A Simple Way To Understand Investing: Consumers and Investors

For virtually everyone living in the United States, investing is crucial for achieving financial goals, whether that means enjoying a comfortable retirement, traveling the world in style, leaving a significant inheritance, or managing healthcare costs in later years. While many recognize its importance, some may struggle to grasp the fundamental concepts of investing in the market. This lack of understanding can lead to unnecessary stress when the market is down, avoidance of investing altogether, or even the selection of the wrong investments. If you find it difficult to understand the core concepts of investing, have never invested before, or are looking for a way to educate your children or grandchildren about investing but don’t know how, this article is an excellent place to start. It will help build a foundational understanding of investing, particularly by exploring the concept of consumers and investors.

Consumers and Investors

There are two categories of people in the world: consumers and investors. Everyone is a consumer, as we all spend our hard-earned money on goods and services we want and need. This spending can range from groceries to electronics, much of which is produced or sold by well-known, publicly traded companies like Walmart, Apple, and Amazon, to name a few. In fact, the U.S. economy relies heavily on consumption, with nearly 70% of economic output each year coming from consumer spending₁. On the other hand, some individuals are both consumers and investors. They allocate a portion of their income—beyond what they spend on everyday needs—into companies that produce these goods and services, helping to grow their wealth and achieve their financial goals. It’s important to note that no one is solely an investor; we all require basic necessities like food, water, and shelter to survive, which means we are all consumers to some extent.

What Does It Mean To Invest?

When you invest in a company, you’re essentially buying a small piece of ownership in that business. For example, if a company is valued at $1 billion and each share is worth $100, owning one share means you own a tiny fraction—1 in 10 million—of that company, which allows you to participate in the company’s growth and profits.

There are two primary ways to acquire direct ownership in a company. First, you can purchase shares during an Initial Public Offering (IPO), which is when a company first offers its stock to the public (often called “going public”). Alternatively, you can buy shares from existing investors in what’s called the secondary market. This is where most stock purchases occur for regular investors like you and me. There are also Additional Public Offerings (APOs), where companies that are already public issue additional shares. However, the concept remains the same: you can buy shares directly from the company or from other investors.

So why might a company choose to “go public”? Let’s imagine for a second that you are the CEO of a very successful privately owned company and are looking to expand but need money to do so. You have two main options: you could borrow money, but that may not align with your business model, or you may not want to take on debt that you have to repay even if your expansion is unsuccessful. The other option is to attract investors by “going public.” Think of it like a larger-scale version of Shark Tank, the popular TV show featuring wealthy investors like Mark Cuban. If, for example, you seek $1 billion and are willing to give up a lot of ownership in your business to get it, you could conduct an IPO to raise that money. In return, the investors who purchase shares now own a portion of your company.

How Does Investing Grow Your Wealth?

When you invest in a company by purchasing its stock, you’re essentially making an educated guess that the company will continue to produce goods and services that people want or need. Specifically, you are betting that they will do so in increasing quantities or at higher profit margins year after year. The interesting part is you may not even know you are consuming these goods and services. For example, everyone knows Apple, but do you know the company that manufactures the microchips that power Apple devices? That would be the Taiwan Semiconductor Manufacturing Company (TSMC). This highlights an important point: don’t shy away from investing in a company just because you haven’t heard of it before. It could be critical to your daily life without you even knowing it. However, always remember to do your research before making any investment decision.

What To Do When Your Worried About the Market

The next time you find yourself worried about the market, I want you to come back to this core concept of investing: consumers and investors. The market ebbs and flows in the short run due to all kinds of factors such as legislative changes, global conflicts, adverse business conditions, regulatory issues, and negative news about companies and industries. Often, these factors trigger emotional responses in investors, leading to market downturns. However, it's essential to recognize that over the long run, companies derive their value from people consuming their products. So, if your portfolio is well-constructed with companies that people want to buy from and will continue to buy from, you shouldn’t panic when you experience short-term fluctuations in the market.

For example, you may have heard about the recent E. coli outbreak linked to McDonald's, which caused its stock to drop nearly 5% in one day₂. While this news might temporarily scare investors, consider the bigger picture: will people still buy food from McDonald's? Is there a McDonald's in nearly every city and town across the country? Is the company still expanding globally? The answer to all these questions is a resounding yes! So, don’t let short-term shocks lead to panic. Now, not every company will successfully weather storms—many have failed or struggled to recover due to various reasons, such as catastrophic losses, obsolescence of their products or services, or regulatory and legislative changes that negatively impact their business models. However, the fundamental analysis remains the same: does this company offer a product or service that people want or need? If the answer is yes, then you shouldn't worry about the market's emotional ups and downs, as long as you're invested in fundamentally sound companies with strong growth potential.

Sources:

1. Council of Economic Advisers. (2023, October 30). As the U.S. consumer goes, so goes the U.S. economy. The White House. Retrieved November 26, 2024, from https://www.whitehouse.gov/cea/written-materials/2023/10/30/as-the-u-s-consumer-goes-so-goes-the-u-s-economy/
2. Canal, A. (2024, October 23). McDonald's stock sinks after CDC reports E. coli outbreak linked to Quarter Pounder. Yahoo Finance. Retrieved November 26, 2024, from https://finance.yahoo.com/news/mcdonalds-stock-sinks-after-cdc-reports-e-coli-outbreak-linked-to-quarter-pounder-205221600.html

The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of the author and not necessarily those of Raymond James. As always with IPOs, the date of the offering is an estimate and subject to change. Please consider the potential risks involved before investing in IPOs.