What Are Stocks?
Stocks are a popular asset that allow you to own a piece of a large company. Learn how they work and about their pros and cons here.
Stocks are often one of the first things that come to mind when we think of investing. But before you dive headfirst into the market, it’s critical to have a good understanding of them. This article will teach you the essentials, including how they can make you money, the difference between common and preferred, and where to buy and sell them.
A Quick Breakdown
A stock represents the number of shares or fractional amounts someone owns in a business or corporation. Investors usually hold these on a long-term basis, intending for them to grow in value over time. This is also known as the amount of equity someone owns in a business.
Stocks are financial assets that you can buy and sell. People trade them on public exchanges such as the New York Stock Exchange (NYSE) and Nasdaq. You can also trade them in a private transaction between two parties.
How Stocks Make Money
Stocks can often yield returns such as dividend income or capital gains. Dividends refer to money that’s paid by a company to its shareholders directly from its profits. Note that not all companies will pay dividends.
Investment, or capital, gains are any rise in value in your stock from the initial time you bought it. Let’s say you invested in Random Company, Inc. If you bought 100 shares at $10 (worth $1,000), and then later sold those shares at $60 (worth $6,000), you’ll have made a profit of $5,000 before taxes or transaction fees.
Another key term related to stocks is a shareholder, or a stockholder. This refers to any person (or sometimes an organization or firm) that owns common or preferred stock in a company. To be a shareholder, a person must hold at least one share in a corporation. For example, if you bought the least number of shares possible in any company, you would be a shareholder of that company.
If a person owns over 50% of a company’s shares, they’ll be the majority shareholder. These people hold a large amount of power when it comes to making key decisions on leadership and the direction of the company. Below are some powers they have:
- They can replace members on the board of directors.
- They can replace high-level officers such as the CEO and CFO.
- They hold increased voting power.
Majority shareholders mainly exist in private companies where there are very few investors. This often leads to the founder being the majority shareholder, leaving them with the most control over the future of their business. A single shareholder having most of the power is less common in public companies because there tend to be far more investors. This leads to a much smaller percentage for each shareholder, even for the founder.
Other shareholders who don’t have majority power are known as minority shareholders. This refers to any shareholder who owns less than 50% of a company’s shares. Because of their lesser percentage, these people have less voting power than the majority shareholder.
Common vs. Preferred Stock
Common and preferred are two different types of stock that you’ll see as an investor. While they are similar in some ways, they’re very different and it’s important to know how to distinguish between them.
What Is Common Stock?
Common stock, like the basic definition, is a type of security that represents the amount of ownership someone has in a corporation. Owners of this type of asset can receive a share of a company’s profits through dividends. They can also vote on things such as who gets to be on the board of directors and corporate policy.
Also, common stockholders are the last to get any payment if a company goes through liquidation. Bondholders, lenders, and preferred stakeholders would receive their payments before the former does.
What Is Preferred Stock?
Preferred stock is another type of security that includes more features than common shares do. Owners of preferred enjoy a priority over common owners to dividends and payments in the event of company liquidation.
Unlike common shareholders, preferred shareholders typically have little to no say in board elections and corporate policy.
Buying and Selling Stocks
There are various ways for regular people to buy and sell stocks. While, as mentioned, trading usually happens at exchanges, such as NYSE or Nasdaq, most people turn to third parties, like brokers, or brokerage platforms.
Here are common ways to invest in the stock market:
Stockbrokers are professionals or companies that offer investment advice and handle trades for commissions or fees. Brokers can be individuals who work at a brokerage or financial advisors who help you manage your portfolio. They typically carry professional designations, often being chartered financial analysts (CFAs), certified financial planners (CFPs), or registered investment advisers (RIAs).
Online Brokerage Accounts
Setting up an online brokerage account is another way to buy and sell stocks. These accounts allow you to deposit money and immediately begin trading various securities, such as:
Below are some examples of online brokerage platforms:
- TD Ameritrade
- Charles Schwab
Because of their accessibility, brokerage platforms are one of the most common ways regular people invest in the stock market. The only downside is that, without the aid of an advisor, these accounts come with little to no guidance. In other words, you’ll have to know what you’re doing to make money.
Online Retirement Accounts
Some companies let you create an online retirement account, such as an IRA or Roth IRA. These also enable you to invest in the stock market while also reserving money for your golden years. The benefit is that your gains may be tax-deferred or even tax-free once you reach the minimum withdrawal age.
Direct Stock Purchase Plans (DSPPs)
DSPPs allow companies to sell stocks directly to consumers. These plans bypass brokers completely and may minimize trading fees. Some, however, may still include enrollment or transaction costs.
