Today’s lesson is capitalism 101.
As an investor, my guess is a good deal of your portfolio will be in stocks and bonds. These are the two primary types of investments for most investors.
Knowing the differences is critical in your journey to being truly money smart.
You may already have a good grasp of what a stock and bond is, but stick with me for this short lesson, as there might be a nugget or two of new information you’ll learn.
What’s a stock?
A stock is ownership in a company. Alrighty then, what’s a company? A company is a separate legal entity that exists apart from its owners. Although the owners of a company are mortal, a company is eternal. Think about Apple – the company, not the fruit. Steve Jobs passed away, but we still get the new versions of the iPhone because the company continues to live. A company is like a person in that it has certain rights and responsibilities – again, separate and distinct from its owners. And unless you live in certain progressive countries such as the Netherlands, New Zealand, or Germany, another key difference is a company can legally sell itself but a person cannot. This is where the idea of stock comes in.
It’s kind of simple, if you think about it. When a company is started, the owner or owners decide how many shares of stock the company should have. It could be just one share or it could be a million shares. And they can change their mind and start with one share and then change it to more later.
Although a company, such as McDonald’s, can own lots of stuff like buildings, trucks, and French fries, the company itself is its stock. If you want to invest in McDonald’s, you don’t buy a vat of their special sauce; you buy shares of McDonald’s stock. And by having just a single share of McDonald’s stock, you actually own a small piece of not just their not- so-special sauce, but everything the company owns. That’s cool, isn’t it?
But why would you want to own stock in a company?
You want to make money, of course! How? You expect the company to make lots of money. You expect them to sell lots of burgers and shakes. If they do, then your little slice of ownership becomes more valuable. But keep in mind that when you own something, it can go down in value. Stocks can lose money. There are other kinds of investments that don’t lose money, but as a stockholder or shareholder, you definitely could lose money.
“In essence, you are investing in the future success and growth of the company.”
Stock, also called equity, is ownership.
As a stockholder, as an owner, you get special rights. You get to vote on important company matters, show up for their annual meetings, and even get income in the form of dividends from their profits. But, sorry, you don’t get a complimentary Big Mac.
This is a painful reminder of the time I took my daughter to Disneyland. I told her we owned Disney stock, which meant we owned a small piece of Disneyland. The initial look of admiration on my daughter’s face was what a parent longs for, but it quickly faded after I told her this didn’t mean we could get a free Mickey Mouse pretzel.
You could do many things with your money, but when you invest in a stock or stocks, you are making an educated decision and placing your money on the management of the company, the people who work there, the new products or services they are going to offer, and their profits. In essence, you are investing in the future success and growth of the company.
The proceeding blog post is an excerpt from Get Money Smart: Simple Lessons to Kickstart Your Financial Confidence & Grow Your Wealth, available now on Amazon.
About the Independent Financial Advisor
Robert Pagliarini, PhD, CFP®, EA has helped clients across the United States manage, grow, and preserve their wealth for the past 25 years. His goal is to provide comprehensive financial, investment, and tax advice in a way that was honest and ethical. In addition, he is a CFP® Board Ambassador, one of only 50 in the country, and a real fiduciary. In his spare time, he writes personal finance books, finance articles for Forbes and develops email and video financial courses to help educate others. With decades of experience as a financial advisor, the media often calls on him for his expertise. Contact Robert today to learn more about his financial planning services.