Let’s Learn Finance: Stocks

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Photocredit: USnews.com

Stocks, not where criminals were placed in colonial times. But the somewhat invisible things people think about when they’re talking about investing. What the heck is a stock? Where did they come from? And why does it matter to me? Let’s try and answer all these questions (and more).

So what the heck is a stock? You can imagine a stock as a piece of paper. At one point stocks were actually certificates and could be held in your hand. But today stocks are mainly in digital form. But this imaginary piece of paper represents something.

The first stocks that are similar to today we’re created in Holland in 1602. Shares of the Dutch East India Company were traded continuously on the Amsterdam stock exchange, and there after stocks were traded and exchanged between traders and investors to try and make money.

One stock or share represents a small ownership of a company. Instead of one person, or a couple of people owning a business, a corporation allows many many people to own that business. That means all the assets and debt as well as the revenue is “owned” by the stockholders.

In a simple example, I own one stock of Big Computer Company. When Big Computer Company was formed, they sold 100 stocks to the public. So there are 100 stocks available to buy or sell from anyone in the public. Because I own 1 of those stocks I own 1% of Big Computer Company.

This ownership was originally created so that people could have access to the revenue that companies produce. Income is passed along to stock holders through a dividend. A dividend is usually a quarterly or annual payment made to stock holders that is some proportion of the profit a company has made.

In order to simplify stocks, I like to think of them as trees. There are many different types of forests (companies) out there. There are small forests and big forests. When I chose to buy one tree in a forest I am guessing that in the future the tree, and thus the forest, will grow to be taller and maybe I can sell it for more than I bought it. But it also could be an apple tree and could produce some apples (dividends) along the way that I could then sell to make more money.

If we think about stocks in this way, we start to understand why people invest in stocks. There is always a chance that a stock you buy could go up in value. If you buy Apple stock at $80 per share, and then sell it at $100 per share you have gained $20 per share.

But in the same way that trees have the potential to grow, they also have the potential to be wiped out by an insect swarm, or be ripped out of the ground by a tornado. Stocks have the benefit of being “worth” anything, but that also means they could be “worth” nothing.

The risk of buying a stock is that it could eventually be worth $0 instead of the $80 you bought it for. So the benefit of it potentially being with more than you bought it needs to be weighed against the pain of it potentially being worth less.

At this point you’re probably wondering why you should even care about stocks or if they even need to exist. But the unfortunate fact is that if you have any desire to invest money for retirement or college savings or just for fun, stocks are one of the most actively used ways to invest. This is good for you as the investor.

The more that stocks are traded the easier it is for you to convert a stock back into actual cash. If only 10 people were trading stocks then it would be really hard to sell your stock in an emergency if you needed to get to your money to actually use it. That’s why most retirement and investment opportunities are through stocks. So you can easily get to your hard earned money if you needed to.

We will talk more about stocks and how they are used in future posts as we talk about retirement and investing in mutual funds in other topics. But as usual please let me know if you have any questions or any suggestions for topics, and I hope this has left you with a better understanding of trees, I mean stocks.

Again here are the previous posts in this series:

Introduction
Goals and Budgets
Banks and Interest

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