In this article, we will cover the basics of the capital market, the stock market, and some of its instruments like Equities and ETFs. Capital market is a broad concept that includes all of the financial securities available such as loans, bonds, and derivatives. The stock market is based on trading shares of companies. Both have the main goal to connect companies’ needs to investors’ will.
Who needs the stock market?
The total market cap of the US stock market is currently $46T (trillion dollars), according to this source. In terms of comparison, the cryptocurrency global market cap is about $ 0.82T (less than 2% in relation to the US stock market). If we consider the global stock market cap, the number can easily surpass $100T, which would make the cryptocurrency global market cap to be even less representative (lower than 1%), but not least important of course.
The stock market is to the companies what the launchpads are to cryptocurrency projects. The company has to balance between the costs and benefits before going public and having a part of its net wealth traded as stocks. There are several rules for a company to go and remain public, including factors like liquidity, accountancy, regulatory affairs, and many others. The main idea of going public is to raise money from investors at a much lower interest than a financial institution would be willing to finance.
The same happens with the cryptocurrency market but in a different way. While a company launches an Initial Public Offering (IPO), a cryptocurrency project can launch, for example, an ICO (Initial Coin Offering), IEO (Initial Exchange Offering) or IDO (Initial DEX Offering). The idea is the same as on the stock market: to raise lower-interest money and grow. If the project succeeds in its endeavors, the investors will be rewarded through the appreciation of their investments. At the best case scenario, it’s a win-win situation. If not, you already know the answer.
Types of Markets
The capital market is divided into two main markets:
- Primary: This is where the companies raise funds and the stocks are issued. Using a simple explanation, in this market, the company (supply) offers its stocks to the investors (demand) and it raises capital if there is enough demand. What the company will do with the raised capital must be well explained in its prospectus. The company can also issue new stocks to finance itself in this market. A publicly traded company is born here;
- Secondary: This is simply the market that comes after the primary (it seems obvious, right?). The main difference is that the investors can now trade the stocks between themselves without the direct participation of the company. New investors are coming and leaving every day. The buy/selling orders are what drive the stock prices up and down. This is where people get desperate and sell their stocks for no reason than then end up crying in the bathroom. The company can also make regular repurchases of its own stocks here if it considers that the stock is undervalued.
Financial Instruments
You can refer to this article to find out more about financial instruments. For instance, let’s present two of them (Equities and ETFs):
1. Equities: This refers to the capital of a company. When an investor buys a stock, then it becomes a shareholder with ownership rights that will depend on the type of share it holds. If the company succeeds in delivering good financial results, the stock price will follow and so does the market capitalization.
Figure 1 shows the weekly price chart of Apple (AAPL) and its Market cap from 2016 to date.
2. ETF: It stands for Exchange-Traded Funds. This kind of investment represents a pool of instruments like bonds and shares. If you believe in a trend like space exploration, cryptocurrency, disruptive technology, or emerging economies, you can buy an ETF that follows these trends. It’s like buying a basket full of goods at a cheaper price than buying each good separately. The difference is that you’ll have to pay for someone to go shopping for you, but the ETF fees are usually very low.
According to VettaFi, the Top-3 ETFs by AUM (Assets Under Management) are:
- SPY:
- Issuer: State Street Global Advisors
- Inception date: 01/22/1993 (mm/dd/yyyy)
- Index tracked: S&P 500
- AUM: $374B
- Expense ratio: 0.09%
- Objetive: SPY tracks a market cap-weighted index of US large- and mid-cap stocks selected by the S&P Committee.
- Performance 10y: 13.39% annualized
- IVV:
- Issuer: BlackRock
- Inception date: 05/15/2000 (mm/dd/yyyy)
- Index tracked: S&P 500
- AUM: $302
- Expense ratio: 0.03%
- Objective: IVV tracks a market cap-weighted index of US large- and mid-cap stocks selected by the S&P Committee
- Performance 10y: 13.43% annualized
- VOO:
- Issuer: Vanguard
- Inception date: 09/07/2010 (mm/dd/yyyy)
- Index tracked: S&P 500
- AUM: $274
- Expense ratio: 0.03%
- Objective: VOO tracks a market-cap-weighted index of US large- and mid-cap stocks selected by the S&P Committee.
- Performance 10y: 13.45% annualized
Figure 2 it’s an interesting one. It compares the percentage change of the weekly prices of all of these ETFs on the same chart and also the US inflation rate from 2012 to present (~10 years window).
VOO was the champion with 251.81% over the period, followed by IVV (+249.55%) and SPY (+230.35%). Nothing bad about more than tripling your capital in 10 years.
Conclusion
The capital market connects investors to companies. This represents the highest point of financial democracy since anyone can become part of a business with only a few dollars. What instruments to consider depends on the investors’ risk profile. Debt securities and bonds tend to be less risky than equity investing which tends to be less risky than derivatives. Choosing the right financial instrument looks like a doctor’s decision during surgery: if he chooses wrong, it can kill the patient.