Deciphering Financial Mumbo Jumbo

Hello everyone.
Before I begin, I just want to issue a caveat. I by no means intend to offend anyone's intellect by this post. There are many intelligent women and men in my readership who are much more knowledgeable about the stock market, economics, and personal finance issues than I am. This post is not for them, or not geared specifically toward them. It is geared toward the reader who always hears terms like "the Dow", "the Nasdaq", and "the S&P 500" and always wonders what those terms mean. This post is intended to be a primer for those who want an extremely basic overview of the stock market. So here goes...

As the name suggests, the "stock market" is an entity in which stocks are bought and sold. To reivew something that I've written about in a previous post, a stock is essentially ownership of a piece of a company. So when you buy stocks, you are buying a company. The stock market, like any other market, is made up of buyers and sellers. Although in the long-term things like how profitable a company is and how it allocates its earnings determine a stock price, in the short-term, how many buyers and sellers there are of a stock determines its price. For instance, think about what happens with hot ticket items like the iPhone or the X-box. When these items first came out, people lined up for them and were willing to pay twice what the store price was just to get their hands on it first. The moral is, the more buyers there are for a particular stock, in the short-term, the higher the price will go. Similarly, the more sellers there are of a particularly stock, in the short-term, the lower the stock will go. That's essentially how stocks work.

Warren Buffett, one of the greatest investors of all time (and the world's third richest man), advises investors though that in the long-term, a stock's price will eventually reflect its true value. What does this mean? Okay, think about it this way. One of my favorite cars, a BMW 325i, costs about $40,000. If you were the proud owner of a new 325i, and someone offered you $10,000 for your car, you would balk. Why? Because you know how much your car is worth. Similarly, in the short-term, lots of people might be selling the stock you own, or offering you a lower price for your stock than you paid. But if you know the true value of your stock because you did your due diligence about its growth prospects and vetted its financial statements, then you will not accept a ludicrously low price for your stock or your BMW. (This was an example and a car, no matter how expensive, does not represent an asset. It's undoubtedly a liability!)

Lastly, what do those terms "Dow", "Nasdaq", and "S&P 500" mean? All of these things are indexes and an index is a representative cross-section of the universe of companies that have stocks for the public to buy. For instance, the Dow (aka the Dow Jones, the Dow Jones Industrial Average, the Dow 30) consists of the 30 largest publicly-traded American companies. These companies change every so often, but currently the Dow consists of companies like McDonald's, Microsoft, Johnson & Johnson, AT&T, Coca-Cola, Citigroup, and Wal-Mart, just to name a few. So when you hear on the news that "the Dow" crossed 14,000 for the first time, this just means that a mathematical equation calculating the worth of these 30 companies spit out the number 14,000. The Dow is also a broad indicator of the health of the economy.

The Nasdaq index contains more companies than the Dow, but it is mainly composed of technology companies like Apple, Cisco Systems, and Google. This is the index that was hurt the most in the last economic downturn that began in 2001, when the "tech bubble" burst. The S&P 500, which stands for Standard and Poor's 500 is an index that is composed of America's 500 largest companies. The S&P 500, often referred to as the S&P, is a better gauge of the health of the economy because when people are spending, these 500 companies are earning. The value of the S&P, like the Nasdaq and the Dow, is determined by a complex equation which factors in the value of the stocks of which it composed.

If you want more information, you can check out www.investopedia.com. This is a great resource for budding investors. Thanks for reading and until next time...