If you buy stock in a company, you own a small part of its business. You take part in the company’s gains and losses, and depending on the type of stock you own, you may get a share of profits or the ability to vote in shareholder meetings and help direct the future of the company.
What is a stock?
When a company wants to raise money for its operations or growth, it sells stocks (also known as shares or equity) through a stock market exchange like the Toronto Stock Exchange, Montreal Exchange or the New York Stock Exchange.
Buying these stocks — often referred to as investing — gives you fractional ownership of the company. Your percentage of ownership depends on how many stocks you own in relation to the total number of stocks available.
The total value of all of a company’s stocks owned by shareholders is known as market capitalization or market cap, which is an indicator of the company’s size.
How do stocks work?
Stocks tend to have higher potential for growth than fixed- income assets like bonds, but they also have higher potential for loss.
If you own stock in a company that’s performing well, the stock value typically goes up, and you can make a profit. If the company does poorly and the stock value goes down, you may lose money. Regardless, gains and losses are realized only when you sell the stock.
Depending on the type of stock you buy, you might also be entitled to dividends, which are a form of income-sharing. You’re called a shareholder of the company because you share in the company’s profits.
There are two main types of stocks you can own, with the main differences being dividends and voting rights:
Common stock entitles you to fractional ownership of the company, including valuations, assets and profits (and losses). You usually get voting privileges that are proportional to your ownership level. You may also receive dividends, but they are not guaranteed.
Common stock values have unlimited growth potential over the long term. But if a company goes bankrupt, you could lose all the money you invested in its stock.
While preferred stocks are considered equities, they behave more like fixed-income investments. Preferred stocks don’t increase or decrease in value like common stocks; rather, you buy a preferred stock for the fixed dividend payments, which are higher than dividend payments on common stocks.
Unlike common stockholders, preferred stockholders typically don’t have voting rights, but they are ahead of common stockholders for a payout of any excess cash if the company goes bankrupt and liquidates everything.
How to buy stocks
You need a brokerage account to buy stocks in Canada. You can go through a stockbroker or financial planner, or open a self-directed brokerage account online.
Within a brokerage account, you can hold stocks in registered accounts, like tax-free savings accounts and registered retirement savings plans, or in non-registered accounts, which are taxable investment accounts used for short- or long-term investing.
Instead of buying individual stocks, you can also invest in stocks by buying exchange-traded funds and mutual funds, which are like mini-portfolios of stocks and other types of investments. These are effective ways to dip your toe into the stock market and diversify your holdings without having to do extensive research on individual companies.
Pros and cons of buying stocks
- Stocks have stronger potential for long-term returns compared to cash and fixed-income investments.
- Stocks provide the ability to earn tax-preferred dividends (when held in registered accounts) and capital gains (when held in a non-registered account).
- Direct stock investing takes a lot of time for due diligence and research.
- You need a strong stomach and conviction to stay the course when the market fluctuates.
- If a company in which you’re invested goes bankrupt, you could lose your money.
How do you make money from stocks?
You make money from stocks by buying low and selling high, at least in the case of common stock. If you buy preferred stock, you make money by holding the stock and receiving regular dividend payments.
For example, if you buy 100 common shares of Company X at $6 per share, your total investment is $600. If the share price increases to $10 and you sell your 100 shares, you receive $1,000. Subtract your initial investment amount of $600, and you are left with a $400 gain, which is considered a capital gain.
But buying low and selling high is easier said than done (at least in the short term). Stocks are priced according to supply and demand, so finding a particularly underpriced stock is difficult, if not impossible, as a member of the general public.
The best way to make money from stocks is to invest for the long term.
Time frame is important
If your time frame is short, the stock market could be an iffy choice. The market could take a nosedive and you could be at a loss when you need to withdraw your investment.
Selling a stock at a loss is the only time you actually lose your money. If you continue to hold the stock, it may rebound. And if you have the constitution for it, buying more shares when the market goes down can result in big gains when it rebounds.
The Toronto Stock Exchange has seen lots of fluctuation since its inception in 1861. No one can predict these fluctuations with 100% accuracy, so having a long investing time frame — and the ability to stay the course — will be a big determinant of whether you can make money in the stock market.
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