What are stocks? Seems simple enough to answer. First thing you need to know about stocks is that they are investments that you can buy, sell, or hold. And they come in shares. And they let you own a piece of the company that issues them, even if just a tiny piece.
But there’s a good deal more to the story, whether we’re talking about individual stocks or stock funds. And as we you learn more, hopefully you’ll also begin to feel more comfortable with your investment decisions. And you’ll be able to speak more knowingly with your broker or financial advisor!
How a stock is born
At any stage, a company decides it needs additional funding for operations (employees, materials, planning, marketing, research, etc.). So they look for more financing. One option might be to take out a loan or issue bonds or other debt instruments (don’t worry about this now). But that will only add to the amount they owe the outside world. And it will add monthly debt payments that can eat up their cash flow.
To avoid extra monthly debt payments, they can instead decide to bring in “equity partners”. These are people who will take on an ownership (equity) share of their business. On the TV show Shark Tank, we see an example of this. Wealthy investors who choose whether or not to give their own money to the company in exchange for a piece of the business.
That’s one way to bring in equity partners: find private investors. But the company can also decide to issue public shares of stock. This way anyone (including you and me) can choose to buy in for a piece of the company’s growth and (hopefully) its profits.
And so, in simplest terms, they figure out how many shares, stock types, appropriate stock exchange, and offering price. Of course, they have to comply with state and federal laws. And then they go live with their IPO (initial public offering). Much more to the story, but hopefully you get the basic picture.
What you need to know about stocks BEFORE buying
Since we’re just talking about the basics, let’s look at what you generally might do when you get the urge to buy a stock:
If you already know the name of the stock
Even if you’ve already decided on the stock you want, it’s smart to do some research first before giving the go-ahead to buy. I like Morningstar.com and TheStreet.com (I usually look at both), but there are lots of other good sites to check.
Look at the current price, earnings per share, short- and long-term trading ranges, yield, and any ratings / cautions. Also do some Google snooping for recent news or other mentions. This way so you go forward with eyes wide open. (Not that it guarantees anything.)
What if you don’t know the stock you want yet?
There’s no absolute for-sure way to find the stock you want. And of course, it depends on whether you’re making a long-term investment. Or maybe you’re just trying your hand at trading for short-term gains (and losses).
Some people start watching financial TV shows (like CNBC). Or they read financial newspapers & magazines (Forbes, Wall Street Journal, Barron’s, Financial Times). And even the business section of regular newspapers can offer ideas about specific companies or interesting business sectors.
You might even find inspiration from other non-business sections like entertainment, real estate, science, technology, etc. If you learn what a company is up to, this might just spark your interest to become part of the action. Even if you only wind up owning a few shares — for now.
One more cool example of how people decide to buy stocks
Some folks simply observe the world around them. And they buy stocks based on that. A broker I know told me that she observed more young people wearing Nike products Under Armour (a competitor). Even though at the time, Under Armour was doing better than Nike. Her hunch paid off.
Then again, others might see Under Armour ads, cool products, and press and say “That’s for me!” despite recent problems. Although in the case of these stocks – or in the case of any other stock – do your research. These are just examples — NOT recommendations.
What are the ways to make money from stocks?
Well, what you really need to know about stocks – especially owning individual stocks — is that you don’t always make money. But since we’re here to learn about ways to make money from stocks, the basic ways are:
- Buy and sell – Buy stocks at a low price and sell them at a higher price. Whether the sale happens in the near future or years from now.
- Dividends – Receive dividend payments either directly to you as they are paid out or have them reinvested automatically to help grow the total shares you own. Not all stocks have dividends. And some dividend rates are higher than others. A portion of my stock portfolio is made up of “high-yield”dividend stocks. So the real money value of those stocks to me is more than just the price increase (or decrease).
- Options (puts and calls) and shorting – I’ll go into this more at another time. Just mentioning it for now. Since these are also a great way to lose tons of money. Definitely NOT for the basic investor.
Isn’t buying stocks essentially gambling?
Yes. Seriously. That’s a BIG part of what you need to know about stocks. There are no absolute guarantees your stock will make you money. And also there’s no guarantee even a well-known company won’t go to zero. (Anyone remember Enron?)
But participating in the market is also one of the best ways not to lose out to inflation. So arming yourself with sound knowledge and research — in addition to making sure you do not put all your financial eggs in just one or two stocks — is an essential ally for any investor.
What are stock funds?
They are a group of stocks selected by the fund for various reasons, i.e. big companies, small companies, solid traditional companies, growth companies, international companies, etc. Also high-yield companies, market-indicator companies (like index funds that follow an Index like Standard & Poor’s), emerging trends, etc.
You should research them as carefully as you do stocks, with an eye toward a fund philosophy you’re comfortable with. Most stock funds have enough stocks in them to provide the portfolio theory safety of not putting all those eggs in one basket. But if they specialize in an area that gets hit by bad news, than having a few different funds (not all risky like emerging trends or high growth) may offer you a comforting balance.
One of my favorite funds is a “socially responsible fund.” But since I don’t give specific investment advice, I just want to let you know these exist too. They apply different types of “responsible” criteria, so look for one that fits you best. You can easily find some names by googling the term.
How long should you hold your stock?
This depends on you. Most folks reading this blog are not in it for the fast trade / quick money. So probably wise not to jump in and out when you see markets shifting up or down. You not only lose money in commissions, but hard for non-pros to get back in fast enough to make it profitable.
Then again, if you know / suspect that a company is headed for perpetual doldrums or just feel you are done with that stock or fund for whatever reason, you might want to shift to something with more future potential. If you have a broker / advisor you trust, this is the time to speak to her or him.
Oh … I also should mention that there are tax implications for how long you hold stocks. A stock held more than a year, if profitable, can be taxed at the usually preferential (but not always if your income is low) capital gains rate. For stocks held short-term (one year or less), profits are taxed at your regular (bracket) income tax rate.
What if you sell your stock at a “loss”?
Although of course the idea is not to lose, you may decide to sell your stock at a loss for any number of reasons. If so, there are accounting rules for applying short-term vs long-term losses.
But without getting you (or me) stuck in the tax reporting weeds, basically stock losses are deductible up to $3,000 per year. As long as you also have income for that year to apply against it.
A few more thoughts
Clearly, I can’t give you every single thing you might need to know about stocks on one handy-dandy page. Well, I guess I could, but then I’d still be writing it — and so you wouldn’t be reading this yet. 🙂
The main thing is never to assume anything. No “sure-thing” stock will make you rich. And not all stocks with problems are always a bad investment. Your best course of action is to do your research, trust your gut, and don’t be afraid to clean house now and then.