How to Invest in Stocks

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Stock of publicly traded companies is the highest-returning category of investment over the long term. But buying shares is also riskier—with a greater chance for losing money—than investing in corporate, municipal, or U.S. Treasury debt. The stock market can be intimidating for new investors, but to get started investing, all you really need to do is learn a few basic principles.

Types of Shares

A share of stock represents part ownership of the business. People generally think of common shares when they think of stock market investing, but corporations may also issue preferred shares.

Common Stock: Holders of common stock elect the board of directors, which supervises the management of the company and decides whether to retain profits or pay out some of them to the stockholders in the form of a cash dividend.

Preferred Stock: Holders of preferred stocks generally don't have voting rights, but they receive dividends that are prioritized over those given to holders of common shares. If the company goes bankrupt, the preferred stock holders outrank the common stock holders in terms of potentially recouping some of their investment. Certain preferred stocks—which are described as convertible—can be exchanged into shares of common stock at a time decided on by either the issuing company or the holder.

Stocks are also sometimes called "securities," because they are a type of financial security, or "equities," because they represent ownership—equity—in a business.

Purposes of Stock

Issuing stock allow companies to raise capital to expand their business. A private company might also go public—by issuing common shares—so it can richly reward its early investors. In addition, a company may eventually use its stock to facilitate acquisitions of other businesses.

Making Money From Stocks

Investors can benefit from owning stocks in two basic ways:

  1. Stockholders can collect cash dividends and use them as they would a traditional source of income, such as a salary. (Alternatively, they could choose to reinvest the dividends in more stock of the same company. The more shares an investor owns, the larger the total dividend payout they can receive.)
  2. The value of the shares can increase, so that the investor could sell the stock for more than they paid to buy it. Whenever someone sells shares at a profit, they experience a capital gain, and they must pay a tax on it to the federal government if their total income puts them in a high-enough tax bracket.

Not all stocks pay dividends. Generally speaking, well-established companies with a long history of steady quarterly earnings and more modest growth in stock prices pay out dividends to shareholders, while less-established companies whose share prices grow faster than average do not.

Ways to Invest

There are several methods you can use to start investing in stocks. You can open one of several different types of brokerage accounts, participate in a company's direct stock purchase plan, or use a robo-advisor.

Brokerage Account

You can easily set up an online brokerage account to buy and sell shares of stock on your own, with research provided by the account provider. If you have a lot of money to invest and want lots of input on investment decisions, you might choose to go with a full-service broker, though your costs of investing will be significantly higher.

Another option is to open up a brokerage account as an Individual Retirement Account (IRA). This type of retirement savings plan comes in a few different forms:

  • A traditional IRA uses pre-tax money to make investments, so you will owe taxes on the gains you make.
  • A Roth IRA is funded with after-tax money, so your capital gains will be tax-free.
  • A SIMPLE IRA is for someone who is self-employed or employed by a small company with 100 or fewer employees.
  • A SEP-IRA is similar to a SIMPLE IRA except only the employer may make contributions on the employees' behalf.

Direct Stock Purchase Plan

A direct stock purchase plan enables you to purchase shares of one company without using a broker as an intermediary. With this plan, you give the company permission to regularly buy its shares on your behalf with money transferred from your bank account.

A dividend reinvestment plan (DRIP) is a similar kind of plan that lets you buy more of a company's shares—or fractional shares—with dividend payouts.

A 401(k) retirement savings plan typically doesn't allow for the purchase of individual stocks. Most 401(k)s enable you to put your money in only a select few mutual funds, which in turn may invest in stocks.

Robo-Advisor

Finally, you may be interested in using a robo-advisor to make your investment decisions for you after you provide guidance on your financial goals. Although robo-advisors deal primarily in exchanged-traded funds—collections of securities that are traded like stocks—most will buy shares of individual companies as well.

The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.

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Article Sources

  1. Investor.gov. "Stocks." Accessed May 13, 2020.

  2. Investor.gov. "Convertible Securities." Accessed May 13, 2020.

  3. TD Ameritrade."Trading New Stocks at TD Ameritrade." Accessed May 13, 2020.

  4. Betterment. "Robo-Advisors: An Introduction to Online Financial Advice." Accessed May 13, 2020.