Investors who want to outpace inflation typically attempt to grow their wealth by investing in financial markets. Basically, companies need money to grow, so they sell portions of their business to investors who become partial owners of the company. If the business grows, investors can potentially profit. But what does "investing in the market" mean, exactly?
A financial market is a place where people buy and sell financial assets, or things of value, like stocks, bonds, and commodities.
While there are different types of financial markets, this course is designed to focus on how investors can use capital markets to grow their money over time.
How capital markets work
In capital markets, investors seeking profits may elect to exchange their money with entities such as companies or government agencies. The entities need to raise money, or capital, to finance long-term projects for growth. These markets function because there's a mutually beneficial relationship between the investors and the entities that need cash. Investors are willing to risk some of their money for the potential to make a profit, and these entities get the capital they need.
In addition to investors, companies, and government agencies, capital markets also have brokers. You may have heard the term "real estate broker" refer to a third party who connects buyers and sellers of houses.
In finance, brokers facilitate transactions between investors and borrowers such as companies or government agencies. Brokerage firms like Schwab hire licensed professionals, or brokers, to buy and sell stocks and bonds on behalf of investors. You can't go directly to a public company, for example, and say that you'll give it money in exchange for ownership and a portion of future profits. However, you can go to a brokerage like Schwab, where you can place orders for investments, or you can work with a financial professional to help you manage your finances.
Types of capital markets
The two types of capital markets discussed in the course are the stock market and the bond market.
In the stock market, investors can buy a piece, or share, of ownership in a company. This fractional ownership in the company is called a stock.
When investors own a stock, if the company’s value rises, the prices of its stock shares should rise as well, which benefits investors who own those shares.
In the bond market, investors lend their money to corporations, government agencies, or municipalities. But unlike the stock market, bonds don't entitle investors to ownership. Bonds are a loan to a company or government for a certain time frame. Bonds earn interest, which are regular payments the borrower has to pay to the investors. At the end of the bond's time frame, investors are repaid the full amount they lent in addition to the guaranteed, fixed-rate interest that may have accumulated.
1. Investor loans money and receives bond
2. Government uses loan money and pays investor interest, then pays back the principal
The following chart summarizes some important differences between the stock and bond markets.
- Stock market
- Bond market
Stock marketParticipants: investors, companies>Bond marketParticipants: investors, companies, governments>
Stock marketInvestors own part of the company>Bond marketInvestors loan their money>
Stock marketInvestors don't receive a fixed rate of return>Bond marketInvestors receive a fixed rate of return>
Stock marketInvestors aren't guaranteed to recoup their investment>Bond marketInvestors are repaid in full at the end of the loan>
Stock marketInvestors hope for growth but aren't guaranteed returns>Bond marketInvestors receive payments on a certain schedule>
In addition to capital markets, there are money markets for cash investments. A typical rate of return for a cash investment might be between 0% and 1%—often not enough to outpace inflation. People may participate in money markets to keep a portion of their money secure and accessible but aren’t expecting to see much growth.
There are also other types of riskier markets, like commodities and derivatives, but these markets are for more experienced traders. If you're building your first portfolio, you'll primarily participate in capital markets.