What is a Stock?
As a CERTIFIED FINANCIAL PLANNER™, financial coach, and blog-writer, I can get caught up in advanced topics pretty frequently. I also tend to occasionally forget that not everyone is in finance as a career path. This isn’t usually a problem for me; however, it can be if someone I’m speaking to (or writing to?) isn’t familiar with some of the terms I’m using. Often, the problem isn’t even unfamiliarity as much as it’s that people know the terms; they just aren’t sure exactly what they mean. Because education is of the utmost importance to me, and to combat this issue, I’m going to be occasionally writing about some of the more essential terms and fundamentals of personal finance. So don’t worry… if you don’t confident about personal finance, or if you’re unfamiliar with a lot of financial terms - you’re in the right place!
Just about everyone knows what investing is. At least at the most basic conceptualization, it’s simple. An investment is something that you put something of value into and hope to get more value out of (I know this is a simple definition, but it works). Most of the time, the value (coming from either side) is money. Most of us also know that there are different forms of investments - stocks, bonds, property, etc. However, the issue is that for most people, that’s about where the knowledge stops and the uncertainty begins. Today we’ll be focusing on just one of those investments: stocks.
What is a stock?
Nerdwallet defines a stock as “…a type of investment that represents an ownership share in a company. Investors buy stocks that they think will go up in value over time.” That is what a stock is, but I know for many that definition may not mean much at a surface level. You can think of a stock as a form of currency that can be bought and sold. While most currency represents something (usually government backing), a stock represents a company - or, more specifically, a piece of a company. Stocks are bought speculatively, meaning that people purchase them in hopes of gaining a return in one way or another. There are also different types of stocks.
There Are Different Types of Stock
There are two main types of stock. These are called common and preferred, and each has its own specific pros and cons. If you’re exclusively looking to make money - you may opt for preferred stock, while if you’d like more control in a company, you’d likely want common stock. (remember... it's important to do your research before investing in ANY Company or asset!) Here’s a little more about each type.
With common stock, you’re the last to get paid but get voting rights in a company. As a common stockholder, you get to cast votes that are representative of your ownership percentage in the company. Usually, these votes are for who will be a board member in the company your stock represents. Like I said earlier, one of the downsides of being a common stockholder is that you’re the last to get a pay-out. You come after debt, preferred stockholders, and other expenses. This means that there’s a possibility you may not be paid any dividend if you’re holding common stock. The price of common stock is also subject to change and does so frequently. This means that you may purchase a stock at one price and sell it at a lower one (a net loss). Alternatively, you may buy it at a discounted price and sell it at a premium (a net gain).
Preferred stocks don’t get voting rights but are in line before common stockholders when it comes time to get paid. This means that preferred stockholders don’t get to vote on major policy issues in the company or board members. This is true no matter how much-preferred stock you hold in a company. The flip side of the coin is that you’re the first to receive a dividend in good times, and in bad times you have more of a claim to the company’s assets in the event of closure and liquidation.
How Stocks Make Money
So now that we have more of an idea of what a stock is and understand the difference between the two main types of stocks, how do you make money with them? The answer to this is multifaceted. There are a few ways to make money using stocks, and how you do it depends on your financial situation, financial plan, and how risk-averse (or how willing you are to take on monetary risks) you are.
With dividend paying stocks, you can make money by purchasing a stock and holding it. Through holding it, a company will issue regular dividends during thriving times. If you’re confused by what a dividend is, it’s essentially a reward payment to stockholders in the form of cash or more stock. These can be issued in regular periods, like monthly, quarterly, yearly, etc.
You could also make money by speculating with stocks in a few different ways. Firstly, you could trade stocks short term. This means that you’re buying stocks and not holding them for long periods of time in hopes that you’ll make money. (Consult your tax advisor when doing this to learn more about tax implications) People typically do this based on fundamental benchmarks of stocks or upcoming events or announcements that they think will affect the stock in one way or another. You could also invest long-term in stocks. Typically this entails purchasing a stock and holding it for a more extended period (think a year or longer), and hoping the stock price will rise over time so that you make money. The most risky way to try to make money with stocks is by day trading. While some do this as a hobby, most who do it pursue it as a career. Day trading essentially means buying and selling large amounts of stock over the course of the day. This can be incredibly risky, and I wouldn’t recommend it to the average investor. You also are required to keep $25,000 or more in a day trading account at all times by FINRA (if you don’t, you could have your account frozen), so it’s not for everyone.
Should You Put Stock in Stocks?
Without meeting someone in person, it’s difficult to say if and or how much they should invest in what way. As with most parts of personal finance, investing in stocks should be highly personalized and custom fit to each person. In other words, think of investing like a nice suit or dress. It’s something that needs to fit you exactly; there’s really no one-size-fits-all because everyone’s different.
A CERTIFIED FINANCIAL PLANNER™ Can Help you create a customized financial plan that includes investing in stocks
If you’d like to learn more about stocks, how they work, and how you can utilize them in your financial plan, please, feel free to call or email to schedule an appointment with me. Together we can create a financial plan that helps you make the most out of your money and investments.
Until next time...this is Melissa Making Cents!
Melissa Anne Cox, CERTIFIED FINANCIAL PLANNER™, is also a College Planning and Student Loan Advisor and Financial Coach in Dallas, Texas.