What Are Stocks? A Complete Beginner's Guide to Stock Market Investing

Ever wondered how people grow their wealth through the stock market?

Nearly 60% of Americans own stocks, yet many still don't understand how they actually work. I remember feeling completely lost when I first heard terms like "equity," "dividends," and "market cap."

I also recall when I made my first jump into stocks. I bought a few shares of Disney and felt like such a BOSS!

I had no plan, no idea what I was doing, and therefore no real success. So if you find yourself in the same situation, don't worry - you're not alone!

Let's turn those confusing financial terms into concepts you can actually use. Whether you're considering your first investment or just curious about the stock market, I'll break down what stocks are, how they work, and how you can start investing with confidence.

Why Do People Invest in Stocks?

For decades people have chosen to invest in stocks due to their potential for long-term wealth growth.

Return on investment, regardless of what asset class you choose, is made up from either income or a growth in value. Stocks have the ability to provide both through earning dividends and capital appreciation.

Stocks have a proven track record for beating inflation over time and are often at the core of most people's investment portfolios.

Since 1965, the S&P 500 has provided annualized total returns of 10.2% through 2023.

What Are Stocks?

Let me explain stock ownership and company shares in simple terms:

When a company offers stocks or shares, they're essentially selling tiny pieces of ownership in their business. Think of a company like a pizza cut into many small slices - each slice represents a share, and buying a share means you own that slice of the company.

For example, if a company has 1,000 total shares and you buy 10 shares, you own 1% of that company.

As a shareholder, you get certain benefits:

1. If the company makes money and grows, your shares become more valuable
2. If the company pays dividends (sharing profits with owners), you receive your portion
3. You usually get voting rights on major company decisions

Real-world example: If you bought one share of Apple, you'd own a very tiny fraction of the entire company (they have billions of shares). While you wouldn't get to tell Tim Cook how to run Apple, you would benefit if Apple's value increases or when they pay dividends.

Think of it this way - when you buy stocks, you're not just buying random numbers on a screen. You're becoming a partial owner of real businesses, with real buildings, employees, and products.

So why do companies issue stocks in the first place?

When a company wants to scale and grow to the next level it needs capital. The company seeks out investors to provide this capital and in exchange issues out stocks.

Usually large institutions are purchasing these newly issued shares in what's called Initial Public Offerings (IPO) but they soon become available to retail investors like you and I on the secondary market.

Different Types of Stocks

Common Stocks vs. Preferred Stocks – What’s the difference?

When most people think of stocks, it's typically common stock that comes to mind. Both common and preferred stock represent fractional ownership in a company and both are tools that investors use to try to profit from the future successes of the business.

One of the key differences is that preferred stock has priority over a company's income, which means that these shareholders are paid dividends before common stock owner's. They are also paid first if a company is liquidated.

That's the pro, the con is that preferred shareholders do not hold any voting rights. Common stock does have voting rights, usually one vote per share owned.

Growth Stocks vs. Value Stocks – Which one is right for you?

Growth stocks are those of companies that are considered to have the potential to outperform the overall market over time because of their future potential.

When you see terms like "small or mid-cap", they're more than likely falling into the growth category. Think of this as a company that could possibly turn into the next Amazon or Uber.

Value stocks are usually larger, more well-established companies that are considered to be trading below the price analysts feel the stock is worth.

When you hear the terms "large-cap or blue chip", they're typically referring to value stocks.

Dividend Stocks – Making money beyond stock price increases.

Dividends are payments companies make to reward their shareholders for holding on to their stock. They represent a portion of a company's profit and are most often paid in cash.

Smaller, growth focused companies, are far less likely to pay dividends as they are typically reinvesting the profits into scaling the business. As it develops and matures the profits become more stable and more likely to lead to dividends being paid out.

How The Stock Market Works?

Let me explain how the stock market works in a way that's easy to understand, using some everyday analogies.

Think of the stock market like a giant marketplace - similar to a farmers' market, but instead of buying fruits and vegetables, people are buying and selling tiny pieces of companies called shares or stocks.

Stock Exchanges: The Marketplace Buildings

The NYSE (New York Stock Exchange) and Nasdaq are like giant shopping malls for stocks. They provide a secure, organized place where buyers and sellers can meet and trade.

The main difference?

The NYSE still has some human traders on a physical trading floor (though most trading is electronic), while Nasdaq is completely electronic - like comparing a traditional mall to Amazon.