The difference between direct stock purchases and regular trading is that you can’t buy the shares at market price. But, rather, you’ll pay an average price at a specific time set by the company. Per Investor.gov, this could be daily, weekly, or monthly.
Employee Stock Purchase Plans (ESPPs)
ESPPs allow employees of publicly traded companies to purchase stock in their employer’s company. If you set this up at work, you’ll be able to buy shares every pay period and the expense deducted from your check. You can often get the shares at a bargain price in an employee purchasing plan. According to Morgan Stanley, this can sometimes be about 5 to 15% off the market value.
Stocks vs. Bonds
Another mode of investing involves bonds. A bond is a loan given to an issuer such as a corporation or a government by an investor. If an investor buys a bond, they’re loaning money to the issuer on the assumption that they’ll receive a greater sum in the future.
The bond’s issuer agrees to pay back the entire loan at a specific later date, as well as any interest that has been accrued over time. The interest rate is usually determined before and many refer to it as the coupon.
What’s the Difference Between Stocks and Bonds?
While stocks and bonds are both very common ways to invest money, they differ greatly. The former involves much more risk in the short term and depend primarily on a company’s performance. The latter are generally lower risk and essentially turn the investor into a lender.
When you buy a stock, you technically become an owner of the company in which you bought shares. This means that you have a direct stake in the company and are now relying on the company to do well if you want your asset’s value to increase, or even stay relatively the same. For this reason, many consider stocks to be high-risk as a short-term investment.
With bonds, the investor will usually get money back, as well as payments from the fixed interest rate. Since bondholders are lenders, they also have less stake in how well the company performs. This is why many claim that bonds are lower risk, especially for short-term investments.
Bondholders also benefit when a company sells or goes bankrupt. When companies must sell off all their assets, bondholders would be one of the first groups to get paid. This is because, as mentioned earlier, they are lenders to the corporation. This means they have a higher priority than stockholders.
At this point, you may wonder: Why would I ever want to buy stocks if bonds are much safer? Well, it’s because they can be lucrative long-term investments. If you invest wisely, you could have large returns. Bonds are typically lower risk but don’t return nearly as much.
Below is a quick chart comparing stocks and bonds:
|Higher risk short term, higher reward long term.
|Lower risk short term, lower reward long term.
|Gives an ownership stake in a company.
|Lender/creditor to a company.
|Last to get paid in a liquidation.
|First to get paid in a liquidation.
|Depend on company’s performance for returns.
|Fixed interest rate and typically recover all money.
Pros and Cons
Stock market investing isn’t without its pros and cons. In short, while they can be lucrative, they often require a bit of knowledge to seriously dive into. It’s almost always recommended to have an advisor or investment manager on your side to ensure you stay on track.
Here’s a full breakdown of the advantages and disadvantages of buying stocks:
- Capital appreciation. Companies you invest in can grow in value from when you first bought in, giving you gains and increasing your worth.
- Diversification. Stocks allow you to put your money to work and spread out your risk either by investing in various companies or simply adding them to a larger portfolio.
- Dividend income. Some companies pay out dividends, essentially giving you passive income.
- Ownership and voting rights. Aside from getting to say you own a fraction of a Fortune 500 company, some stocks could even give you certain voting rights. This is especially the case if you have a large number of shares.
- Risk and volatility. Market prices fluctuate constantly. Various trends, geopolitical events, interest rate changes, company news, and other risks could affect your portfolio’s worth.
- No control. You often have no say in how the business you invest in runs day-to-day, apart from possible shareholder votes. Management could drive the company into the ground and there’s nothing you can do.
- Time and effort. Trading in individual stocks successfully requires a lot of research and time. Keeping track of every factor that can influence one’s price is a daunting task.
- No guaranteed returns. There’s no guarantee that any individual company will do well or even survive. You could end up with as much as you started or face significant losses.
Frequently Asked Questions
What does it mean to invest in a stock?
Buying stock means that you are buying shares of ownership in a company. If the company grows or drops in value, so do your shares. Becoming an owner can grant you various benefits such as capital gains (profit) or passive income via dividends.
What are the pros and cons of investing in the stock market?
Investing in the market can prove to be very beneficial, especially if done wisely. Stocks can provide passive income, as well as increase your net worth. The only disadvantage is that you are essentially making a bet that a company will do well. This is why it’s important to do proper research and understand what you’re investing in.
What time does the market open?
The NYSE is open Monday to Friday from 9:30 AM to 4:30 PM EST. Sometimes, though, it’ll close altogether due to holidays, such as New Year’s Day, the Fourth of July, Labor Day, and more. Occasionally, the market may also close early, often for a variety of reasons.
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