The Wall Street Journal Guide to Understanding Money and Investing

1. Money's Value Evolves from Barter to Electronic Exchange.

Most money doesn't have any value of its own. It's worth what it can buy at any given time.

From barter to currency. The history of money began with simple barter, exchanging goods directly. This evolved into commodity currency, using valuable items like salt or precious metals, which were durable and portable. The invention of coins simplified exchange by allowing payment by counting rather than weighing.

Paper and fiat money. Paper money emerged in China and later Europe, initially as promissory notes. Modern currency is largely fiat money, authorized by governments and not backed by physical commodities like gold. Its value is based on the issuing country's economic strength, making it susceptible to inflation, where too much money in circulation causes prices to rise and purchasing power to fall.

Electronic transfers dominate. Today, physical cash and coins represent a small fraction of the money circulating in the economy. The vast majority of transactions occur electronically through checks, credit cards, debit cards, and wire transfers. This shift towards digital money continues to revolutionize how we use and transfer funds, suggesting the story of money is still being written.

2. The Federal Reserve Manages Money Flow and Economic Stability.

The Federal Reserve System is the guardian of the nation's money—banker, regulator, controller and watchdog all rolled into one.

The Fed's structure and roles. The Federal Reserve, or Fed, is the central bank of the U.S., comprising 12 district banks and a Board of Governors. It acts as the government's banker, regulates member banks, and serves as a lender of last resort. Its primary mission is to keep the economy healthy and maintain the dollar's value.

Controlling the money supply. The Fed influences the amount of money in circulation through monetary policy. Key tools include setting the reserve requirement for banks, adjusting the discount rate (the interest rate at which banks borrow from the Fed), and buying or selling government securities in the open market. Buying securities injects new money into the economy, while selling withdraws it.

Impact on the economy. The Fed's actions aim to balance economic growth and inflation. An "easy money" policy (increasing supply) tends to stimulate growth but risks inflation. A "tight money" policy (slowing supply) combats inflation but can slow the economy. Significant policy changes typically take about six months to fully impact the economy.

3. Economic Indicators Reveal Health and Cycles of Growth and Contraction.

Economists keep their fingers on the pulse of the economy at all times, determined to cure what ails it.

Measuring economic health. Economists use various indicators to assess the economy's condition. These include jobless claims, unemployment rates, durable goods orders, housing starts, and factory orders. The Index of Leading Economic Indicators, a composite of ten such measures, is designed to predict short-term economic trends, with three consecutive rises or drops often signaling growth or potential recession.

Consumer confidence matters. Consumer attitudes significantly influence economic activity. When consumers feel confident about their financial situation and the future, they tend to spend more, boosting growth. Conversely, worries about job security or the economy lead to increased saving and reduced spending, slowing the economy. Surveys like those by the University of Michigan and the Conference Board measure this sentiment.

Economic cycles and inflation. The economy moves in cycles, with recurring phases of inflation and recession. Inflation occurs when prices rise, often due to high demand and ample money supply in a growing economy. Recession is a slowdown marked by decreased demand, falling prices (deflation or disinflation), and rising unemployment. Central banks try to manage these cycles to avoid severe depressions.

4. Stocks Represent Company Ownership with Potential for Growth and Income.

When you buy stocks, or shares, you own a slice of the company.

Stocks as equity investments. Buying stock makes you a shareholder, owning a portion of a corporation. Investors buy stock expecting it to increase in value (capital gains) or to receive a portion of the company's profits as dividends. Common stock offers voting rights and potential for high returns but carries the risk of losing value. Preferred stock reduces risk with guaranteed dividends but limits potential gains.

Stock value fluctuates. A stock's price is not fixed; it changes constantly based on market conditions, investor demand, and the company's performance and outlook. Factors like earnings growth, product competitiveness, management strength, and the overall economic environment influence whether a stock's value rises or falls. Stock splits can lower the price per share to stimulate trading, while reverse splits increase it.

Making money with stocks. Investors profit from stocks through capital gains (selling shares for more than the purchase price) and dividends. Capital gains on stocks held for over a year are taxed at a lower long-term rate. Dividends, typically paid quarterly by established companies, provide regular income. Stocks focused on reinvesting profits for growth are called growth stocks, while those paying regular dividends are income stocks.

5. Stock Trading Involves Various Methods and Risks, Including Shorting and Margin.

Buying stocks isn't hard, but the process has its own rules, its own language and a special cast of characters.

Accessing the market. To buy or sell stocks, investors typically use brokerage houses, which are members of stock exchanges. Transactions are handled by licensed stockbrokers. Investors can also buy stock directly from some companies via dividend reinvestment plans (DRIPs) or through online brokerage firms, which often offer lower commissions.

Order types and costs. Investors place various order types, such as market orders (executed at the current price), limit orders (executed only at a specified price or better), and stop orders (triggered at a specific price to limit losses or protect gains). Trading costs include commissions paid to brokers and fees set by the brokerage firm. Online brokers generally offer the lowest fees.

