The stock market allows companies to raise capital and gives individuals and institutions an opportunity to own portions of publicly traded businesses. Stock prices can rise or fall, and every investment involves risk. Learning how stocks, funds, and market indices work can help people better understand the choices commonly available in investment and retirement accounts.
What Is a Stock?
A share of stock represents fractional ownership in a company. When someone buys stock, that person becomes a shareholder alongside the company’s other shareholders.
When a privately held company needs money for expansion or operations, it has several options. It may borrow money, which involves taking on debt and generally repaying it with interest. It may also raise capital by selling ownership interests through private markets or by offering shares to the public.
By issuing stock, a company can obtain funding for its business. Shareholders own a portion of the company and may benefit if the business grows, although neither business performance nor investment returns are guaranteed. Depending on the type of shares owned, shareholders may also receive voting rights and dividends.
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Stockmark101.com is a free educational site focused on explaining how stocks and markets work. Company write-ups reflect general market commentary and publicly available information and are used to illustrate business fundamentals and market behavior — not to provide personalized investment advice.
Mutual Funds
The first modern U.S. mutual fund was established in 1924. A mutual fund pools money from many investors and invests it in a portfolio that may include stocks, bonds, or other securities.
Mutual funds can provide exposure to numerous investments through a single fund. Each fund follows the objectives and policies described in its prospectus. Common objectives include growth, income, capital preservation, or a combination of these goals.
Actively managed funds employ professional managers who select investments and decide when securities should be bought or sold. Funds charge operating expenses, generally expressed as an annual expense ratio. Costs vary substantially among funds and can reduce the returns received by shareholders over time. Some funds may also charge sales commissions or other fees.
Index Funds
The first publicly available index mutual fund in the United States was launched in 1976. An index fund seeks to track the performance of a selected market index, such as the S&P 500, by holding all or a representative sample of the securities included in that index.
Because an index can contain many companies, an index fund may provide broader diversification than owning only a few individual stocks. Diversification can spread exposure across multiple holdings, but it does not eliminate market risk or guarantee against losses.
Index funds are designed to approximate the performance of their underlying benchmarks rather than outperform them. They often have lower operating expenses than actively managed funds because they generally require less investment selection and trading. Performance varies, and lower costs do not guarantee higher returns.
Exchange-Traded Funds
Exchange-traded funds, commonly known as ETFs, were introduced in the United States in 1993. Like mutual funds, ETFs may hold baskets of stocks, bonds, commodities, or other investments. Unlike traditional mutual funds, ETF shares trade on stock exchanges throughout the trading day at market prices.
Traditional mutual funds are generally bought or sold at their net asset value, which is calculated after the market closes. ETF prices can fluctuate during the day and may trade slightly above or below the value of their underlying holdings.
Many ETFs track market indices, although actively managed ETFs are also available. ETF expenses vary, but many index-based ETFs have relatively low expense ratios. Their structure may also make some ETFs more tax-efficient than similarly invested mutual funds. Tax consequences depend on the fund, the account type, trading activity, and an investor’s individual circumstances.
Mark Notes
As index funds and ETFs have gained popularity, many specialized indices and sub-indices have been created. Funds are now available for numerous sectors, industries, company sizes, investment styles, and market themes.
Funds can offer diversification and may experience less company-specific volatility than a single stock. However, their values still fluctuate, and narrowly focused funds may carry concentrated risks. Fund information is commonly found in prospectuses, fact sheets, financial publications, and the websites of fund providers.
Four Major U.S. Stock Indices
1. The Dow Jones Industrial Average
What it is: The Dow Jones Industrial Average, often called the Dow or Dow 30, tracks 30 established U.S. companies representing several major industries. Transportation and utility companies are covered by separate Dow Jones averages.
How it works: The Dow is price-weighted. This means a company’s influence on the index is based largely on its share price rather than its total market value. A higher-priced stock can therefore affect the Dow more than a lower-priced stock, even when the lower-priced company has a larger total market capitalization.
2. The S&P 500
What it is: The S&P 500 includes 500 prominent publicly traded U.S. companies. It is commonly used as a benchmark for the performance of large U.S. companies and as one indicator of the broader stock market.
How it works: The S&P 500 is weighted by float-adjusted market capitalization. Companies with larger publicly available market values have more influence on the index’s performance than smaller companies.
3. The Nasdaq Composite
What it is: The Nasdaq Composite includes thousands of securities listed on the Nasdaq Stock Market. Although it covers companies from multiple industries, it has historically had substantial exposure to technology and other growth-oriented businesses.
How it works: The index is market-capitalization weighted. Its largest companies therefore have considerably more influence on its movement than its smaller members. This concentration can cause the performance of several large companies to have a meaningful effect on the overall index.
4. The Russell 2000
What it is: The Russell 2000 is a widely followed benchmark for smaller U.S. publicly traded companies. It consists of approximately 2,000 of the smaller companies included in the broader Russell 3000 Index.
How it works: The Russell 2000 is weighted by float-adjusted market capitalization. Because many smaller companies generate a substantial portion of their revenue domestically, the index is sometimes examined for information about small-company performance and conditions within the U.S. economy. However, no single index provides a complete measure of economic health.
Mark Notes
Understanding individual stocks can make it easier to interpret a fund’s description, objectives, holdings, and sources of risk. A fund’s performance is frequently compared with similar funds and an appropriate market benchmark.
Fund materials commonly list the ten largest holdings, although these holdings can change. Reviewing a fund’s holdings, strategy, costs, concentration, and historical behavior can help someone understand how the fund operates and whether its characteristics align with their objectives, time horizon, and tolerance for market fluctuations.
This material is provided for general educational purposes only and does not constitute financial, investment, tax, or legal advice or a recommendation to buy or sell any security. Investing involves risk, including the possible loss of principal. Past performance does not guarantee future results.
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