Investing Basics: Stocks

Upbeat music plays throughout.

Narrator: Learning about investing is a lot like learning to ride a bike.

At first, it may look intimidating or complicated. Dangers seem to be everywhere.

That's why it's important to learn the basics and ways you can help minimize risk and protect yourself.

After a good amount of practice and learning, you can take the training wheels off and really start riding.

Along the way, the roads may change.

There'll be good days and bad days.

And while learning to ride doesn't guarantee you a spot in the Tour de France, riding a bike could get you where you want to go a little faster.

On-screen text: Disclosure: Stock trading involves high risks, and you can experience a significant loss of funds invested.

Narrator: Let's start with the basics and look at one of the most common investments: stocks.

A stock represents partial ownership of a company.

When you purchase a stock, you're buying a piece, or a "share", of a company.

By owning a share, you own a small fraction of the company's assets and have a claim on its future earnings.

There are two ways you can make money by investing in stock. The first is through stock appreciation—when a stock you own goes up in value. If an investor bought the stock at one price, and the price went up, the investor could then make money by selling the stock to another investor at a higher price.

The second way is through a dividend. This is a periodic payment issued by some stocks. A dividend is a way for a company to give a portion of its earnings to shareholders.

Here's an example of how stocks work: Suppose there's a company called Bull Flag Cycling.

This company makes bikes. Really good bikes.

The bikes are so good, in fact, the company wants to expand, so it can sell more bikes to people all around the world.

To do this, the company needs to raise money, also known as "capital".

There are a few ways this company could do this. It could take out a loan, but that would mean taking on a significant amount of debt.

Or it could issue shares of stock.

By issuing stock—which is called going public—the company can raise money without going into debt.

Instead, it sells shares of ownership and a claim on future earnings to investors.

So, let's meet a typical investor. Our investor is someone who has a little extra cash.

They're looking for an investment that has the potential to offer better returns than a savings account, and are willing to accept the higher risks of investing in a stock.

They think Bull Flag Cycling is a promising company that's likely to grow. Because of this, they think buying a share would be a good investment.

So how much does a share cost?

Suppose the company decides to raise $1,000,000, and it decides to issue 1,000 shares of stock.

Each share represents a fraction of the company's worth.

On-screen text: Disclosure: This is a simplified example. Market forces play a significant role in the price of a company's stock.

Narrator: Because the company is raising $1,000,000, at the initial public offering, or IPO, each share would initially be valued at $1,000.

On-screen text: Disclosure: Stock trading involves high risks, and you can experience a significant loss of funds invested.

Narrator:  Let's suppose the price doesn't change after the IPO, so our investor purchases a single share on the open market through their online stockbroker for $1,000. Now let's see what could happen to their investment.

If the company does well and profits increase, the value of the company is likely to go up.

As a result, the stock price may increase as well.

Assuming the price of the stock goes up, our investor could now turn a profit by selling their shares to another investor in the stock market.

However, if the company's ventures don't go as planned, its value could decrease, and so could the stock price. If this happens, our investor could lose money if they decide to sell at the current price.

When it comes to investing in the stock market, the basic goal is to buy when prices are low and sell when prices are high.

But stocks in the stock market don't always go up. Sometimes, they stay the same and sometimes, they go down.

And sometimes, prices change quickly.

Because of this, stocks are considered riskier than other historically safer investments such as bonds or CDs.

However, investors keep coming back to the stock market.  Because with this increased risk, comes the potential for greater returns.

Savvy investors take precautions to try to minimize risk like creating an investing plan, adding diversity to their portfolios by investing in a variety of companies, putting money in other investments besides stocks, and learning trading strategies for up, down, and sideways markets.

Now you know some of the basics about investing in stocks, but that's just the beginning.

You can learn more with our investing education.

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