What Are Stocks?

Let’s face it: Investing can seem intimidating. All the numbers, charts, jargon and acronyms—it’s enough to make any casual observer dizzy.

But there can be serious consequences to being so scared of getting your feet wet that you stay out of the game entirely. “If you do not invest, you are risking your future financial security,” says Certified Financial Planner Stacy Francis, CEO of New York-based Francis Financial.

That could mean the difference between retiring one day on your own terms or having to work throughout your golden years, paying for your kids’ college tuition or having them take out student loans, affording the life you want or always playing catchup.

The good news is that it isn’t as hard as you think to get started investing. Let’s brush up on the basics of stocks, one of the fundamental aspects of investing: what they are, how they get their value and how people use them.

What are stocks?

When you purchase a stock, you’re purchasing a fraction of the overall value of a company that represents a proportional piece of ownership. Certified Financial Planner Vid Ponnapalli, founder of Holmdel, N.J.-based Unique Financial Advisors, puts it this way: “A stock is nothing but [a fractional ownership in] a company.”

Because your share is inherently tied to the rest of the company’s shares and the company’s performance, the value of your share goes up and down with the company’s financial well-being—or, rather, with investors’ perception of that company’s well-being. So your stock has the chance to either give you returns or losses depending on how the company performs over time.

How do stocks work?

Going public is one way for a private company to raise money and expand its business. The process is usually launched with an initial public offering, or IPO. An IPO is when a company issues shares to the public through the stock market for the first time. New shareholders then own a stake of the business, and the company (hopefully) gets an influx of cash to (hopefully) grow.

Before the IPO, a company enlists the help of an investment bank to help determine its value, using a lot of assessment techniques and formulas to consider historic and projected revenues, profits and costs, as well as potential plans for new products, whether marketing can drum up more interest in the company and how similar companies are valued.

After that, the bank will advise the company’s board about how many shares to sell. Then the board makes the final decision. Typically, owners want to keep more than half of the shares to maintain control.

A company's IPO price is decided by a few factors. The investment bank can calculate an estimated price given the number of shares it recommends. But part of the valuation process is determining public demand for a company’s IPO.

If demand for the stock is high—i.e. if you, your friends and everyone else are in love with a company’s products or services—the price of the stock may also be high. If demand is low, the price will follow suit, and the company may even hold off on going public.

What are dividends?

Dividends are periodic payouts of earnings that companies give to certain shareholders. Most companies that regularly pay dividends tend to be larger established companies with more predictable profits. In fact, a steady history of paying dividends may indicate to investors that the company is financially healthy which could also attract more investors, potentially attracting more investors. 

That’s not to say that companies that don’t pay dividends can’t be financially healthy or attractive. They may be using their earnings to expand their businesses or reinvest in the company in other ways. That's one reason why many startups or other companies aiming for speedy growth don’t pay dividends.

Stock market fluctuations

Ups and downs are totally normal. A lot of factors can influence fluctuations—from oil prices to economic reports to the weather. The best thing you can do as an investor is to prepare yourself for invevitable market swings and focus on a the big picture and long-term investment goals. 

Comparing stock performance to an appropriate benchmark is a good way to gauge how it’s doing. For example, on a day when Standard & Poor’s 500-stock index drops, a drop in the price of a large-company stock you own can be expected.

But remember: “When you start investing, you are not investing for daily movements,” says Ponnapalli. “All people who invest in the stock market should do it for the long term.”

How long to hold onto your stocks

There are many factors that can determine how long you hold onto your stocks.  

But if you’re concerned about holding onto a stock whose price is sinking, Poannapalli say to consider going back to square one. “The decision-making [process] is exactly like when you’re buying a stock,” he says, recommending you focus on whether the company is making a profit and how the leadership is running it. “After your analysis, if you still believe that the fundamentals you liked when you bought the stock are the same, you don’t have to sell.”

In fact, when the price is down, it might be a good time to buy more at a discount, he says.

What is a stock split?

When a company does a stock split, it increases the total number of shares outstanding by a multiplier while decreasing the price per share by an equal proportion. The value of the company does not change. For example, if a company’s stock is priced at $100 a share, and the company executes a 2-for-1 stock split, the number of outstanding shares doubles and the stock price drops to $50 a share. For every one share you owned at $100, now you'll own two at $50 each.  

A few reasons a company might do this is to make its stock accessible to more investors, or to increase liquidity. (Presumably, more people would be able to afford that $50 stock price than $100.) 

