WHAT ARE STOCKS AND HOW DO I INVEST IN THEM?
According Forbes and many other studies, the average stock market return since 1965 is over 11%. That means if you owned $10,000 in stocks, after 5 years you would have 16,850.58. Almost 7 thousand dollars for doing nothing… not bad.
When it comes to investing, the stock market can be a daunting subject. Any financial adviser will tell you that you should to get into the market.
New investors can easily suffer from “paralysis by analysis” syndrome, where you know you need to do something, yet you do nothing because of the dizzying amount of information out there. Although there are many investing options, the most widely known and invested in is “stock”. We will attempt to answer some of the more common questions about this primary investing vehicle.
What is a Stock, Anyway?
A stock is a single piece of ownership in a company. A company that offers stock, known as a public company, is a company that offers equal shares of ownership. Almost all large corporations offer stock, including McDonalds, Walmart and Honda. For example, if Apple Inc. had 100 shares of ownership to sell and you bought one of those shares, you would own 1 percent of the company.
A stock is an asset, or a piece of a company. If a company makes a profit and the value goes up, then each share of ownership becomes worth more.
Let’s say, for example, your 1-percent ownership cost you $10. After a few years of iPhone and iPad sales, the value of Apple as a company went up from $1,000 to $1,500. The increase in value of the company increased the value of each individual share from $10 to $15.
Many stocks will offer an added benefit of a dividend, which is essentially a cash “bonus” above the current value of the stock, as a “reward” for being an owner of a successful company. Dividends are normally paid out quarterly and many investors buy stock solely to receive these cash flow dividends.
How Many Types of Stock are There?
For our purposes we will address three types of stocks – common, preferred and unlisted(OTC).
Common stock is what most of us hear about on the news. The Dow Jones Industrial Average is a formula based on the common stock price of 30 large publicly traded companies. When you hear about Apple’s stock price each day, that price refers to the common stock. A person who owns shares of common stock has the benefit of voting rights in selecting the company’s board of directors, and in many cases some of the company’s chief executives. Common stock also gives the owner an opportunity to receive dividends and a piece of the company’s growth in earnings.
Preferred stock differs in that there are fewer shares compared to common stock, and preferred shareholders do not get voting rights. However, preferred stock is ahead of common stock in line if a company goes under – preferred stockholders will be paid first after all creditors are paid.
Unlisted stocks are often called OTC, or over-the-counter stocks. These stocks are usually directly issued by the company and are not “listed” on any stock exchange around the world. Most stock exchanges have criteria by which a stock may be listed, including the price, number of shares, as well as other regulatory guidelines.
How Do I Buy Stocks?
Most stocks are bought and sold on what is called a stock exchange, which is a marketplace where buyers and sellers can engage in trading. Most stock trading is done online. The daily price of stock is always fluctuating because of news, current events and supply and demand.
With online trading platforms like E-trade or TD Ameritrade, you can buy stocks on an exchange directly from your home for as little as $10 per trade.
Stocks can also be bought “over-the-counter,” which means they can be bought through a broker or from the company directly, depending on where you have your stock-trading account. These can be very high-risk investments, but careful investors have been known to do well.
What are the Risks with Stocks?
Buying a stock is literally buying a piece of a company and at the end of the day there is no guarantee you will get your initial investment back when you sell. If you buy a share of Apple for $10 and Apple has a very bad year to where the initial $1,000 value of the company drops to $600, your $10 share is now worth only $6. If you sell at this point, you would take a loss.
In a bankruptcy, stock holders are not creditors – they own the assets of the company, and when a company is bankrupt, a judge usually orders a company to sell assets to pay the debts. In the order of who gets paid, stockholders are in the back of the line. They get only whatever money is left after creditors are paid – and that may only be pennies on the dollar.
If you own a stock in a bankrupt company, you could easily come away with nothing.
Invest in great companies and you will come out ahead
If you are an investor, you will want to do your homework and invest in solid companies with a strong track record of growth. The stock market has historically gone up on a long-term basis, so if you approach it with a long view, you should do well. But always understand the risks, knowing that a bad investment could very well lose value. It is always wise to know what you are investing in, so make sure you have a broker or financial services professional on hand to give you the information you need to know. Happy investing!