Understanding Stocks 101
Maybe you’ve heard that investing can be the key to unlocking your financial future—or maybe you’ve just watched Wolf of Wall Street one too many times. Either way, if you’re hoping to start investing, you’ve probably already realized how much there is to learn.
Understanding the stock market can be confusing on its own, let alone actually opening an account, choosing individual stocks, and deciding when’s the right time to buy and sell them.
This post will cover helpful investing basics for getting started on your own investment journey, from how to understand stocks to actually pulling the trigger and buying some of your own.
Welcome to Understanding Stocks 101.
How Does the Stock Market Work?
Understanding stocks begins by—you guessed it—understanding the stock market. And although you may have learned the basics back in grade school, chances are you could use a refresher.
The stock market is, simply put, the space in which investors buy and sell stocks—portional pieces of ownership of publicly owned companies, otherwise known as shares. Other assets, like ETFs, are also sold on the stock market, but for the purposes of this post, the focus will be on stocks.
What Is a Stock, Exactly?
So what does “portional pieces of ownership” mean?
When you buy a stock, you become a partial owner of a company, which means you’re entitled to a cut of the profits—and to a say in certain corporate matters.
Common stockholders generally get voting rights in important business affairs, like electing the board of directors, as well as shifts in corporate goals or major changes to the business structure.
The more shares you own, the more ownership you claim over the company—which means you get a proportionally higher cut of the earnings and sometimes more voting power, as well. It depends on the company: Some issue one vote per share, while others issue each shareholder a single vote regardless of how much stock they own.
Stock earnings can be paid in the form of dividends—a certain amount of the company’s profits in a specific time period—which the company issues at its discretion.
Some companies pay dividends on a regular basis (for instance, quarterly), and other companies pay dividends only if and when they meet certain profit thresholds and have “residual” capital available to disperse. Some companies may choose to not pay a dividend at all.
Investors also earn money on stocks in the form of appreciation in value: As the company grows and performs and its stocks are in higher demand, the value of an individual stock can go up. So if you purchase a share of Company XYZ for $10 in 2014 and then sell it for $30 in 2015, you’ve earned $20 in profit.
A Caveat: Preferred Stock
There is one exception to the rules outlined above: preferred stock. This is a separate type of asset that works similarly, but not in the exact same way, as common stock—which, as its name suggests, is the most common type of stock on the market.
Preferred stockholders are so called because they’re paid first when it comes time to issue dividends—and in the case of a catastrophe or company failure, they’re remunerated before common stockholders are, which makes them a slightly less risky asset to hold. (More on risk in just a minute!)
In exchange for this right to be paid first, preferred stockholders forego voting rights, and in many cases, preferred shares appreciate less than their common stock counterparts.
As in all things, it’s a tradeoff between risk and reward: Preferred stocks may be more stable but are also potentially less valuable than common stocks. And there’s typically no such thing as a risk-free investment!
Pros and Cons of Investing in Stocks
So why do people invest in stocks, and what are the drawbacks?
Strengths of Stock Investments
• Stocks often have exponential earning potential, and can potentially yield a much higher return than other types of investments like bonds or CDs.
• Stocks are flexible—you can often buy and sell them on the market at will, whether that means same-day trading or buying and holding for much longer periods.
Drawbacks of Stock Investments
• Stocks are one of the riskiest asset classes; the exact same market dynamics that can lead to exponential growth can also lead to significant losses if a company doesn’t do well—or even possibly leave you with absolutely nothing if the company folds.
• Stocks may not be as stable of an income vehicle in the same way other assets, like bonds, are. For example, if you purchase a bond, you’ll have a face value dollar amount guaranteed to you at the time of maturity, which allows you to plan for those specific earnings assuming the bond issuer doesn’t default. Stocks, on the other hand, may or may not pay dividends and might appreciate or depreciate in value; nothing is guaranteed.
• Smart stock investing often requires a decent amount of research and footwork, particularly as compared to other assets readily available on the market, like mutual funds and ETFs, which offer a pre-diversified basket of assets that might help you hedge your bets against crashes and company failures.
Speaking of research…
Choosing Stocks
If you decide that stock market investing is right for you, a good next step is to put on your thinking cap. Choosing which stocks to buy can be a project in its own right.
Since stocks walk that knife’s edge between great return potential and relatively high risk, it’s often helpful to be choosy when you’re deciding which company you want to put your money into.