Buybacks Explained

A buyback, like a dividend, is another way a company can spread the wealth and return excess cash to shareholders. Isn’t that nice of them? But hold on— it’s not simply an act of generosity.

Typically, this move will push up share prices because it decreases the amount of outstanding shares in the market. So, in a best-case scenario, a company might buy back its stock because it feels the market has undervalued its worth and wants to give itself a boost. But it might also use the strategy to goose its numbers and give the appearance of being worth more than it is.

Types of Stocks & Investments

There are a few different investment options to understand before investing.

Exchange-traded funds (ETFs) vs mutual funds

Although there are some similarities between ETFs and mutual funds, these are some of the most common differences. Because most ETFs track indexes, and are therefore more passively run, they tend to charge lower fees than mutual funds. The former are also traded like common stocks at varying prices throughout the day. Conversely, shares of mutual funds are priced based on their net asset value (NAV) once at the end of the trading day. (That’s calculated by dividing the total value of all the securities in the fund, based on the closing prices that trading day—minus any debts or obligations the fund has—by the total number of shares outstanding). Information on ETF's and Mutual funds, including their fees and expenses, can be found in the fund prospectus, which should be read carefully before investing.  

Funds vs individual stocks

“Single-stock investing is risky and does not provide diversification,” says Ponnapalli. In other words: If you invest all your money in one stock, and it goes down, you can lose a lot of money (assuming it doesn’t go back up before you need to sell). And putting together a well-diversified portfolio of individual stocks can require a lot of homework.

On the other hand, if you invest in a stock mutual fund or an ETF, the fund managers are doing most of the hard work for you. They can put together a portfolio of possibly hundreds of different stocks, allowing you broad diversification with just one investment.

Target-date funds, on the other hand, are actively managed and rebalanced to adjust portfolio risk as you get older. You simply choose the year in which you expect to reach your financial goal—usually it’s your retirement year—and the fund’s managers build a portfolio to suit your time horizon, adjusting it when necessary as the deadline approaches.

NYSE vs Nasdaq vs Chicago Mercantile Exchange

The New York Stock Exchange (NYSE) and Nasdaq are the two main U.S. stock exchanges. When you picture a mass of investors on the exchange floor shouting out trades and waving pieces of paper in the air, that’s typically the NYSE. The Nasdaq, on the other hand, operates electronically with no physical trading floor.

The Chicago Mercantile Exchange is the largest exchange in the U.S. for futures. Futures are agreements to buy or sell an asset like a commodity (which is a basic good, such as orange juice, oil or gold) or a financial instrument like interest rates at a set price on some future date.

Taxes on Stock Gains

When you are ready to sell a stock, understand that if the stock price has gone up since you bought it, you may owe Uncle Sam capital gains taxes. If you owned the stock for less than a year, the tax rate is higher than if you had held it longer. But if you own another stock that has gone down, you can sell it and use that loss to offset your gains. “A little tax planning comes in here,” says Ponnapalli.

For example, if you bought one share of Stock A for $10 and want to sell it at $50, you’d owe taxes on that $40 gain. If you also own one share of Stock B, which you bought for $50 and is now priced at $10, you could sell it in the same year and deduct your $40 loss to wipe away your $40 gain from Stock A on your tax bill. One catch: Once you take the tax benefit of the loss, you cannot buy that stock or a similar one again for 30 days.

Of course, if you’re investing within a 401(k), individual retirement account or similar tax-advantaged plan, this is all moot. You won’t be taxed on gains, and you can’t deduct losses. (Just remember, you can buy and sell holdings in those retirement accounts, but if you actually withdraw money before you turn 59 ½, you may have to pay penalties as well as taxes.

Article contributors, referenced firms, or companies are not affiliated with Acorns Advisers, LLC. and do not provide investment advice to Acorns’ clients.  The views expressed in the articles above are generalized and may not be appropriate for all investors. This content is for informational purposes only and should not be relied upon as accounting, legal or tax advice.  You should consult your tax or legal advisor regarding such matters.  The information contained in this article should not be construed as, and may not be used in connection with, an offer to sell, or a solicitation of an offer to buy or hold, an interest in any security or investment product. There is no guarantee that past performance will recur or result in a positive outcome. Carefully consider your financial situation, including investment objective, time horizon, risk tolerance, and fees prior to making any investment decisions. No level of diversification or asset allocation can ensure profits or guarantee against losses.