that you're investing in "the markets" or Wall Street. But what do these terms mean, and how are markets defined?
Simply put, financial markets are where traders and investors buy and sell assets. Markets can be used as a way for businesses to reduce risk and raise capital. Through markets, investors can buy into these companies in a way that hopefully makes money. The benefits of financial markets in a capitalist economy are numerous, from bringing confidence to the economy and helping to fund entrepreneurial ventures to providing liquidity to businesses.1,2
Several types of financial markets can be invested in, including but not limited to stocks, bonds, derivatives, and commodities. We review and explain the basics of these four types of financial markets below.
The Stock Market
The stock market is a financial market where companies can go to raise capital to expand. Investors can buy the shares of a company—called stocks—through a broker-dealer. Stocks may be traded on listed exchanges, such as the New York Stock Exchange (NYSE) or the National Association of Securities Dealers Automated Quotations (Nasdaq) stock market. Indexes such as the Standard and Poor's 500 Index and the Dow Jones track the averages of a group of companies that are publicly traded.1,2 However, these stock markets are primarily filled with copies that are doing business or highly connected to the United States economy. But there are other major markets where stock options can be purchased.
A few of the stock exchanges are the Euronext, Japan Exchange Group, London Stock Exchange, and SIX Swiss Exchange, among many others around the globe. These exchanges offer other investments that may not be listed on the NYSE and the NASDAQ. Some investors who are heavily invested in the U.S. markets may be interested in looking to other investments outside of their domestic market for diversification purposes.
The Bond Market
Bonds are used when companies or governments need to raise a large amount of money. Unlike stocks, bonds are a security in which an investor loans money for a defined period at a preestablished interest rate. It can also be referred to as a debt instrument, as it is an investor loaning money to the government or a company. Furthermore, unlike stocks, in which there is no guarantee of financial gain. The bond market sells securities, such as notes and bills issued by various governments.
Derivatives entail a more complicated financial market. Essentially, a derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset (e.g., a security) or set of assets (e.g., an index). Derivatives are secondary securities whose value is solely derived from the value of the primary security that they are linked to. In and of itself, a derivative is worthless. Rather than trading stocks directly, a derivatives market trades in futures and options contracts, as well as other advanced financial products, which only have as much value as the primary security.1,2
The Commodities Market
Commodities markets involve physical goods that are bought, sold, and traded. Whereas stocks and bonds are more akin to financial contracts, commodities markets deal in physical goods. There are four main types of commodities markets: energy, metals, agricultural products, and livestock.1,2 As we stay quite basic with our explanation of the various markets, it is essential to discuss the most common commodities sold on the market.
Gold and silver have been investments that have been a part of building investment portfolios for a long time, even more so since the end of the gold standard. Like all investments, the asset's value is partly made by those willing to purchase the investment. The U.S. government held the $35 per ounce price until August 15, 1971, when President Richard Nixon announced that the United States would no longer convert dollars to gold at a fixed value, thus altogether abandoning the gold standard.3 The price per ounce of gold has gone up and down since then and hit a peak value of $1972 in September 2020. despite the recent fall in price, the growth in value since the end of the gold standard is staggering.
When it comes to investing, there are many options to choose from, which can seem intimidating. While working closely with a financial advisor can help you decide which investments are right for you, it's also important to understand the basic concepts of your investments. Don't be afraid to ask your financial advisor about your investments. Diversifying your investment portfolio is important from the beginning to ensure you are not holding too much risk. Investing outside of your domestic investment market can bring tangible benefits to reducing the risk to your wealth if done correctly. However, it is important to find a professional investment advisor who understands the investments you are interested in to ensure you are finding suitable investments to meet your investment strategy and existing portfolio.
It is critical to remember never to be afraid to ask your financial advisor about your investments. An intelligent investor is worth their weight in gold. If you are interested in learning a bit more about building a portfolio, you can check out a blog we wrote on "Building a Wealth Worthy Portfolio".
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