How to Invest in Stocks — The Basics
Written by: Kristy Welsh
Last Updated: August 18, 2017
Fortunes can be made or lost investing in the stock market. Investing in stocks in one of the best ways to create financial security and generate wealth. Whether you are beginning to save or already have a nest egg for retirement, your money should be working for you. Buying and selling stocks is one way to increase your wealth, but you need a solid understanding of how the stock market works and how to invest wisely. This article covers only the tip of the iceberg, but it should give you a general idea of using stocks as an investment tool.
What are Stocks?
To put it simply, a stock is a share in the ownership of a public company. Stocks represent a claim on a company's assets and earnings. When you buy a stock, you are in essence buying ownership in a company and these stocks are called "equities."
Why Would a Company Issue Stock or Shares of their Company?
Stocks are sold by the original owners of a company to acquire additional funds to help the company grow. This is called the Initial Public Offering (IPO) and the owners are basically selling control of their company to the stockholders. After the IPO, the shares are then resold on the stock market.
What Determines the Price or Cost of a Certain Stock?
Stock prices are driven by the expectations of a corporations earnings, or profits. If traders think a company has high earnings or maybe their earnings will increase in the future, they bid up the price of the stock. So, if you buy a stock at $2 and say this company has a record year in earnings and now their stock is selling for $10, you can sell you stock and make a nice profit. But beware, the opposite can happen, too, and you will lose money.
How Do Stockholders Make or Lose Money?
A stockholder will make money on a stock as indicated above, buy the share at a low price and sell it later at a higher price. Another way stockholders can make money on a stock is through dividends. A dividend is a quarterly payment distributed to the stockholders based on the profits made by the company. The company's board of directors pays dividends out of earnings as a way to reward the stockholders for their investment.
On the flip side, a stockholder can lose money if they bought a stock at certain price and now that stock is selling for a price lower and they sell the stock at this lower price. A stock price will go down if a company is not doing well financially or maybe the products/services offered by this company are no longer needed and this company has fallen out of "favor" by the public.
Types of Stocks
There are two types of stocks; common stocks and preferred stocks. The stocks you see tracked by the Dow Jones or S&P 500 are common stocks. The value of these stocks depend on how they are traded at any given time.
Preferred stocks can be issued by a corporation and these have the properties of both common stocks and bonds. Their values rise and fall along with the company's common stock prices, but they are like bonds in that they always make a fixed payment. It is for this reason most preferred stockholders do not sell their shares.
What Kind of Investor Will Use Stocks in Their Portfolio?
In a recent article published by Forbes, 43 percent of Millenials identify themselves as conservative investors, whereas 27 percent of Gen-Xers and 31 percent of Boomers do. Also, 43 percent of Millenials said they would never be comfortable investing in the stock market. It seems that Millenials are more likely than any other generation to be "risk-adverse" and keep 52 percent of their savings in cash. So, the older the investor, the more likely that person is to invest in stocks.
Terms to Be Familiar With Before You Start Investing in Stocks
Before you jump into the world of stock buying and selling, you need to become familiar with some commonly used terminology.
NYSE, SEC, NASDAQ — These are stock exchanges and act as a clearinghouse of sorts for buying and selling stocks. Each exchange buys and sells certain stocks and each one plays a major role in our global economy.
Stockbroker — A stockbroker is a regulated professional who is usually associated with a brokerage firm, who buys and sells stocks for clients. In return for his/her services, a stockbroker is paid a fee or commission. In the U.S., a stockbroker must pass both a Series 7 and either a Series 63 or 66 exams in order to be properly licensed.
Commissions — Before you open up an investment account, you need to consider the costs you will incur from buying and selling stocks. There are a lot of investment companies out there so do your homework and find out all their costs associated with trading stock. You will be paying a commission to the firm or stockbroker when you buy and sell stocks.
Diversify — Diversification means investing in a wide range of assets so you reduce the risk of losing all of your money based on one company's performance. To coin an old adage; "Don't put all of your eggs in one basket." Buy stock in different companies that offer totally different products. For example, maybe buy stock in Apple and then buy stock in a Utility company. Completely different products with completely different markets.
Are Stocks a Good Thing to Have in Your Investment Portfolio?
As we stated before, diversity is a good thing when it comes to investing and having different types of investment tools in your portfolio. The best advice we can give it to talk to a financial professional before you risk a lot of money in any one investment. And, always do your homework and be an educated and informed investor — don't leave it all up to others since it is YOUR money they are dealing with.