What are Stocks?

You want to build wealth, right?

You probably want to help your kids with college tuition, buy a house, and even retire someday.

But how will you do that?

If you read about investing, you’ll learn that stocks are supposed to be one of the best tools for creating long term wealth. But if you watch the news, it seems like the stock market fluctuates for no apparent reason.

Investing in stocks can be extremely confusing, but I don’t want you to miss out on an extraordinary opportunity to build wealth, so today I’m going to give simplified answers to 2 questions:

  1. What is a stock?
  2. What does owning a stock allow you to do?

 

1. What is a Stock?

To explain stock market basics, I have created a set of info graphics.

Take a look at the first one, in which Bob sells shares of stock to raise money for his hotdog stand:

stock-market-basics-1

Initially, Bob’s hotdog stand was a private business. He owned the company and made all of the decisions. Then, Bob split his business into shares and sold some of them. In the stock market, this is called an initial public offering (IPO).

 The graphic is a simplified example, so in the real world, there might be thousands of people who buy shares of a company during the initial public offering. In order to “go public”, a company must meet certain criteria and submit to regulation by the Securities and Exchange Commission (SEC… not the college football kind). Once a company is public, shares of its stock can be bought and sold on the open market. This is generally done through an online trading platform or a bank.

There are basically 2 reasons to create stock in the first place:

  1. To raise money to fund the business (buy more equipment, hire employees, etc.)
  2. The current owner wants to make money by selling part of the business

In our scenario, Bob went public for the first reason; he wanted to buy more hotdog ingredients. Even if the stand had plenty of supplies, he could have sold part of the company for the second reason and used the money to go on vacation or buy a car.

Now that Bob’s business has gone public, let’s move on to the second half of the scenario.

2. What Does Owning Stock Allow you to Do?

Now that shares of the hotdog company have been on the market for a while, 10 different people own part of the company. Let’s take a look at how decisions are made now that Bob isn’t the only owner.

stock-market-basics-2

In a real company like Walmart or Amazon, tens of thousands, even millions of people, can own shares of stock.

Obviously, that many people won’t be able to agree on anything. In order to actually get things done, shareholders vote to elect a board of directors, which actually runs the company. This board hires a CEO, who makes decisions.

When you own shares of a company, you technically own a percentage of the company: all of its assets, cash, and future profits. Even though it seems like you have no control, you have the ability to be part of a large number of voters who choose the people that run your company.

As the company buys new buildings, hires new employees, and creates new products, the amount of money it makes each year should increase. When this happens, the company becomes more valuable, so the price of the stock you own increases.

Over time, the company will even pay small sums of cash to the shareholders as a way to return some of the profits to its owners.

Why Does This Matter?

Hopefully, this simple example about a hotdog stand makes you feel more comfortable with investing. Stocks really are one of the best tools for building long term wealth, so I don’t want you to be scared out of a great opportunity simply because it’s hard to understand.

If this article helped you, share it with your friends! Hopefully it will help them understand the stock market as well. I’ve even included convenient sharing buttons just for you.

Still have questions about the stock market? Click on the “ask a question” tab at the top of the page, and I’ll respond as soon as possible.

3 thoughts on “What are Stocks?

  1. tirelessworker says:

    I love this post! A super simple example that gives a great explanation on what stocks are.

    I really like your infographics too, how did you create it?

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