Stocks and investing. That’s why you’re here, right? To find out what a stock is exactly? Please don’t be embarrassed if you don’t know exactly what stocks are. You should never be embarrassed of where you are in your life at the current moment. Just work to move forward, gain knowledge, and learn. 🙂
That’s why you’re here!
So let’s get into it. Let’s figure out WTF stocks are and how they work.
(1) Stocks
I can’t tell you how many times that I have been asked, “What stocks should I buy?” or “What stock tips do you have?”
If I had a nickel for each time that someone asked me that I would have like $40 or $50. As I type that, it doesn’t seem like a lot of money, but it is a lot of times to be asked if I have any stock tips.
There are several different types of stocks, but I’ll keep it simple. It’s more important for you to understand the concept first before you get too fancy. I’ll explain the different types of stock in future articles.
A stock, simply put, is a piece of ownership of a company.
That means that when you buy a stock, you own part of that company, right?
Not exactly.
Technically speaking, when you buy a share of a company (AKA a stock), you buy a share that was created by the company. You don’t own a portion of the actual company.
Legally speaking, a corporation is treated as a legal person. The corporation can be sued, has to file taxes, can own property, etc. Just like an actual person. And just like you cannot own an actual person, you also can’t own an actual company.
I don’t want to get in the weeds too much with this, but just know that you can’t walk into the company headquarters and take an office chair because you own some stock in the company.
I wouldn’t say that if it hadn’t happened. Seriously.
(2) Benefits of Owning Stock
So what does a share of stock actually do for you? It means that you get to have a few benefits:
- Potential for higher returns than most other investments.
- You get to vote on the leadership of the company, dividend amounts, etc.
- Stocks are liquid. (A fancy way of saying that they are easy to buy and sell.)
- You might get dividends as well as the growth of the stock price.
Let’s dissect these one by one:
Potential for Higher Returns
At the end of the day, if you are an investor, you want to see the stock price go up. You want to buy a stock at $10 and it goes up over time. Once it goes up, you can sell it and make a profit. But if it goes down and you sell it, you will take a loss.
Stocks typically return a higher rate than bonds over time. (I’ll get into what bonds are and how they work in a future article.)
Since 1926, stocks have returned an average of about 10% each year, while bonds have returned an average of 5-6% each year.
You might be asking yourself, why would anyone invest in bonds if they don’t return as high of a rate? The answer is that in some situations, it might be more beneficial for someone to take on a lower rate of return but to also have less risk, than to take on more risk and the potential of a higher return. This topic is for another day, though.
Voting Rights
When you own common stock (which is what most people own), you can vote on certain corporate actions. You don’t have to vote if you don’t want to. And in fact, most people don’t vote. But you have the right to vote on the direction of the company to a certain degree.
You can generally vote on:
- Board of directors.
- Dividend payments and amounts.
- Some corporate actions (such as new company headquarters, mergers with other companies, etc.).
You will not be able to vote on decisions that affect the day-to-day of the company for the most part.
So if you own stock in Walmart, don’t think that you are going to be able to tell them to build a new store closer to your house or that they should start carrying a specific product that you like. They can’t drive to Bentonville and tell them how to run their business just because you own 4 shares of Walmart stock, Chad. So don’t even try.
Liquidity
This one is huge. It is really easy to buy and sell stocks in the world today. You can call up a financial advisor and them execute a buy or sell order for you if you want. Or you can download any number of free apps and buy and sell stocks with ease on them. There will nearly always be a buyer out there to match with a seller.
Dividends
These are pretty cool.
Dividends are basically overflows of profit that the company makes that they give to the shareholders.
So if you own a share of a company that is worth $100 and the company declares a 3% dividend you will get a check for $3. That might not sound like a lot of money but believe me, after several years of investing, I know people who live very comfortably on their dividend income alone.
Not all companies issue dividends. In fact, most don’t. Dividends are usually issued by older, mature companies like Procter and Gamble, Coca Cola, and Johnson and Johnson. A company like Tesla, or Netflix will probably not issue dividends in the near future (or maybe ever) because they plow the profit that they could pay out in dividends back into the company to grow faster.
Now that we’ve talked about the benefits of stocks. We need to talk about the draw-backs of stocks.
Now that we have gone over the benefits of stocks, we need to go over the potential drawbacks of investing in stocks.
(3) Drawbacks of Owning Stock
- Stocks are riskier than bonds.
- If the company goes bankrupt, you’re probably losing all of your money.
- It can be very emotional to invest in stocks.
Let’s dissect each one of these.
Stocks are Riskier than Bonds
As we’ll get to in a later article, bonds are boring. Yes, stocks will usually have a higher return (make you more money) than bonds, but there is also a higher potential for loss than bonds.
Not all stocks are created equally though. Some stocks are extremely safe (usually referred to as Blue Chip stocks). And some are extremely risky.
Remember, there is a direct relationship between risk and reward. The higher the risk, then the higher the potential reward. The lower the risk, then the lower the potential reward.
Bankruptcy Risk
If the company that you purchase stock in goes bankrupt that sucks for you. You won’t personally go bankrupt because you are in no way personally responsible for the debts of the company. But all of the money that you invested in the company is probably gone.
In the event of a corporate bankruptcy, there is a line of people who want to get paid. They include anyone on the current payroll, vendors and suppliers, the IRS, bondholders, preferred shareholders, and common shareholders.
If you own stock in a company, you will only get paid if everything else has been paid. And that rarely happens.
Emotions at Play
Emotional investing is dangerous. In order to successfully invest (in any financial product), you have to pretend you are a robot. You have to invest based on the analysis that you have done on the company and on math.
But that is really hard to do. When you see a stock going up and up and up, it’s hard not to get wrapped up in the excitement and buy and buy and buy.
Likewise, when you see a stock going down and down and down, it’s hard not to get scared and sell.
Final Thoughts/This is What I Do
Here is the bottom line. Do not invest in ANY stock unless you plan to keep it for the next 5 years at a minimum. Do not buy stock waiting for it to go up next week or next month. That is called day trading, and on top of taking on a big potential tax bill, hardly any day-trader is successful.
This is what I do. Instead of investing primarily in stocks, I invest in mutual funds. This allows me to buy little slivers of stocks in a whole bunch of companies. There is a much less chance that they will lose money, and even if a company goes bankrupt within the mutual fund, it’s okay. It won’t hurt me because I’m invested in hundreds of other companies.
I do have money in regular stocks. Just a small amount compared to the amount that I have in mutual funds.
To learn how mutual funds work, just read my article here.
I really hope this has helped you.
Remember, only you can create the life that you want!
Until next time!
0 Comments