Stocks; just the word sounds old and stuffy. The reason for that is really good, stocks have been around forever.
What are stocks?
When you buy a stock in a company, you are giving that company money to be able to grow. In return you get a share of the profits (dividend) or the profits are reinvested and the stock is worth more when you sell it.
Example with flowers:
Let’s say your friend wants to open a flower business and they ask you for $100. You have two options; you can lend them the money for interest or buy stock in the company for $100.
Option 1. Lending $100 for interest.
You and your friend agree you will get 5% a year until the $100 is fully paid back. The up side is you know just how much you will be getting, and you will be getting money coming in. Also, they will owe you the money even if the company is not going well or in a down turn.
Option 2. Buying $100 worth of stock.
You buy 10 shares of stock at $10 a piece.
First year: the Tulip Business is doing well, so well that next season the friend plants more bulbs to sell in a new plot of land.
Option 1. You were paid $5 interest and $10 principle (you have made $5)
Option 2. You still own 10 shares worth $10 each.
Second year: The company has sold all the bulbs from both plots of land and has decided to start selling potted tulips along with the flowers.
Option 1. You were paid $4.50 interest and $15 on principle (you have made $9.50 total)
Option 2. Because the company is worth more now than when you started, the 10 shares you own are now worth $11 each if you were to sell. (if you sell you will have made $10). But because the company hasn’t had to pay you interest or principle they can reinvest the profits.
Third year: The company is selling flowers and potted plants like hot cakes. All profits are being reinvested back into the company.
Option 1. You are paid $3.75 in interest and $15 on principle (you have made $13.35 total or 13% of your investment)
Option 2. The company stocks are now worth $11.50 each if you were to sell. You don’t and the company again reinvests the profits.
Year four: The company is now not only selling tulips and potted plants but also pots and soil for flowers. The decide to pay a dividend.
Option 1: You are paid $3 in interest and $15 on principle (you have made $16.35 and been paid back $55 of your initial loan)
Option 2: Your 10 stocks are still only worth $11.50 each but you also get paid a 5% dividend, so $0.57 a share. If you were to sell you would make $1.50 on each stock and the $5.75 in dividend payment for a total of $20.75 in profit!
Buying stocks is a little like lending a company money, you are an investor in the company. You are buying a part (share) of the company and they use your money to help it grow bigger. They can reinvest the company profits into the company and branch out into new things or pay some profits back to the stock holders in what is called dividends.
The down side.
Companies can close down. If you were a lender they may have already paid you back or will still owe you the money. When they sell any capital or left over products you will be repaid.
If you are an investor, you have just lost any money you put in.
This makes buying stocks risky. But not as risky as people think. Look at the strong companies that have been around for over 100 years.
If you invest in good companies and not the “hot thing” or “new thing” you will get the rewards for investing with less risk. Think of it this way; the less risk the less reward. But 7 or 8% growth of a stock is better for wealth building then 1% in a bank savings account!
If you want to learn even more about stocks and how they work, click the article below:
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