Companies seeking to raise money for growth sometimes choose to sell shares of stock to the public instead of taking out loans, issuing bonds, or other financing methods. A share of stock represents a small fraction of ownership in the corporation. The stock market involves the trading of shares among investors through stock exchanges. Putting money in the stock market is a common strategy for wealth creation, but before investing it is important to understand the basics of how the market works.
What Determines Stock Prices
Investing in the stock market is risky because the prices of stocks rise and fall according to investor demand. Any factor that influences demand for a stock can affect short-term prices. For example, if an oil company is responsible a spill, investors might worry about the impact on the company's profits, leading to a stock sell-off and a declining stock price. Over the long term, stock prices tend to follow corporate earnings.
How You Make Money From Stocks
You can make money from stocks in two ways: capital gains and dividends. After you buy a stock, its price might increase over time. If you sell it at a price that is higher than what you originally paid, you make a profit, called a capital gain. Some stocks also offer periodic cash payments, called dividends, to attract and retain investment. Dividends tend to be offered by large corporations with steady earnings.
How You Buy Stocks
Stock investors typically purchase shares through intermediaries called stockbrokers, who make trades for their clients. Many stockbrokerages offer electronic trading accounts that let you buy and sell shares online without actually talking to a human stockbroker. When you make a trade with a broker, you generally have to pay a transaction fee. It's sometimes possible to purchase shares of stock directly from the company that issues the stock to avoid brokerage fees. But this forces you to deal with one company at time, and it increases the paperwork needed to sell shares.
How Stocks Are Taxed
Capital gains on stock investments are taxed at a maximum rate of 15 percent for stocks you hold longer than a year. If you sell a stock in a year or less, any profit you make is considered a short-term gain and is subject to your normal income tax rate. Dividends generally at taxed at 15 percent if you meet a certain holding period requirement. According to the IRS, to qualify for the 15 percent rate, you have to own a stock more than 60 days during the 121-day period that begins 60 days after the stock's ex-dividend date. The ex-dividend date is the first day new investors aren't entitled to receive the next dividend payment. If you don't meet the holding period requirement, dividends are taxed at your normal income tax rate.
Gregory Hamel has been a writer since September 2008 and has also authored three novels. He has a Bachelor of Arts in economics from St. Olaf College. Hamel maintains a blog focused on massive open online courses and computer programming.