What is a stock?
The ownership of a publicly traded corporation is separated into shares of common stock, which is a type of investment. When you invest in common stock (buy shares) you become a partial owner (shareholder) of a corporation and you take on some of the risks and rewards of being an owner of a company. Equity is another word for stock.
Why buy stock?
To make money. Although, you can lose the money you invest, that is the potential reward vs. risk of stock investing. There are two opportunities to make money on stocks 1) capital gains and 2) dividends.
Capital Gains and Capital Losses
The dollar value per share of stock will fluctuate up and down depending on the perceived value of the share of stock. Stock is sold in an environment where there are buyers and sellers and it is their perception of the value of the stock that drives the price up and down. The buyers and sellers are observing many variables, some of which are directly tied to the stock itself, some of which are related to the stock’s competitors, some variables pertain to the U.S. economy as a whole, and some variables pertain to markets overseas. There are so many factors that go into the daily fluctuation of the price of the stock; it isn’t just the underlying value of the corporation itself that determines the share price of a stock.
If you buy a stock for $10 per share and sell it for $15 per share you have a capital gain of $5 per share. Congratulations, you have made money on your investment! Don’t get too excited though, Uncle Sam wants his cut. You will have to claim the income on your tax return. If you have held the investment for less than a year (short term capital gains); it will be taxed at your income tax rate. But it isn’t all bad news; for investments that were held longer than a year (long term capital gains); the 2012 capital gains tax rates are lower than income tax rates; 15% for those in the 25% income tax bracket or higher and 0% for those in the 15% income tax bracket or lower.
If however, you buy a stock for $10 and you sell it for $8, then you have a capital loss of $2, you have lost money on your investment. Uncle Sam lets you write losses against gains, and then write off $3,000 of capital losses against income as a capital loss deduction and then carryover any remaining loss to be used in future years.
See the www.irs.gov website for details.
One of the rewards of being a shareholder includes participating in the earnings of the company, if they are paid out, in the form of dividends. Keep in mind that sometimes companies keep their earnings to invest back into the company with the goal of improving the company.
Shareholders also have the opportunity to vote on the election of board of director members and mergers and acquisitions.