What are stocks?

Every incorporated company–even the coffee shop on the corner and the used record shop next door–has stock. Stock is a way of holding ownership in a company, tangibly, through stock certificates (which are today mostly virtual). When you “buy stock” you are buying a small percentage (a share) of ownership in that company.

In the simplest case, if the company does well–makes a profit by selling a product or service for a price that is higher than the company’s cost–the value of your stock will rise. Conversely, if the company cannot sell its product or service, or has expenses that are too high, the value of your stock will fall.

Why buy stock?

Let’s take an example company: a bookstore. In order to open for business, the bookstore owner must rent a store, buy shelves and tables, buy books from distributors and hire employees to sell the books. If all the money for these expenses comes from the owner’s savings account, great: she will own all the stock. As long as she has enough revenue to cover expenses, she can continue as the sole shareholder.

But let’s say the owner is your high-school English teacher. She has been inspired by you and your classmates to open a store dedicated to literature for young adults. She offers shares in the business to you in exchange for your money. You buy stock in the business by trading money for ownership. She’ll use your money to buy books and sell them at a profit. Because you own stock, you can share in those profits in proportion to your share of ownership.

Who can buy stock?

You can invest in a company’s stock only when its shares are available for anyone to buy. The bookstore ownership opportunity described above probably isn’t available to the public. Once a company is so large and growing so fast that it cannot easily get financing from friends, family and small investors like venture capitalists, it can look for money from banks or from the public markets.

When a company first offers shares to the public on a stock exchange like the NASDAQ or the NYSE, that’s called an initial public offering, or IPO. If the IPO is for our young-adult bookstore (which now has multiple locations in major cities with plans to open several more), anyone can buy a very small percentage of the high-school teacher’s business.

The stock market

When you buy stock, unless you buy into the IPO, you are typically buying stock from another stockholder or institution through the stock market, on whichever stock exchange handles the stock. While companies do occasionally offer the public new shares to raise money for growth or other operational plans, most of the buying and selling of stocks occurs between stock owners in the stock market.

The stock price reflects what people believe the tiny piece of the company is worth. It can fluctuate up or down, depending not only on the company’s performance but also on emotions, including how optimistic buyers and sellers feel about the company’s prospects, the performance of that company’s peers, and economic conditions in general.

How to buy stock

While deciding which stock to buy is beyond the scope of this article, the process of buying stock is easy. While some investors still prefer to work with a stock broker (someone who trades stock on your behalf and sometimes offers advice, for a fee, of course), most small investors use online stock brokerages (or brokerage services offered by online banks) to buy and sell stocks with the click of a button.

It’s as easy as buying books or shoes online…except stocks aren’t returnable in the retail sense. If you want to sell a stock, you’ll generally get the current market price at the time you sell, which may be higher or lower than it was when you bought it.

While that makes stocks more risky in the short term, stocks are an important component of a long-term investment plan (such as a retirement plan) because the growth potential of stocks has historically been much greater than ordinary savings accounts.

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