Investing in stocks can be a great way for you to passively build wealth over time. Investing wisely and with patience can effectively yield returns that increase your income. Getting started boils down to learning how the stock market works, determining your goals, and deciding how much risk you are willing to take on. Use this guide as a resource to begin your stock-investing journey.
What Are Stocks?
As equity investments, stocks represent ownership in a company. When you purchase stock in a company, you technically become a part-owner. Businesses typically issue stock to raise money in two ways:
- Common stock entitles the stockholder, you as the investor, to a share of the company’s profits.
- Preferred stock comes from a predetermined dividend payment.
When most people talk about purchasing stocks, they are usually talking about common stocks.
You make a profit from stock investments when the share prices increase or from quarterly dividend payments. Your investments will accumulate over time and can produce a great return due to compound interest, which is when your interest begins to earn interest.
Stock Price Fluctuations
The stock market functions like an auction. In the market, buyers and sellers can be individuals, corporations, or governments. A stock price goes down when there are more sellers than buyers. The price of stocks increases when there are more buyers than sellers.
How successful a company is doesn’t influence its stock price directly. However, the investors’ reactions to this success or lack thereof can make stock prices fluctuate. More people will want to own stock in a company if the company is performing well, which will make the price of the stock go up. When a company underperforms, investors no longer want to own the stock.
Stock market capitalization is a number that equals the total number of shares outstanding multiplied by the share price. A company’s market cap will be $200 million if it has 2 million outstanding shares priced at $100 each.
The market cap allows investors to evaluate the company against other companies in the industry based on the size of the organization. A small-cap company should never be compared to a large-cap company.
A company can create a split when it increases its total shares by dividing up the shares that it currently has. If you own 100 shares priced at $80 per share, you’d have 200 shares at $40 each if there was ever a split. While the number of shares can change, the total value does not.
These splits occur when prices increase in a way that is disadvantageous to smaller investors. By creating a larger buyer pool, they keep the trading volume high.
Value vs. Price
Stock prices have nothing to do with a company’s value. A company with stock priced at $100 per share could potentially be more valuable than a company with stock that trades at $1000 per share because share price means nothing without value. On the contrary, organizations may keep stock prices high by avoiding a stock split because they believe the high price gives the company a more prestigious feel. Hence, what you really need to look at is a company’s price-to-earnings and net assets to determine if a stock is over or undervalued. For these reasons, it is essential for you to not make assumptions or stock market predictions based on price alone.
Dividends are payments to investors that are made on a quarterly basis, and dividend investments are ones that issue those dividend payments. These types of stocks produce passive income that many investors appreciate because they can make money from the regular payouts and the growth in price of the stock simultaneously.
Sometimes companies increase dividends to attract investors when the company itself is in financial trouble, so you can’t judge a stock by dividend price alone.
In poker, the most valuable chip color is blue, which is where this type of stock gets its name. Companies with a history of paying consistent dividends regardless of economic conditions are considered to have blue-chip stocks because they are seen as extremely desirable.
Many investors like these stocks because they consistently outperform inflation. An owner with one of these stocks can increase their income without buying more shares.
Preferred stocks are different from common stock shares that many investors own. Holders of this stock receive dividends first and will get paid even if there’s a bankruptcy. Preferred stock prices don’t fluctuate like common stock prices, so gains can be missed when companies experience hypergrowth.
A kind of hybrid between common stocks and bonds, preferred shareholders don’t get any voting rights in company elections.
You can find stocks in many ways. Companies that sell stocks tend to have research tools available for use, and there are plenty of online resources that can inform you about new companies too. You can look for trends and companies that are in a position to have a promising couple of years in the upcoming future. Additionally, some employers may even offer the company’s stocks and other investment opportunities as a form of unique benefits.
Consider diversifying the stocks that you invest in by looking for stocks in different companies and different industries. A diversified portfolio will have more securities such as bonds, as well.
How to Buy Stocks
Buying stocks is easy if you use a brokerage account or an investment app. Investment apps give you the ability to buy, sell, and store your stocks on your smartphone easily. The only differences between these two methods are the fees and resources.
How to Choose a Stockbroker
You can easily buy stocks from a stockbroker. There are two main types:
● Full-service: These brokers tailor recommendations for you, so they charge high fees, including service charges and commissions. Because these individuals provide research and resources, many investors are happy to pay a premium.
● Discount: With a discount broker, you’ll be doing the majority of the research yourself. A discount broker lets you perform trades and provides customer support.
If you’re a newer investor, you might want to spend the extra money to go with a full-service broker who can guide you. More experienced investors who learn how to perform their own research can go with a discount broker and avoid paying fees.
Timing is critical for both buying and selling stocks. The objective is to buy when a stock’s price is low and sell when it is high in order to claim a profit. There are plenty of strategies to consider, although each investor needs to decide their preferred strategy themselves.
Stocks and Taxes
Any profit you make when selling stocks is taxable. The specific tax that those gains are subject to is usually determined by how long the investor held onto that stock. Your dividends are also taxable, so it’s important to use tools like tax software so that you make sure you know how much you owe and can stay ahead on your tax situation.
Getting Started With Stocks
Learning how to invest in stocks is only the beginning, and it takes time. Once you’re well on your way and get the hang of it, you can begin making better stock purchasing decisions. Make sure that you stay updated on the stock market and try different brokers along with trading apps so that you can diversify your profile for the best return on investment.