Economics | Beinnger | Investing
What Is “The Market?”
Explaining an important concept for beginners
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The History Of Markets
If you’re new to investing, you probably see “the market” mentioned across social media and wonder what exactly it is. Some specific examples are the housing market, the bond market, and the stock market. But how do people measure something so abstract?
The most simple definition of a market is where buyers and sellers exchange goods and services.
In the olden days, before money, people would barter all kinds of goods and services with each other. For example, a hungry carpenter might trade a chair for a sack of potatoes from a farmer tired of standing all day.
The only problem with this system is that it’s often challenging to compare thousands of different goods to one another. For example, a blacksmith would be willing to pay more for a hammer than a school teacher (unless they were teaching a woodshop class, I guess).
So, we came up with the concept of “money.” The earliest currencies were gold and silver coins, which eventually morphed into paper bills that represented receipts for gold and silver stored at a bank. These “receipts” eventually turned into today’s crisp dollar bill.
American dollar bills used to be backed by gold until 1971, when President Nixon took us off the gold reserve. Now the dollar’s value is simply “the belief that dollars will continue to be valuable in the future.”
So, instead of bartering goods and services, we started exchanging them for money. One chair would be worth $5, and a sack of potatoes would be worth $1. It was far easier to compare the “value” of different goods and watch their prices fluctuate over days, months, and years.
And thus, several types of “markets” were formed. The “potato market” was simply how much people were willing to pay for potatoes. If potatoes were worth $1 per pound on Monday and then $2 per pound on Tuesday, then potato farmers were pretty happy because they could sell their potatoes for more money!
But let’s say potatoes became worth only 25 cents on Wednesday. This is an example of the “potato market crashing” and would really piss off potato farmers.
How Is This Relevant To Me?
Let’s say you wake up tomorrow to find yourself unemployed. Being the self-motivated hustler that you are, you decide to drive around your town to look for a job.
The first place you walk into is a grocery store, and you walk right up to the manager and ask if they have any openings. The manager delightfully responds, “Why yes, we are looking for a cashier!”
Jackpot! With a sigh and relief, you ask what the hourly rate is. To your confusion, the manager responds with “One dollar per hour.”
Without even thinking, you turn around and walk out. Why? Because the Federal minimum wage is $7.25 per hour.
Translation: You can walk into any other place of employment and receive $7.25 per hour at the very minimum. Nobody in their right mind would work for $1 per hour, knowing they could make at least 7 times as much anywhere else.
This is an example of understanding “the market rate” for your labor. Though you can likely earn much more than minimum wage, you know that the “market rate” for your labor is at least $7.25 per hour.
The manager clearly did not understand this. He thought someone would be willing to work for an hourly wage of $1. However, he will struggle to fill the position until he increases the hourly rate to “meet the market.”
What About Investing In The Market?
The example above describes the “labor market.” Your labor is worth whatever an employer is willing to pay, and the Federal Government makes it illegal for an employer to pay anything less than $7.25 per hour.
However, when people talk about “the market,” they usually refer to investment returns in various markets. And the most “popular market” is the American stock market, which has a market capitalization of over $46 trillion.
The Stock Market
Many people wonder what the “best stock is.” Millions of Wall Street analysts spend countless hours and hours researching companies and their financial statements, consumer behavior, and macroeconomic trends to determine what stocks are going to shoot up and make them rich.
However, around 90% of hedge fund managers fail to outperform the most boring investment you can make: The S&P 500 Index Fund. If you’re wondering what that is, it’s a collection of stocks from the 500 largest U.S. companies.
Even Warren Buffet, arguably the greatest investor of our time, failed to beat the S&P 500 over the past 30 years!
The performance of every single index fund and hedge fund is compared to the S&P 500. Why? Because the S&P 500 has historically provided incredible returns over a long period. It has returned an average of 11.82% per year since its inception.
The Real Estate Market
The Real Estate Market is represented by the prices homes and commercial properties are selling for and how quickly this number is rising. Homeowners typically know how much their neighbors’ houses have sold for in the past few months.
Several factors influence the real estate market, including the fed funds rate, the unemployment rate, demographic shifts, immigration changes, and many more.
When houses sell for more and more each month, your high school classmates leave their jobs to get their real estate licenses. Billion-dollar companies start buying up homes and turning them into investment properties. Builders start, well, building houses, driving up supply.
When people start getting laid off and savings accounts dry up, the unprepared fail to make their mortgage payments and lose their homes. If this happens to enough people, housing prices start to fall.
U.S. Government Bond Market
In 2017, the market cap of the U.S. Government bond market was over $13 trillion. Bonds are the only thing more boring than index funds but are becoming more attractive as the Federal Reserve continues to increase the fed funds rate.
Click here for a detailed description of how bonds work. But in short, they are assets you can purchase that provide periodic interest payments and return the principal amount to you at the end of their term.
Government bonds range from 3 months to 30 years, and they all pay slightly different interest rates. They can be held until maturity or traded on the open market.
To view current government bond yields, just click here.
If you’re wondering what affects the interest rate of bonds, then look no further than the Federal Funds Rate. When this rate increases, government bond interest rates also increase. And the reverse is also true.
Takeaway
It is crucial to understand how the market works for both your labor and your investments.
Keeping up with the market is essential in investing because you will miss out on potential gains if you let your cash sit in a checking account for decades on end.
For example, suppose you inherited $1,000,000 today. You could let it sit in a savings account and generate interest each year without taking any risk (besides your bank going under). After 30 years, the current average savings account interest rate of 0.16% would leave you with $1,049,130.
However, if you instead invest that $1,000,000 into the S&P 500 index fund, assuming an average annual return of 7%, you’d have $7,612,255 after 30 years.
This is an extreme example of the power of “the market” and its power to generate wealth. Therefore, it is in your best interest to know the best place to put your money so it can grow for you.
Having a high salary is excellent, but if you fail to invest any of it, you will work until the day you die.
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This is not financial advice. I am not qualified to give any financial advice or recommendations. Everything written is for entertainment purposes only. Nothing in this publication should be construed as investment advice.
