Upbeat music plays throughout.
Narrator: You’ve done a good job managing your money, your rainy-day fund is in place, and you even have little money left over. Now that extra cash is just sitting in a bank, and you're probably wondering whether there's something else you could do with it. Investing in stocks is one way to potentially make your money work harder for you. But it brings up new questions, like “Aren’t stocks risky?” and “What exactly is a stock anyway?”
We're going to answer those and other common questions people may have when they start investing.
Let’s start at the beginning: What is a stock? A stock is simply a share of ownership in a company. In fact, when you buy stock, you buy shares.
When you own a share, you’re called a shareholder. A shareholder has a claim on the company’s earnings and assets. That doesn’t mean you can walk into the company and demand money or walk out with printer or office supplies. It means that the value of your stake in the company rises and falls with the success of the business.
This may answer another question: “How do I make money owning a stock?” The first way is if the stock’s price goes up—or what's known as price appreciation. Price appreciation occurs when the price of the stock increases. For example, let’s say you bought 50 shares of a stock at $25 per share. You’d pay $1,250, not accounting for commissions. A month later, you check on the stock and you see it’s now worth $27 per share—a $2-per-share appreciation. So, your investment is now worth $1,350. If you sold the shares, you’d have a gain of $100.
Of course, there’s also price depreciation when the stock price falls. Let’s say the stock price fell instead, and a month later it's trading at $23 per share. That would make your investment worth $1,150. If you sold shares, you’d have a loss of $100.
Another way to make money is through dividends. A dividend is literally a portion of the company's earnings that’s sent to you, usually on a quarterly basis. The more shares you own, the more in dividends you’ll receive. Not all companies pay dividends but many do, and some increase them on a regular basis. However, dividends aren’t a guarantee and a company may reduce or discontinue them at any time.
Also, stock ownership gives you voting power. Shareholders are represented by a board of directors who are elected to oversee the management of the company—even the president and CEO of the company report to the board. As a shareholder, you get to vote for who sits on the board. The more shares you hold, the more votes you get.
That might make you wonder: “Why do companies even sell shares?”
Many companies sell shares to raise money for improving products and or expanding the business. It's typically first done when a company sells shares to the general public during what's known as the initial public offering, or IPO. If the company wants to raise more money in the future, they can sell more shares.
If you're wondering who buys and sells shares, it includes retail investors like yourself. But the biggest buyers and sellers are institutions: banks, mutual funds, pension and retirement companies, insurance companies, hedge funds, endowments, and corporations. In fact, so many institutions buy stocks, many people are already invested without realizing it. If you have a company retirement plan, you’re probably invested in stock.
With all of this buying and selling, you might wonder, “How are stock prices determined?” The price is first set during the IPO process and based on the company's financial metrics, as well as investor interest. Then, like any other product or service, it's about supply and demand. If a lot of people are buying shares of a company, and there aren’t enough sellers at the current price to fill those orders, the price will typically rise to find investors that are willing to sell. Conversely, if investors start selling shares, the price will likely fall. It may keep falling until it hits a point where people are willing to buy again.
Sometimes new investors worry that they’re making a bad choice because someone else has to sell the shares for them to buy it. If it was a good investment, the other investors wouldn’t be selling, right? However, there are many reasons for investors to sell a stock, like taking profits, avoiding the risk of having too many eggs in one basket, or freeing up cash for other investments. Some also are realigning their portfolio to reflect a change in their goals or risk tolerance. None of these necessarily mean that a stock is a bad investment.
Likewise, there are many reasons investors choose to buy a stock. Those large institutions we talked about have professionals analyzing stocks, determining what to buy and sell. Retirement and pension companies have money coming in each week that has to be invested. And, of course, investors like yourself have as many reasons to buy as they have to sell.
Now, when it comes to buying and selling, you don’t have to run down other investors. Your brokerage will help you do that. A brokerage is a company that specializes in helping investors buy and sell shares. Charles Schwab, of course, is an example. Brokerages take buy and sell orders from customers and then execute them at the venue that gives them the best price, including stock exchanges or other market participants.
