If you're reading this, it's probably because you want to learn more about investing. Either you heard about it somewhere, or see its potential, or feel like it's something you should start doing. If you don't know anything about it, put simply, investing is taking money and making more money with it.
Besides being really fun, it's one of (if not THE) best way to build wealth and achieve financial success. There are many ways to do this, but stocks are a super common and super straight-forward way to start investing. In this post, we cover everything from what is a stock, to how to start investing right now.
What Exactly is a Stock?
So, what exactly is a stock? Well, in one sentence, a stock is a piece of a business that you can trade with others for agreed-upon prices. In fact, stocks of a company are often referred to as ‘shares' because the company is being split up and shared.
“That's crazy; you're saying if I buy a Google stock I OWN a piece of Google?” YES, absolutely you do! A very very very very very small piece of Google, but definitely a piece.
In fact, if you buy enough Google stock, you can actually VOTE on what happens inside the company. (Yes that's right. If you owned enough of the company, you could theoretically decide to increase Google Drive storage for all students.)
This might be hard to conceptualize so here's a quick case that might help.
A lot of people use the typical “lemonade stand” as a basic business example, but today we are going to be using an online business as an illustration (keeping up with the times.)
Let's say you have a knitting business called CovidSocks. You knit socks and sweaters and hats and sell them online. People pay you money for your knitted creations and you ship them via FedEx or some other delivery service.
You start small, knitting once a week, but slowly your business grows more and more. Before long, you are knitting non-stop for 8 hours every day. It's exhausting. You decide that you want to buy a knitting machine to make things easier for yourself. But, you don't have enough money to pay for the machine. So what do you do? You decide to sell shares of your company through STOCKS.
Someone can buy 1 stock for the price of $500 and each stock represents 1% of your company. Because of the killer price, lots of people buy this stock, and pretty quickly, you raise enough money to buy that knitting machine. BUT, now all of those owners have a say in the company: if they don't like what you're doing, they can sell their stock back to you and you have to return their money. Moreover, the owners of the stock can now go around and sell the stock to other people who will then own a piece of CovidSocks.
Benefits of Stocks
You might still be wary about stocks, but the pros truly outweigh the cons in the long run.
If picked right, stocks can help you amass huge amounts of wealth. As an example, if you simply tracked the general stock market for the last 50 years, you would have an annual return of around 10% per year! If you had invested $20 every week into the stock market starting 50 years ago, you would have 1.5 million dollars today. Most of that money is actually in gains earned from the stock market, with only around $50,000 being actual money you put in.
How is this possible? The power of compounding and the power of time.
Why Do the Price of Stocks Change?
Put simply, stock prices fluctuate because of supply and demand. Think of Gucci bags. Why are they worth so much? “Because they're fashionable.” Maybe, but imagine for a second if every single person on this earth had a Gucci bag… would you still be willing to fork over $1000 for one?
I imagine that you answered no. And that is basic economics: the more people want a limited thing, the more it is worth. In regards to companies, they are typically “wanted more” when the public thinks that they are doing well and have a bright future. Emphasis on “thinks”. The best company ever could have the lowest stock price if people think it's not worth much. On the other hand, the worst company ever could have the highest stock price if people hype it up and think it is the future.
Let's go back to the knitting example. As you grow, you set up your website, partner with big companies like Walmart, and become more and more popular. After a while, people see this and this popularity causes your stock price to increase:
“Can I buy that stock of CovidSocks that you own?”
“Mhmmm, I don't know, I really like the company and don't want to sell it to you.”
“Oh come on… I'll give you $550 for it!”
“I don't know… they're really popular now and I can see them going places in the future which makes me want to own a little piece of the company when they're big.”
“$600! I'll give you $600 for the stock!”
“…Ok fine, sold!”
Because the buyer and seller saw a piece of CovidSocks as more valuable than $500, they raised the price of it. Now, whoever owns a stock of CovidSocks will be able to sell their stock for more because people are paying $600 for it. Their stock is “worth more” now. But the reverse can also be true:
“Do you want to buy my stock of CovidSocks?”
“Heck no… did you see the news? CovidSocks is smuggling money and the quality of their knittings is getting worse and worse!”
“Ahhh, what about if I sold it to you for $400?”
“No way! The most I'd pay for this failing business' stock is $300!”
“OK take it! I'll sell it to you for $300!”
When bad news comes out about companies, their stock price often takes a hit because people think the company will do poorly in the future.
How to Make Money Off of Stocks
There are 2 ways that you can make money off of stocks:
- Capital gains
Capital gains are just a fancy way of saying “buying low and selling high.” Right now, Apple's stock is at around $130. Let's say I bought it today and the stock price jumped to $150 tomorrow because they surprise-released the iPhone 14 with 7 cameras. If I sold at $150, my capital gain would be $20 (150-130). Capital gains are the most common way that people try to get rich off of stocks: it's what stock traders chase all day long.
