What Can I invest In?
A stock or rather a share of a company directly represents a small portion of that company. Essentially, when you buy a stock, you are now a part-owner of the company in question. For example, if Ford separated its company into 1,000 shares and you purchased 100 of them, you would own 10% of Ford.
In reality, Ford has many, many more shares than that, but you get the point.
People typically purchase stocks in order to get capital gains or receive periodic cash payments called dividends. A capital gain occurs when you sell a stock for a price that is greater than what you originally purchased it for. An important thing to note is that you do not have a capital gain until the stock is actually sold. Improvement in the value of your stock before it is sold is referred to as “paper gains” or “unrealized gains”. Once sold however, capital gains, or the amount you earned in excess of what you paid for it, are taxed based on US capital gains tax on your income tax forms.
Dividends, meanwhile, are a distribution of a portion of a company’s earnings to stockholders. The amount of the dividend is determined by the board of directors and is typically quoted as the dollar amount received per share (e.g. dividends per share). More secure and stable companies offer dividends to reward shareholders for owning their stock, as they typically don’t have a lot of movement in the price of the stock itself. High growth companies, however, most often do not offer dividends, and instead, choose to reinvest their earnings into new projects in order to sustain higher than usual growth.
Not all stocks are created equal however. In general, there are two types of stocks: Common Stock and Preferred Stock.
Common stock is just that: common. As discussed before, this type of stock represents a part ownership in the company and can sometimes give you a partial claim on profits in the form of dividends.
This sort of stock usually yields higher returns than most investments over the long term since it is one of the riskier types of investments. For example, if the company in question enters bankruptcy and liquidates its assets, the common shareholders are at the bottom of the pecking order in getting reimbursed, with creditors, bondholders and preferred shareholders receiving money first.
Preferred stock still represents some degree of ownership in the company in question, however, it does not have the same voting rights (This depends on the company). Also, preferred shareholders are oftentimes guaranteed a fixed dividend for as long as the company is in business. And, as mentioned before, preferred shareholders get paid back before common shareholders in the event of bankruptcy. However, preferred stock can be callable which means that the company can purchase back the shares at any given moment for any reason, usually at a premium. As such, preferred stock can be considered more like debt than equity, falling in between bonds and common shares.
Companies can customize different classes of stock virtually however they want. Usually, this is done so that voting power can remain with a certain group, thus different classes of stock are given different voting rights. For example, one class of stock, let’s say Class B - preferred shares, will be given 10 votes per share while Class A - common shares (the majority of shares available) will be given 1 vote per share.
This is a debt based investment where an investor loans money to an entity such as a corporation or even a national government which subsequently borrows the funds for a defined period of time at a fixed interest rate. The money is then used to finance various projects.
As bonds are a bit more complex topic, we’ll provide you with more details in later chapters.