In our last Investing Basics article, we talked about securities and what that term includes. The next few articles in this series will focus on the specific types of securities available. We’ll look at stocks, bonds, mutual funds, options, futures, and short-term savings options. Today, we’re going to talk about stocks.

What Is a Stock?

       As I explained in the post about securities, a stock represents ownership. Stocks are also referred to as equities, which simply means they represent an ongoing ownership interest in a business. Each share of a company’s stock represents a piece of ownership interest in that company. When you own a share of stock, you own a part of a company.

       The return you get from owning a stock comes in one of two ways: dividends or capital gains/losses. Dividends are payments the company makes to its shareholders (owners) from its earnings. If a company declares a dividend of $1.00 per share and you own 100 shares, you’ll get $100 in dividends.

       Capital gains or losses result from changes in the price of the stock. If the stock’s price goes up from where you bought it, you’ll have a capital gain when you sell it. If the stock’s price goes down, you’ll have a capital loss when you sell.

       Stocks are considered riskier investments than bonds because of what happens when a company liquidates or goes bankrupt. Stockholders are the last people to be paid when a company goes belly-up. Bondholders get paid before stockholders, so there’s less risk. If there’s no money left when it comes time to pay the stockholders, then they get absolutely nothing.

       Finally, there are two main types of stocks: common stock and preferred stock. The biggest difference between the two is in how dividends are paid out. Common stock comes with no dividend guarantees. Preferred stock comes with a stated dividend rate (either a specific dollar amount or a percentage of the stock’s par value – the face value). Also, preferred stocks have priority over common stocks when dividends are paid. That means that dividends owed to preferred stockholders must be paid out before common stockholders receive anything. They’re a little more complicated than that, but that’s the basic difference.

       In the next article, we’ll look at bonds. Make sure you sign up for free updates to Provident Planning if you want to learn more!

       Once you understand what an investment is, you can begin to learn about the different types of investments available. We’ll start by looking at the broadest types of investments first, and then later we’ll narrow it down by looking at more specific types of investments.

What Is a Security?

       There are two main types of investments – securities and property. We’re going to look at securities today.

       I’m sure you’ve read about the securities markets in the newspapers or heard about them on TV. But what does that mean exactly? A security is any kind of investment that represents debt, ownership, or the legal right to buy or sell a security.

       Bonds are an investment that represent debt. When you invest in a bond, you’re basically loaning money to the person who issued the bond.

       Stocks are investments that represent ownership. When you invest in a company’s stock, you are becoming an owner of that company.

       Finally, options are investments that represent a legal right to buy or sell a security. An option is basically a contract that you purchase to give you the right to buy or sell a certain amount of a security at a certain price for a certain amount of time (until the contract expires). The person who sells you the option is legally obligated to sell that security to you or buy that security from you at the specified price whenever you choose to use your rights.

       So when you hear someone talking about securities (or the securities market) they’re talking about stocks, bonds, and options. Securities would also include mutual funds, which are simply a portfolio (a collection) of securities. These are very basic things in the investment world, so it is important you understand what they mean.

       As I continue this series on investing basics, we’ll go into more depth about all of these types of investments so you’ll understand what they are and how they work. Make sure you sign up for free updates to Provident Planning if you want to learn more! You can also enter your email address below to get free updates in your email: (Don’t worry, I’ll never share nor sell your email address.)

       Because I spent four years in college studying personal finance, most of the basic questions don’t occur to me any more. It’s called familiarity blindness. I’m just so used to this stuff that I no longer realize what other people might not know. That’s not to say they’re stupid. They just haven’t spent as much time studying these things.

       Part of my purpose for writing on Provident Planning is to educate people. I want to teach people enough to make good financial decisions on their own. So it’s with that mindset that I’m approaching several topics from here on out by focusing on the basics. I’m planning on looking at the basics of investing, insurance, taxes, retirement planning, and estate planning. These will start off very basic (like today’s post), and I’ll look at more complex issues as time goes on. So let’s get on to today’s post.

What Is an Investment?

       If you’re new to the idea of investing, a great place to start is to define what an investment is. An investment is simply anything you put money in with the expectation (or hope) that it will generate income and/or increase in value. An investment return is the reward you get from investing – basically current income or increased value.

       For example, money in a savings account provides income in the form of interest payments. A share of stock is expected to increase in value over time while possibly providing income in the form of dividends. A rental home could be considered an investment because you expect to generate rental income while the property value increases over time. You can even consider education to be an investment because you expect it will help you earn more income or increase your value to employers. While that’s true, this series is going to look more at things like stocks, bonds, options, mutual funds, real estate, and other such traditional investments.

       So that’s a basic definition of an investment – something that is purchased with the hope that it will provide income or go up in value. But be sure you don’t get “investing” and “speculating” confused. Investing involves the creation of wealth through legitimate means. Speculating is often a zero-sum game, where someone else has to lose so you can win. No wealth is created in speculating – it simply changes hands.