Stocks, company shares or equities are a fundamental part of many investors’ plans to grow their wealth. Despite their common name, stocks aren’t easily understood and can be confusing for new investors.
A share of stock is a fractional ownership of a corporation or company. It can be bought or sold, either privately or through exchanges like the NASDAQ. These transactions are closely overseen by governments and companies to prevent fraud, protect investors and benefit the economy.
Companies issue stock to raise money for growth projects and other operations. Different types of stock, including common and preferred, offer different rights and benefits to shareholders, such as dividends and price appreciation. A company’s total value, called market capitalization, is calculated by multiplying the number of shares outstanding by their current price.
Investors buy and sell shares to earn income and build long-term wealth. Stocks are one of the core tools for saving to fund retirement and other financial goals, but they can be risky investments because prices aren’t always rising. A drop in prices could wipe out your savings balance and may even make your shares worthless.
While there are risks to owning shares, over the long term, they can provide strong returns on your investment. That’s why they’re often the main source of income for most retirees and savers.
Stock prices are driven by supply and demand. Supply is the number of shares being offered for sale at any given time and demand is the number of people willing to buy them. Stocks trade on public exchanges, where the supply and demand are more transparent than private transactions.
The stock market is made up of thousands of individual companies with millions of shares. It’s important to diversify your portfolio by investing in a variety of companies, big and small, and by sector, to minimize your risk and maximize your potential return.
When you invest in a stock, you’re not personally liable for the debts of the company if it goes bankrupt. That’s a significant advantage over other types of investments, such as partnerships. In a partnership, creditors can seize personal assets such as cars and houses to pay off any debts the partners are unable to pay.
Another way investors can make money is through capital gains, which are the additional proceeds from selling a stock after paying any applicable taxes. This can happen when the value of a stock rises significantly over time, or when you purchase a stock at a low price and then sell it at a higher price. When you sell your shares, any profits will be taxed as capital gains in the jurisdiction where you live. This is a major reason why it’s important to keep track of your cost basis and earnings when you sell shares. Especially with larger gains, the tax bill can be significant. Investors who want to avoid or reduce their capital gains taxes can short sell, which involves immediately selling borrowed shares and then buying them back at a lower price (covering). This strategy is used by traders seeking to generate immediate cash or hedge against falling stock prices.
