What is a stock?
Stocks represent ownership in a company. The amount of ownership depends on the number of shares owned versus the number of issued shares. For example, if a company issued 100 shares of stock and you buy 5 shares of stock in that company, you own 5% of the company. As a stock owner, you are entitled to any earnings the company makes, any assets it owns and have certain voting rights. At the same time, you have limited liability. Stock owners are not personally liable for any loans the company may make.
A stock literally is a certificate of ownership in a company. In the old days, stock owners actually traded stocks with certificates by taking them to a brokerage before a trade was made. Nowadays, most brokerages hold the certificates electronically for their clients and trades are made in a matter of seconds.
Why are stocks issued?
Most companies start small and are private companies. We’ve all heard the stories of companies such as Dell that made its humble start in a garage and grew to be a multi-billion dollar success. How did Dell get there? Well as a company grows, it sometimes needs an infusion of money to keep pace with its growth. This money can either come from borrowing from a bank or by raising capital through issuing shares of stock. The great thing about issuing shares of stock versus borrowing is that the company doesn’t have to pay any of the money back. Instead, share holders buy into the prospect of the company’s value and stock price, rising in the future.
How can you buy stock?
Buying stock can be achieved in many ways. The first way is by opening an account with a brokerage such as E*TRADE or Scot trade. These accounts are much like bank accounts where you can deposit and withdrawal money. In fact some brokerages you can also write checks against any cash balance in your account. There is normally an initial deposit minimum of $500 to $1000. This is the balance that you will make your trades with.
DRIPs or Dividend Reinvestment Plans are also a way of buying stock through a company. They allow investors to invest small amounts of money are regular intervals.
Another way of buying stock is through a retirement plan such as an IRA. Again you can open an IRA account with many of the popular brokerage accounts. The main difference is that your capital gains are not taxed every year like a traditional brokerage account. Also you may not withdrawal your balance until a certain age or you face a hefty tax penalty.
A company’s 401k is another way of buying stock although you don’t really have the flexibility of choosing the individual stocks, but rather pick a mutual fund that purchases certain stocks for its portfolio.
Risks vs. Rewards
Owning stocks can be risky business as not every business is successful and in fact many go bankrupt. Some stocks are riskier than others, but the potential for reward is also greater. In the stock market, there is normally a correlation between risk and reward. Buying a stock like Wal-Mart may not be as risky as a smaller company, but also may not give you much upside potential as far as an increase in stock value. Everyone has their own risk tolerance and this should be considered before purchasing certain stocks.
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