Understand the basic concepts of stock market investing
Everybody about the stock market, but not everyone has a sound understanding of how the stock exchange works. Many investors see the stock market as a way to get rich quick, but if they don’t understand their investment, or how stock works, they could be in for trouble.
Before investing, it’s a good idea to get a handle on some of the fundamental risks and benefits of owning stocks.
A stock is a security in the form of shares, representing partial ownership in a company. Stockholders are also called shareholders, and shareholders who buy stock are buying an interest in the company. Shareholders then hold a claim on the part of the company’s earnings and assets, and collectively, shareholders own that company. Each shareholder’s ownership depends on the percentage of shares purchased, or the number of shares owned by a given individual divided by the total number of shares sold by the company.
A company can raise money in two ways: by borrowing money, referred to as debt financing, or by selling a portion of the company through stock, known as equity financing. Shareholders who purchase the stock have the potential to make money in two ways: through dividends and/or through capital appreciation.
Dividends are taxable payments paid to shareholders by way of the company’s earnings. Dividends are based on the company’s performance and are not guaranteed. When a company is profitable, it may decide to pay dividends to shareholders, or it may choose to reinvest profits back into the company instead. Shareholders can also earn money through capital appreciation. Capital appreciation is an increase in the market price for a stock or the difference between the amount initially paid and the stock’s current value when resold.
Shareholders have the potential to make money from dividends and/or from capital appreciation, but they can also lose money if the company performs poorly. The value of stocks is based on a company’s performance on the stock exchange. Shareholders can trade their stocks on the stock exchange, and when sold, the shares can be worth more or less than their original cost.
There are two kinds of stocks: common stock and preferred stock. Both represent a share of ownership in a company, but each type is slightly different. Shareholders of common stock typically have voting rights on major business decisions, such as electing the company’s board of directors, with one vote for each share of common stock owned.
Shareholders of preferred stock do not have voting rights. However, if a company pays dividends, preferred stockholders receive their dividends before common stockholders, who may or may not receive dividends depending on the decision of the board of directors. Common stock is often chosen by investors who plan to make more significant sums of money in capital appreciation, while investors seeking steady dividends usually select a preferred stock.
Stockholders have the potential to make money from dividends as well as from capital appreciation if the stocks increase in value. Stockholders also can lose money if the company does poorly and stocks decrease in value. The value of the shares fluctuates with changes in market conditions.
Investing in stocks involves risk, and a general rule of thumb is that the greater the risk, the greater the potential reward. However, a risk is always involved, and investors should be sure they know the risks as well as the potential benefits before deciding to invest in stocks.