So, “What is a stock exchange?” you ask. A stock exchange is where shares are bought and sold, or “traded.” Many countries have their own exchanges and some countries have more than one. For example, the U.S. has the New York Stock Exchange (NYSE), the National Association of Securities Dealers Automated Quotations, or Nasdaq®, and the Chicago Board of Options Exchange (CBOE) among others.
Despite the iconic image of a trading floor in movies, today, most trading takes place on computerized exchanges. Orders are quickly routed and often filled in a fraction of a second.
Narrator: If you regularly watch the news, you may be asking, “If stocks trade on exchanges, what are the Dow Jones Industrial Average® and the S&P 500®?” These are stock indexes. An index is a measuring tool based on the values of a group of stocks. For example, the S&P 500 stock index tracks 500 of the largest companies from a variety of industries. In contrast, the Russell 2000® attempts to track 2000 smaller companies. There are a lot of indexes for various market sectors, industry groups, international markets, and more.
On screen text: DAX 30, Nasdaq Composite®, Dow Jones Industrial Average, S&P 500, Russell 2000(R0, S&P 100®, and Nikkei 225.
Narrator: Indexes can be helpful for tracking stock market performance.
Animation: A graph shows that from 1970 to 2023 $1 invested in large-cap stocks grew to $242, in small caps to $200, in international stocks to $78, in bonds to $29 and in cash or Treasury bills to $10.
This graph here compares small, large, and international company stock indexes to other investments like bonds and cash. It shows that a theoretical investment of $1 in small-company stocks from 1970 to 2023 could’ve grown to $200. However, if the dollar was just left in cash, the value only would've grown to $10. It’s important to note that even though these returns have occurred in the past, there’s no guarantee the future will look the same.
Additionally, stock returns vary year to year.
Animation: A table showing S&P 500 annual rates of return from 1927 through 2023, divided into columns based on various ranges of return from less than –25% to more than 25%.
Narrator: A study of the S&P 500 index over 98 years showed that the average rate of return was 10.1%. But when looking at each individual year, the index only achieved returns of 8% to 12% six times.
Animation: Two columns on the right side of the graph are highlighted. The column title 12% to 25% list 25 year along with their respective returns. The column title More than 25% has 27 years with their respective returns.
Narrator: These columns over here show that there were several years where returns were above 12%—many were even higher.
Animation: The five columns on the left are highlighted. The column title 0 to 8% shows 14 years and the respective returns.
Narrator: However, the columns on this side show that there were several years where returns were below 8%.
Animation: The four columns on the left titled Less than -25%, -25% to -8%, and -8% to 0 are highlighted.
Narrator: In fact, the index saw negative returns about 27% of the time.
One thing this shows is that investors had to be willing to ride the ups and downs of the stock market over the past century, which is why investors generally consider stocks a long-term investment.
Alright, we’ve come a long way, but there’s one more question to answer: “How do I get started?”
Many people begin stock investing through their company or organization’s retirement plan—like a 401(k) or 403(b). These accounts have some tax benefits that you could consider. Also, employers will often add to your account if you’re contributing to it.
Retirement accounts tend to use mutual funds. A mutual fund is a company that pools money from various investors and invests it in securities like stocks, bonds, and short-term debt. Stock mutual funds provide investors the ability to invest in several stocks at once, so they aren’t putting all their eggs in one basket. However, putting your eggs in more baskets doesn’t ensure that you’ll make money, nor does it protect against losses in declining markets.
Some stock funds are actively managed, which means they have experts picking and choosing which stocks to buy and sell. Other funds are passively managed and simply try to mimic the performance of a stock index. You’ll have to select the funds that best suit your goals and your individual risk tolerance. You also need to consider a fund's fees because high mutual fund fees can have a big impact on your portfolio. Actively managed funds tend to have higher fees than passive funds. To learn more about these fees, the objectives of a fund, and other risks, each fund has a prospectus that provides this information.
A brokerage account allows you to invest in several types of assets, including mutual funds and individual stocks.
Buying individual stocks requires the investor to analyze a company’s prospects. This type of analysis often includes learning more about how the company makes money, examining its financial statements, and forecasting future earnings and potential issues the business could face.
There’s a lot here to consider, but don't worry if you have more questions. Check out our extensive library of investing videos to get answers to your other questions while getting started on your journey as an investor.
On-screen text: [Schwab logo] Own your tomorrow®
