What is a Stock
Stocks represent a share of ownership in a corporation. Put another way, if you own stock you are a shareholder. As a shareholder, you legally own a fraction of the company that issued the stock. This equity ownership provides you certain rights. The rights are different under two main classifications of stock. Common stock is the largest class when measured by amount outstanding. Preferred stock is a smaller class but still a very large part of the stock market.
Common stock shareholders have the right to participate in elections of board members and on proposals that would have a major impact on the company. They also have the right to participate in share value growth if the company enhances its value through, profit, growth, or increased assets.
Preferred stock shareholders also own a portion of the company but in most cases do not have voting rights. Owners of preferred stocks instead get to enjoy a stated dividend amount that’s paid to them before any dividend is paid to common stock shareholders.
Why Invest in Stocks
Investing in stocks is a way for an individual to provide themselves an opportunity to participate in capital appreciation (rising prices) and dividend payments (profit distribution.) Of course, there is no guarantee of either. In fact, there is always a risk of prices declining or the board suspending dividend payments. This possibility should also be viewed in any decision to invest in a company. Let’s note that there is also a risk that if your money is sitting idle, it could lose buying power to inflation. Inflation increases prices which erodes the value of your money. One of the most common arguments for investing in stocks is to outpace inflation.
Direct Stock Purchase versus Fund Ownership
Most individuals participate in the stock market in one of two ways. At the most basic level, they open a brokerage account and buy shares of companies they’re interested in owning. This is direct ownership. Direct stock ownership allows an investor to retain the voting rights for their holdings, dividends are also paid directly to them. A significant amount of individuals own stocks through mutual funds, (see What is a Mutual Fund.) These funds will exercise your vote for the underlying stocks in the fund. They do this depending on their view of what is best for shareholders. They also collect dividend payments and typically disperse them by increasing your fund share valuation.
Direct Purchase of Stocks
To trade stock (buy and sell) you’ll need a brokerage account. This account at a broker or broker-dealer will allow you to give orders to a stockbroker who will then place your order as requested. If you wind up buying or selling the stock, the order is considered filled or executed. The most common way to place an order is online or by phone.
Broker-dealers that provide research, trade ideas, customized portfolio screening, and execution are often referred to as “Full-service” brokers. Often investors do not want to do the research and follow the market, industry, and company trends – or whatever else they believe is important to be involved with stock investing.
Online brokers that cater more to the do-it-yourselfer provide platforms on which to transact. You can typically fund an account for $2,500 or less. They often provide access to historical prices, trends, and charts for you to use when making decisions. Online brokers cost a fraction of what is charged to place an order through a full-service broker. Most allow standard online stock orders for $10 or less per trade.
When directly buying or selling a stock you will typically be purchasing many shares at a time. Older convention suggested it was most efficient and therefore cheaper to buy and sell in “round” lots of 100 shares. Today, this is still the convention, but it is more out of tradition and not because of cost. You may place an order for 299 shares just as easily as you place an order for 300. The order will likely be executed at the same price, and your commission isn’t higher on the “odd” lot. What is critical to understand thoroughly are these three types of orders.
Market order
Limit order
Stop Order
A market order is you saying buy or sell at the best price you can get now, or as soon as possible. It doesn’t guarantee a specific price, but this order type will increase the chance of your order being filled. Any stock that trades actively is likely to be executed close to what you see as the price online.
When you place a limit order, you’re directing the broker to buy or sell at a price you specify, or better (beneficial to you.) If you’re new at trading, think it through before placing a limit order. Remember, if you’re selling you want the highest possible price if you’re buying you benefit from the lowest price you can get.
Stop orders can be used, for example, if you own a stock and want to limit your downside by placing an order at a price which you’d prefer not to drop below. This is why it is sometimes referred to as a “stop-loss” order. If the price is reached, your stop order becomes a market order, and you will be filled at the market.
You’ll also want to specify if your order is good until canceled (GTC) or for a specific time-period such as good until closed (GTC) which means once the market closes your order does not carry to the next trading day. The NYSE (New York Stock Exchange) regular trading hours are from 9:30am until 4 pm EST. It’s important to understand the lingo and terms used in transacting. Your broker will provide you with the terms and acronyms they specifically use before you place an order on their system. For example, one brokerage firm may say Good-Until-Cancelled, while another uses Open-Until-Cancelled. If you’re using a full-service broker, you’re likely to encounter less jargon.
Investment in Stocks through Mutual Funds
If your main intention is to be in the stock market to benefit from any growth or dividend payments, but you feel you don’t know enough about the companies available to invest in. Or, you don’t have enough money to diversify over at least a handful of issues, you may also invest in a fund which owns stocks.
Mutual funds will offer generic stock funds which are intended to track the performance of a popular stock index such as S&P or NASDAQ, or they can also be focused on a segment of the market such as high tech, or pharmaceuticals. There are even mutual funds which invest exclusively in the stock of companies that meet their definition of “ethical,” or “green.”
You may already be invested and exposed to stocks and not have realized. Most 401(k) and 403(b) accounts have various stock fund options available to you. Make sure if you’re calculating your percent of assets exposed to the stock market, that you don’t overlook counting your retirement assets.
