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Stock Investing. So What Are Stocks and Shares?

Mutual Funds

About Stocks

And no, we’re not talking about livestock! Actually, the word stock originally did come from the word livestock, but instead of trading cows and pigs we trade pieces of paper (or entries in an account) that represent ownership (shares) of a corporation. You may hear people refer to stocks as equities or securities, but the majority of people call them stocks, which means supply. After all, the foundation of the stock market is based on the economic theory of supply and demand.

Stocks Investing

Stock Investing. So What Are Stocks and Shares?

In order for corporations to do business, they must have money to make their company grow and expand. In order to get this money, they offer stocks and bonds to investors. Buying stocks in corporations makes you part owner. You share in the success (or failure) of the business. For every share of stock you own, you receive one vote; therefore, the more shares you own, the more of the corporation you control. Corporations sometimes issue different classes of shares, common or preferred, for example, which have different privileges associated with them.

The owners elect a board of directors who are in charge of making the company’s major decisions, most of the time these are the people who own the majority of the shares. Most shareholders just own a small sliver of the corporation, with little control over how the corporation is run and no ability to boss anyone around. You’d have to own millions of shares of stock to become a primary owner of a corporation whose stock is publicly traded.

What Happens to the Profit?

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Let’s say that a new corporation is created and raises $20 million by selling 1 million shares for $20 a share. The corporation buys its equipment, hires new employees, and finds real estate with that money. In the first year, when all the income and expenses are added up, the company makes a $1 million profit. The board of directors of the company decides what to do with the profit they have made. They have several options:

  • Put it in the bank and save it for a rainy day.
  • Give the profits to the shareholders, declaring a dividend of $1 per share.
  • Use the money to expand the company by investing in more equipment and hiring more employees.
  • Any combination of these three options.

Income vs. Growth

Dividends are portions of a corporation’s profits that are issued back to the stockholders. Dividends are normally distributed quarterly after the company’s board of directors reviews the company profits and determines whether to pay and how much the dividend will be.

A corporation that traditionally pays out most of its profits to shareholders is referred to as an income stocks or dividend stocks. The shareholders get income from the company’s profits. But if the company generally puts most of the money back into the business, it is called a growth stock. The company is trying to expand by increasing the amount of equipment and number of people who run it.

Invest In Stocks Summary

In summary, a corporation creates some stocks and shares and sells them to investors for an agreed upon price. The corporation now has money. In return, the investor has part ownership in the company and can exercise some control over it. The corporation can continue to issue new shares, as long as there is someone willing to buy them. If the company makes a profit, the board of directors decides whether to reinvest the money back into the business or to use some of it to pay dividends on the shares.

Bonds

Did You Know…?
More people buy bonds than invest in the stock market. They are especially popular among people who are nearing retirement.

There are a number of ways to invest your money besides stock. Where stocks make you part owner of a company, bonds lend money to a company with no right of ownership. Companies sell bonds to borrow money. If you buy a company’s bond you’re essentially holding a company’s debt or the debt of a government entity. The company, in turn, promises to pay you interest on this loan at regular intervals (normally semiannually), and agrees to repay the principal or face value of the bond at a designated date in the future when the bond matures. Bonds are like IOUs.

The big difference between stocks and bonds is that bonds are debt obligations and stocks are equity. Bonds have a fixed term. Stocks have an indefinite life and dividend payments can continue for as long as you own the stock. Bonds are considered safer than stocks because if a company files bankruptcy, bondholders are paid before stockholders. Also, with stocks there is a chance you could lose all your money if the stock value goes to zero.

Mutual Funds

Investing in mutual funds is an alternative to investing directly in the stock market. Mutual funds are created by companies who pool investor’s money together and use it to invest in an assortment of stocks, bonds, or cash (normally a group of people who have the same investment objectives and common interests). In a way, it’s like hiring your own professional money manager. The fund manager makes all the buying and selling decisions and determines what is best for everyone involved. It’s perfect for people who don’t have the time or knowledge to research individual companies and determine whether a stock is a good buy at its current price.

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Mutual funds have become popular. With a minimum investment of $2500, or sometimes less, you can buy a slice of a whole basket of stocks. If you are interested in investing in mutual funds, look in the financial section of your local newspaper. There are well over 7000 mutual funds to choose from, each with its unique style and strategy. When you find a mutual fund that meets your criteria, you send a check to the investment company. You can also trade mutual funds online.

But keep this in mind. Because there are so many different types of mutual funds, it’s wise to invest as much time in choosing the correct mutual fund as you would take to choose a stock. Look in the newspaper to see how well your mutual fund did during various periods, from yesterday to three years ago. The mutual fund corporations have done an awesome job in letting their shareholders know exactly what their performance records are. If you don’t like their investment performance, you can simply switch to another mutual fund.

Many people choose mutual funds because they allow diversification, which means that instead of investing all your money in only one stock (a risky move), you are able to buy a slice of hundreds of stocks. They are also good for people who have never invested in the stock market and are afraid to venture out on their own.

Mutual funds aren’t perfect. They can go down as much as stocks. Most mutual funds are designed to do well in bull markets and tend to fail during bear markets. Mutual funds have been known to go down as much as 70 percent in a bear market.

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