How Stock Prices Move: The Dance of Supply and Demand

Stock prices change constantly based on a simple principle: when more people want to buy a stock than sell it (high demand), the price goes up. When more people want to sell than buy (high supply), the price goes down.

Imagine a rare baseball card - if everyone suddenly wants it, the price skyrockets. If nobody wants it anymore, the price falls.

What affects these prices? Several factors:

• Company performance (like Apple releasing a new iPhone)
• Economic news (interest rates, employment numbers)
• Global events (pandemics, wars, natural disasters)
• Market sentiment (whether investors feel optimistic or pessimistic)

Market Indices: The Market's Report Card

Think of market indices as the "temperature readings" of the stock market. They help us understand how the overall market is doing:

S&P 500: Tracks 500 of America's largest companies. It's like checking the average price of items in a supermarket to understand overall food prices.

Dow Jones Industrial Average: Follows 30 major U.S. companies. It's a smaller sample but includes household names like Disney, McDonald's, and Apple.

Nasdaq Composite: Heavily weighted toward technology companies. It's like focusing on just the electronics section of our marketplace.

The key thing to remember is that the stock market is really just a reflection of what millions of people think companies are worth at any given moment. It's like a giant voting machine where people vote with their money based on what they think will happen in the future.

Pro Tip: Don't judge a company by it's stock price alone.

Making Money with Stocks

When it comes to making money with stocks there's a few different methods you can take advantage of.

Stocks give you flexibility to be used for both long-term and short-term investing. Long-term would be anything more than a year and short-term is anything less than a year.

How long you own a stock is really important because their are some serious advantages at stake. When you sell a stock you're subject to paying capital gains tax or basically the difference in value of what you invested and what it grew to.

If you've held a stock for more than a year you'll be able to take advantage of long-term capital gains tax treatment. This is a huge deal because you can get taxed at a lower rate than your marginal income tax bracket.

For instance, let's say you sold a stock for a gain of $10,000. You may be in a tax bracket anywhere between 22-32% and could still pay as little as 15%. That's a big difference in the bank account.

Guess what, dividends work in the same way! Let's say you built a portfolio that's providing $50,000 a year in passive income. Tax rates can be either 0%, 15%, or 20% MAX depending on your earned taxable income.

Not focused on living off of this income from dividends or gains from the sales? That's okay, the power of compound growth in stocks can be exponential if you decide to simply reinvest them back into new stocks.

Risks of Investing in Stocks

Market volatility and price fluctuations can vary based on broad economic factors, political climate, or seasonality of specific industries. Understand exactly what affects the particular companies you're considering investing in before committing.

The main risk of stocks is the potential for loss of your entire investment. The upside is theoretically unlimited but the downside is a total loss.

"Investments work - investors don't"

Be mindful of emotional investing – avoiding panic selling and FOMO buying. If you're feeling either ecstasy or anxiety then you need to really take a step back and consider your next step.

Diversification can reduce risk but it won't eliminate it. Spread your holding across several companies or leverage the power of index funds to invest in hundreds of companies with one fund.

How to Start Investing in Stocks as a Beginner

I'll go into detail of how to develop a well diversified portfolio in another article. For now let's just get a brief overview of the process to get started with stocks.

Opening a brokerage account – A simple account that you can hold with a discount broker and buy/sell stocks. It's easy to create so you can start investing immediately.

The importance of research – Understanding financial reports, trends, and analyst ratings is a big factor of being successful. Invest in companies with good business systems and a strong track record.

Choosing stocks – Shooting from the hip is how people lose money big time. Know what factors to consider such as price-to-earnings, profit margins, and debt-to-equity when assessing stocks on your watchlist.

Investing strategies – Dollar-cost averaging, long-term investing, and diversification are always solid principles to follow regardless of which asset class you decide to pursue.

People love to share how that one stock paid off big time. Funny enough they never seem to share their losers. Just because someone had a big winner once doesn't mean they can do that over and over throughout decades. You need a strategy for long term success.

Now that you understand the basics of stocks, you're ready to take your first steps into the world of investing. Remember, every successful investor started exactly where you are now. Stocks are an easy first step to building wealth and the stock market isn't as scary as it seems.

Start small, no more than 5% of your portfolio should be in any single company. Stay focused on learning, and don't be afraid to ask questions along the way. Remember it's not set and forget, you've got to manage your portfolio. Consider opening a practice account first and begin with a small investment in a broad market index fund.

The most important thing is to take that first step - your future self will thank you.