Leverage and risk. Some strategies involve leverage, using borrowed money to increase potential returns but also magnifying potential losses. Selling short involves borrowing shares to sell, hoping to buy them back later at a lower price for a profit. Buying on margin means borrowing up to half the purchase price from a broker. Both strategies are speculative and carry significant risk, including margin calls if the stock value drops.

6. Bonds Are Loans Offering Fixed Income, Valued by Rates and Issuer Strength.

Bonds are loans that investors make to corporations and governments.

Bonds as debt securities. When you buy a bond, you are lending money to the issuer (a corporation, government, or agency) for a fixed period. In return, the issuer promises to pay regular interest payments (the coupon rate) and repay the principal (par value) when the bond matures. Bonds are considered fixed-income securities because the interest rate is typically set at issue.

Bond value and interest rates. While the coupon rate is fixed, a bond's market value fluctuates, especially for longer-term bonds. Bond prices and interest rates have an inverse relationship: when market interest rates rise, the value of existing bonds paying lower rates falls (selling at a discount), and when rates fall, existing bonds paying higher rates become more valuable (selling at a premium).

Ratings and risk. Bond rating services like Standard & Poor's and Moody's assess the issuer's financial condition and the likelihood of timely interest payments and principal repayment. Ratings range from high-quality "investment grade" (lower risk, lower yield) to speculative "junk bonds" (higher risk, higher yield). U.S. Treasury bonds are considered risk-free and are not rated. Municipal bonds offer tax-exempt interest, making them attractive to high-tax-bracket investors.

7. Mutual Funds Pool Money for Diversified, Professionally Managed Portfolios.

A mutual fund buys investments with money it gets from selling shares in the fund, and manages its portfolio to meet its financial goals.

Pooling money for diversity. Mutual funds allow investors to pool their money to buy a diversified portfolio of stocks, bonds, or other securities. This provides greater buying power and diversification than most individual investors could achieve alone. Funds are managed by professionals who make investment decisions based on the fund's stated objective.

Fund types and objectives. Mutual funds are categorized by their primary investments: stock funds (equity), bond funds, and money market funds. Within these categories, funds have specific objectives, such as current income, long-term growth, or a combination. Examples include blue-chip funds, small-company funds, high-yield bond funds, and tax-free municipal bond funds. Focused funds concentrate on specific sectors or regions, increasing potential gains but also risk.

Evaluating fund performance. Fund performance is measured by changes in net asset value (NAV), yield (income as a percentage of NAV), and total return (change in value plus reinvested distributions). Investors can compare a fund's performance to benchmarks (like stock or bond indexes) and other funds with similar objectives. Fund costs, including sales charges (loads) and annual expenses (expense ratio), impact net returns and should be considered.

8. Futures and Options Offer Leveraged Bets on Price Movements for Hedgers and Speculators.

Futures and options are complex and volatile but also useful investments.

Derivative investments. Futures and options are derivative investments, meaning their value is derived from an underlying asset like a commodity (wheat, oil), financial instrument (Treasury bonds, currency), or stock index. They offer significant leverage, allowing investors to control a large value of the underlying asset with a relatively small initial investment (margin or premium).

Futures contracts. A futures contract is an obligation to buy or sell a specific amount of an underlying asset at a set price on a future date. They are traded on exchanges through open outcry or electronic systems. Hedgers (producers or users of the commodity) use futures to lock in prices and reduce risk. Speculators trade futures solely to profit from anticipated price changes, providing market liquidity but facing high risk due to leverage and price volatility.

Options contracts. An option gives the holder the right, but not the obligation, to buy (call option) or sell (put option) an underlying asset at a specific strike price within a set timeframe. Buyers pay a premium for this right, limiting their potential loss to the premium. Sellers (writers) of options collect the premium but are obligated to complete the trade if the buyer exercises the option, facing potentially unlimited risk, especially with "naked" (uncovered) options.

9. Global Markets and Currency Exchange Impact International Trade and Investment.

Currencies are floated against each other to measure their worth in the global marketplace.

Currency value and trading. A currency's value relative to others is determined by supply and demand in the global foreign exchange (forex) market, a vast electronic network operating around the clock. Factors like a country's economic stability, inflation rate, interest rates, and demand for its products or investments influence its currency's value. Governments may intervene to stabilize or devalue their currency.

International investing dynamics. Investing in overseas markets offers diversification, potentially offsetting downturns in the domestic market. Rewards can include capital gains, dividends, and gains from favorable currency exchange rates (when the foreign currency strengthens against the investor's home currency). However, risks include potential losses from unfavorable currency movements, differing tax and accounting rules, less available company information, and political or economic turmoil abroad.

Ways to invest globally. U.S. investors can access international markets through large brokerages with overseas offices, by buying stocks of multinational companies listed on U.S. exchanges, or through international mutual funds (which invest exclusively abroad), global funds (which mix U.S. and foreign assets), regional funds, or single-country funds. American Depositary Receipts (ADRs) allow trading shares of foreign companies on U.S. exchanges.

Last updated: June 18, 2025