Stocks are another type of investment vehicle. When you own a stock you own a portion of a publicly traded company. Your ownership in the company is referred to as a share in the company. For example, if you own one share of stock in Bank of America, then you own (although a small portion) a portion of the company.
Companies issue shares of their stock as a means of raising money to further grow their business. Stocks are purchased and sold (traded) on exchanges like the New York Stock Exchange (NYSE) or Nasdaq. Publicly traded companies issue millions of shares of stock, purchasing shares of the company makes you a co-owner in the company along with millions of others.
What are Stocks and How Do They Work?
- You make money from a stock in two primary ways.
- You buy a share of stock for one price and if the company is doing well financially the stock price goes up. For example, you purchase shares of Ford Motor Company for $10.00 after a year the stock price goes up to $15.00. The value of the Ford stock you own has gone up by 50% you made $5.00. (i.e. the stock has appreciated in value)
- Dividends are a means of how a company rewards its investors for ownership in their stock. Dividends are typically paid out quarterly. Dividends represent a share of the profits the company has made.
- The gain or loss of the stock you own and the dividend you receive are the primary drivers for determining the rate of return on your stock investment.
- Stocks are traded on exchanges (NYSE, Nasdaq) based on what is called their “ticker symbol”. The ticker symbol identifies a specific company. For example, the ticker symbol for Walmart is WMT, and for Ford it’s F.
- Stocks can be purchased through a brokerage firm/company. Larger banks like Bank of America or Wells Fargo have their own brokerage company where you can purchase stocks directly from them. Online brokerage firms like Etrade, TD Ameritrade, or TradeKing sell stocks online directly to investors.
- Typically there is a fee for buying and selling shares of stock through a brokerage firm, rates vary but typically range from $4.95 to $7.95 per trade.
- Stocks are typically considered a risky investment because the value of a stock can fluctuate based on the company’s performance, market conditions, political events or even world events. In an effort to minimize risk – Stocks are generally considered a long-term investment.
- Liquidity – similar to risk, how liquid a stock is depends on its short or long-term performance. Buying a specific stock today and having that stock price drop 50% would cause you to lose money if you needed to sell the stock to use those funds to purchase a car or house. In this case, the stock would be viewed as not being a very liquid investment. However, a stock price that increases 50% in a couple days would allow you to sell the stock immediately and recognize the gain – making the stock very liquid. Because stock prices fluctuate in the short-term they are not considered an investment that provides immediate liquidity.
- Unlike savings accounts, CD’s, and Money Market accounts that are federally insured (FDIC) – stock investments are not.
The ideal scenario for owning stock as an investment vehicle is owning a stock (company) that has a track record of strong financial performance – the longer the better. Strong financial results will result in the stock price increasing over time and the consistent payout of dividends to its shareholders.
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When are Stocks a good investment option?
Because of the risk, lack of liquidity, fluctuations of a stock based on financial performance and various market conditions, investing in stocks for most should be considered a long-term investment.
To minimize risk most investors diversify their stock portfolio with companies that operate in multiple business sectors – like owning stocks in the technology industry and oil industry at the same time.
If you’re considering an investment in stocks that saying “don’t put all your eggs in one basket” definitely applies here. Starting with a small investment is a good way to learn about stocks and the stock market and whether you can handle the volatility of this investment vehicle.
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Do you invest in stocks? What’s your strategy? Comment below.