Although they can seem complex at first glance, understanding stock charts—the graphs that show how a stock’s price has changed over time, as well as a wealth of other information—isn’t impossible.
The trend line follows the value the stock has fetched on the market historically, and if it’s going upwards to the right, that means the stock has increased in price.
Keep in mind, past performance is never a guarantee of future returns and there is typically much more to deciding if a stock is a good investment, but learning how it has performed historically can be a good place to start.
When it comes to what to look for in a stock, it’s helpful to consider the company’s overall position and corporate policies, as well as diving into more granular data like its earnings per share figure or price-to-earnings ratio.
And choosing individual stocks is just the beginning. What do you do with the stocks once you own them? After all, the biggest earning potential in stock market investing is all about selling those shares, not buying them.
Some Investment Strategies
Different investors use different investment strategies to meet their financial goals. Which method is best for you will depend on what you’re hoping to get out of your stock market experience—as well as how much work you want and are able to put into it.
For instance, day trading can lead to high earnings in a short timeframe if you do it right—but that’s a big “if.” Figuring out the right time to buy and sell on such a short-term basis requires considerable study and considerable luck, too, not to mention time and effort. Many day traders make the stock market their full-time occupation.
In the case of most stock market beginners, buy-and-hold investing could be a good place to start. As the name suggests, this type of investment strategy is often about the long game: buying carefully selected stocks (and other assets) that could potentially lead to long-term earnings and which you don’t plan to sell for quite a while.
One of the best things about buy-and-hold investing is that long-term capital gains—earnings made on assets held for a year or longer—are subject to lower tax requirements than short-term capital gains.
While earnings you make on short-term holdings will be taxed by regular income brackets, long-term capital gains are sometimes taxed at lower overall rates (0%, 15%, or 20%), although there are exceptions.
Of course, timing can be important, even to buy-and-hold investors; learning when to buy stocks and when to let them go is a beneficial step towards becoming a well-informed trader.
Where to Buy Stocks
Now that you’ve got more of an understanding of how the stock market works and you feel informed enough to choose your first stock, where can you go to buy it?
Although it’s called the stock market, there’s no one central building you visit to pick stocks off a shelf. Instead, stocks are often traded through a broker (like Leonardo DiCaprio’s character in that infamous stock-related movie) or brokerage firm.
These days, you don’t have to call someone in a chaotic office to make a stock purchase. You can open a brokerage account online in minutes, all from the comfort of your couch and pajamas—and if you play your cards right, you can do it without spending money on fees.
Although many major brokerage firms offer actively managed investment accounts that charge annual management fees (often expressed as a percentage of your assets under management, or AUM), some also offer free brokerage accounts that allow you to DIY your portfolio.
You can buy and trade stocks and ETFs directly without paying an advisor to assist in choosing them. Although you’ll often still be assessed a trade fee or commission fee for each sale or purchase, some of these accounts allow you to trade certain assets without paying a fee.
Once you choose a brokerage, you’ll also be able to decide between a range of different types of investment accounts, including specialized account types like a Roth or traditional IRA.
These investment vehicles, which carry special tax incentives but also strict withdrawal rules, can be great for long-term financial goals. But when it comes to plain-Jane investments that you can cash out whenever you choose, a regular investment account will often suffice.
Ready to Get Started on Your Investment Journey?
Whether you’re simply trying to solidify your financial future and retire with a comfortable nest egg, or you’re hoping to turn your investing hobby into a regular source of daily income, becoming an investor all starts with a single step—or, in this case, click.
Thanks to the magic of the internet, you can get started with the stock market right from your laptop, or even your mobile phone.
If you’re interested in learning all the ins and outs of the stock market and creating a customized, personally picked portfolio of stocks and other assets, active investing might be the right path for you.
Active investors who trade online with SoFi are often able to ramp up their stock market knowledge by actually making hands-on trades, all with the support of a dedicated team and a wider community (and, of course, with no stock or ETF transaction fees—that part’s really important!).
If you’re interested in stock market basics, but mostly want to get the benefit of investing without all of the research and footwork, there are still plenty of options available to you.
SoFi Invest® offers educational content as well as access to financial planners. The Active Investing platform lets investors choose from an array of stocks, ETFs or fractional shares. For a limited time, funding an account gives you the opportunity to win up to $1,000 in the stock of your choice. All you have to do is open and fund a SoFi Invest account.
External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
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