The stock market is constantly in the news, and people are always talking about buying and selling shares on the stock market. However, it seems invisible, abstract, and mathematical.
It is a very strange market, but it is also very important, so how exactly does it work? Here are the essential facts about the stock market.
What Are Stocks and Why Are They Traded?
Say you have a great business idea, like starting a brand new landscaping business. To get started, you need some money to buy equipment. You need gardening tools, gasoline, a truck, and maybe you want to rent a billboard to advertise your new company.
One way to do this is to get money from investors. In exchange for the funds needed to run your business, you give the investors a little piece of your profits. That is the point of the stock market, to raise money from public investors.
A stock is a little piece of ownership in the company in which you invest. They are also called shares, and the people who own shares are called shareholders. If the company does well, it will grow in value, and the shares will go up in price.
That means the shares are worth more than they were purchased for, and shareholders can sell them to collect a profit. Some companies will pay dividends or cash payments of their profits based on owned shares, and that way shareholders don’t have to sell shares to make money.
The basic principle of the stock market is to buy low and sell high and you can learn more about it starting with trading simulators. A skilled investor can buy the right stocks at the right time and sell them at the right price. This is a way to multiply your money or investment capital.
Capital is simply wealth in the form of money or other assets, like stocks or land. That is why it’s at the root of the term ‘capitalism.’ The stock market is crucial for raising capital, and most of the biggest employers are traded on the public stock market. They are called public companies.
Who Can Own Stocks and Make Money From Them?
The best thing about the stock market is that anyone can buy and sell publicly traded shares. These shares used to be pieces of paper that represented value or equity in a company, much like how a dollar bill represents value. However, today it’s all done electronically.
Individuals who buy their shares on the stock market are called retail investors, and they can make their purchases from a type of business called a retail broker. This is how most people invest in the stock market. However, the biggest buyers and sellers on the stock market are banks and large corporations. They are called institutional investors.
The most critical owner of stocks is the company that sells or issues shares of their business to the public. When public investors buy up their shares, hoping to make a profit, the money from the sale goes to the business.
The people who own and issue these shares from the company are called insiders, and they have to follow a specific set of rules so that they are fair and transparent about the stock they sell. These are the sellers that supply the stock for the public to buy.
Anyone can buy and sell these shares with a brokerage account, but they don’t always make money. It’s important to remember that every investment has risk, and you should understand how stock market investing works before investing your hard-earned money.
What Kinds of Stocks Can You Own?
There are many types of products on the stock market, and there are even more on the financial market in general. It’s best to understand the market as a whole before investing.
Common Stock
As the name suggests, this is the most commonly held type of stock on the stock market. Common stock represents ownership in the company and can also give voting rights to shareholders. If you own enough common stock, you can sit on the board of directors and have a say in how the company is run.
However, suppose the company is closed and all its assets are sold, a process known as liquidation. In that case, common stockholders can only access the company’s assets after debt holders such as preferred shareholders and bondholders.
Common stock is an excellent option if you are just looking to make returns in the stock market. In other words, common stock is the best choice if you just want to buy and then sell your shares in the stock market for profit.
Dividend Stock
A dividend stock is a special type of stock that pays out a cash portion of the company’s profits in scheduled installments called dividends. This stock is a great choice for investors trying to dividend invest, which is an investing method that seeks to maximize income from owning assets.
For example, a $10 stock may pay $0.10 in dividends every month. This is called a monthly dividend stock, and shareholders would receive $0.10 for every $10 stock they own. This is an example of a 1% monthly dividend, which is quite high. The dividend is paid in capital in excess of the stated value of the common stock.
The strength of dividend investing is compounding. You can reinvest the dividends, leading to exponentially larger dividend payments in the future. A diversified and well-performing dividend investing portfolio is a great way to build wealth and generate a steady income from owning assets.
Additionally, stock dividends are subject to special tax regulations. For example, T2 dividends paid to shareholders are subject to corporate tax. However, for 401(k) accounts and Roth IRA accounts, dividends can be held until retirement without tax burden.
Finally, one must consider the difference in monthly dividend stocks vs. quarterly dividend stocks. A monthly dividend stock will pay out a cash portion of dividends every single month. A quarterly dividend stock will pay every three months, and some annual dividend stocks pay yearly.
Preferred Stock
This type of dividend stock gives the owner special access to higher dividends and to company assets if a liquidation occurs. Think of it as a high-priority dividend stock. Preferred stock owners have priority access to dividends and receive larger payments.
In a way, preferred stock is a hybrid of stocks and bonds. A preferred stock generates a steady income while also presenting the opportunity to profit from increases in share price. The issuer can also choose to redeem preferred stock if they choose.
Fund Products
Choosing stocks is no simple task; for some, it is their entire career and focus. These professional investors will create investment funds to manage a large pool of money in stock and other financial markets. These funds are a collection of different stocks and investments distributed to generate the maximum possible return.
An everyday investor can buy a piece of these funds just like they would buy a stock, and they can benefit from the work and expertise of professional investors without having to pick stocks themselves. One of the most commonly owned funds is an index fund called the S&P 500, which is made up of the top 500 companies in the stock market.
There are many other exciting fund products on the market that focus on dividends, returns, growth, specific sectors, and much more. These funds are often a wiser choice than trying to pick stocks on your own. Many of them even outperform the general market by a wide margin, which is a challenging feat to achieve on your own.
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