Contrary to what math might teach, stock dividends are not the second term in a division equation. They are actually like little rewards companies hand out for owning their stock. In the case of CovidSocks, I might be so happy that you bought my stock that I issue a dividend of 10%. What this means is that every year you own my stock, I pay you %10 of whatever value you hold. If you hold $500 I'd pay you $50. If you owned $10,000 I'd pay you $1000. Dividends are great incentives to keep holding onto a stock, and also a great source of passive income!
CovidSocks (sadly) doesn't exist, so let's use a real-life stock to base this example on. The stock we will be looking at is of a fast-food restaurant that we all know and love: McDonald's. I want to find out how much money I would have made if I bought 1 share of McDonald's exactly a year ago and sold it today.
The information we need for this is:
- Price of stock 1 year ago: $198
- Price of stock today: $212
- Dividend yield: 2.4%
Capital gains = $212 – $198 = $14
Dividends = $200ish x 2.4% = $4.8
The reason I put “200ish” is because the dividend is issued 4 times throughout the year and the stock price can fluctuate. I just decided to take a number in between last year's price and this year's.
With the capital gains being $14 and the dividend being $4.8, I would have made around $19 had I bought McDonald's stock one year ago and sold it today.
What Stocks Should I Buy?
Here's the part of the post where I could get in trouble. Just as easily as you can make money on stocks, you can also lose all of it. Things could be going great but one day, your portfolio drops to zero and you can point a finger at certain websites and say “I'm suing you because you made this stock recommendation and it cost me money!” So this is a big disclaimer that I am NOT making any stock recommendations and that you should definitely seek out a professional's advice before making ANY financial transactions.
After reading that, you might think “Jeff said my portfolio could drop to zero but what if I buy stocks in companies like Google. Google will never fail!”
The possibility of Google dying is very slim, but there is still that possibility and you need to understand the risks of every stock before you buy it.
I personally don't trust my own judgment at all! This is why I prefer to invest in ETFs and index funds. I have a whole post about it, but ETFs and index funds are basically baskets of many many stocks instead of just one. This way, as long as most of the companies do okay, a few can still fail and I won't lose money.
Things to Consider Before Buying a Stock
Some questions to ask yourself before trying to make money off of stocks are:
- How long am I planning to hold on to this stock?
- What will I do if the stock price drops 10%? 20%? 50%?
- What does this company do?
- How does this company make money?
- Does this seem like a company that will still make money in 10 years?
- Do I believe in this company's mission?
- Who makes the big decisions at this company?
- Do I trust these people to keep the company alive?
- How much money am I ok with losing forever?
If you answered “I don't know” to any of these questions or they make you uncomfortable to think about, you should not be investing in the company's stocks.
Here are a few more indicators that you should not be buying a certain stock:
- You need the money in less than 5 years
- You think you are going to get rich quick off of stocks
- You don't have a plan
- You are tempted to sell when the price goes down
- You are going to check the price of the stock every day to see how it's doing
Fees to Watch Out For
Like most things in life, there are always hidden fees to watch out for when buying stocks. The three main ones are commissions, transfer fees, and taxes.
- You pay these as a fee to the financial institution buying stocks for you
- They can range from $0-$20 per transaction
- Even though $20 doesn't seem like a lot, it adds up really quickly
- Do the research and ask financial institutions what their commission fee schedule is like
2. Transfer fees
- You pay these when you transfer from one financial institution to another
- They are typically undisclosed when you sign up for an account
- They usually range from $50-$150
- You pay these when you have capital gains or get dividends
- 50% of any gains you make are taxable
- The only way around this is through tax-free and tax-deferred accounts
How to Start Buying Stocks
With all of these scary possibilities and hidden fees, you might be tempted to drop the idea of stocks altogether, but with the right research and plan, they can be an extremely powerful investment vehicle. If you're interested in trying your hand at stocks, here are the steps you can take to buy your very first stock.
- Research various online brokerages (these are the financial institutions through which you'll buy a stock.)
- Find one that has the lowest fees and cost or that fits your plan.
- Go to their sign up page
- Fill in your information (you'll need your Social Insurance Number for this)
- Follow their steps
And that's it! Opening the trading account is the easy part, picking winning stocks is a different question altogether.
I personally use WealthSimple Trade. It's commission-free and a pretty intuitive platform in my opinion. Definitely do your research before signing up, but if you choose WealthSimple, feel free to use this link to sign up and we'll both get a $25 credit!
- Stocks are parts of a company. When you own a stock, you own a little bit of the company.
- Even though it's a piece of a company, a stock's price is generally determined by what people think of the company.
- It is possible to amass large amounts of wealth through the stock market with time and consistency.
- There are still many risks and fees involved that you must be aware of.
- If you're interested, do some research for online brokerages and register to start buying stocks!
So there it is! A comprehensive post on what a stock is and how you can leverage it to your advantage. Hope you got something out of it, and that you will use what you learned to build some long-term sustaining wealth. Always do your research and good luck!
Jeff is a current Harvard student and author of the blog Financial Pupil who is passionate about learning, living, and sharing all things personal finance-related. He has experience working in the financial industry and enjoys the pursuit of financial freedom. Outside of blogging, he loves to cook, read, and golf in his spare time.