A stock gives people (investors) the ability to be a part of ownership in a public company. Say you like this company, ABC Company, and you want to participate in its potential growth. You invest some of your hard-earned money into their stock. You have $5,000 to invest. ABC Company's stock is listed at $50 per share. This works out to you owning 100 shares of ABC Company.
You can make money by owning a company in one of two ways:
- The price per share could go up. If you invest $5,000 at $50 per share and the stock goes up to $60 per share, you just made $1,000.
- The other way is by a dividend. A company pays dividends to reward its shareholders (the people that own the stock) by returning a portion of its earnings for that year, quarter, or month (depending on how often they pay out dividends).
A few things I'd like to expand on regarding the above two points:
- The price of the stock may go up and it may look like you've made money, but you really only actually make money when you sell the stock. Before you sell it, you'll either have an unrealized gain or loss (depending on what the price of the stock is now compared to what it was when you initially bought it). When you ultimately sell, you realize that gain or loss.
- As I mentioned, a dividend is a portion of the company's earnings. When you go to a company's stock listing (via Yahoo Finance or another platform), it will show a dividend yield. That data point is listed as a percentage, and that percentage is a reflection of the dollar amount of the dividend compared to the price per share of that stock. If you receive a $5 dividend for a stock priced at $100/share, the dividend yield is 5%.
Now that we have the technical details about stocks out of the way, it's time to talk about your decision to invest in stocks and what the implications are.
Investing in stocks, and the broader stock market is a good way to make your savings go further by having it work for you. Historically, this has been how a lot of people have been able to fund their retirement. They saved their money into a retirement savings vehicle, like a 401(k) or an IRA (more on those types of vehicles in the future), and the investments within those vehicles grew.
There's a risk-reward dynamic that you need to be aware of, however. When you invest in a company, there's a chance your $10 stock becomes a $100 stock, and you 10 times your money. There's also a chance that it goes to zero and you lose what you put into it. The dynamic is, the more risk you're willing to take, the greater the opportunity there is for a large return. The inverse is also true. If you're unwilling to take risks, your money won't grow as much.
Now when it comes to what happens when you sell a stock. You'll either have a realized gain or a realized loss. And for sake of discussion, let's just say you're investing using a standard brokerage account, not a retirement account because the taxes are treated very differently with retirement accounts.
When you realize a gain, you owe capital gains taxes on that gain. The percentage you owe depends on your income, but the three brackets are 0%, 15%, and 20%. When you realize a loss, you're able to deduct it from your gains, or if you don't have any gains, use it as a deduction on your tax filing. I won't dive into taxes too much, as we will discuss them down the line. There's also the topic of different types of companies, industries, and geographic areas which are all used and needed to discern your investment portfolio. That will also be discussed at a later date.
For now, we'll wrap up this post about stocks. Please don't hesitate to reach out and ask questions.