What is a Stock?
The basic definition of a stock is a certificate indicating partial ownership of a company. Unlike bonds (see What are bonds?), where you are granting an interest-only loan to the borrower (you are a lender), purchasing a stock makes you part owner of the company. And the more shares you own of a specific company, the greater your percentage of ownership.
Stocks and Bonds From The Perspective of Companies
When it comes to raising start-up or working capital, either the company can borrow money by issuing bonds, or they can sell off shares of ownership in the company.
In the case of issuing bonds, the company will be obligated to pay periodic interest (coupon payments) on the loans as well as having to pay back the principal borrowed on the day the bonds mature.
In the case of selling off shares of ownership, the company is not obligated to make periodic interest payments (though they may choose to pay periodic dividends) nor are they obligated to buy back the shares.
Stocks and Bonds From The Perspective of an Investor
From an investor's standpoint, investing in bonds typically provides a fixed, periodic income (interest or coupon payments) and in most cases, they can expect to get their initial investment back on or before the date the bond matures.
In the case of investing in stocks, the investor has the opportunity to share in the success of the company rather than just receiving a fixed return on investment. However, if the company goes out of business, the stockholder could lose all of their initial investment. In other words, stockholders share in the profits and the losses.
Why Invest In Stock?
To make money, of course. But how do you make money investing in stocks? You can make money in one of three ways:
- Income from optional dividends paid by the corporation (distribution of company profits).
- Appreciation of the stock value (increase in share price).
- Stock splits (shares owned are divided into a larger number of shares).
Of course, if you're a shareholder in a company that goes belly up, so will the value of your shares. This is one reason I choose not to invest in stocks of other companies but instead choose to invest in my own company.
How to Calculate Stock Return
Here is the formula you use to calculate stock profit and return on investment (ROI):
| SP | = | Selling price per share |
| NS | = | Number of Shares |
| DR | = | Dividends received during ownership period |
| SC | = | Total sales commission paid to sell the shares |
| BP | = | Buy price per share |
| BC | = | Total commission paid to buy the shares |
For example, if you purchased 100 shares at $0.85 per share, paying $10 in purchase commissions, and later sold the shares for $1.20 per share, after receiving $23 in dividends and paying $10 in sales commissions, your stock return on investment would be calculated as follows:
| Profit | = | [($1.20 x 100) + $23 - $10] - [($0.85 x 100) + $10)] |
| Profit | = | [$120 + $23 - $10] - [$85 + $10)] |
| Profit | = | [$133] - [$95] |
| Profit | = | $38 |
| Return | = | $38 / (($0.85 * 100) + $10) |
| Return | = | $38 / ($85 + $10) |
| Return | = | $38 / $95 |
| Return | = | 0.40, or 40% ROI |
Why Invest In Your Own Stock (Business)?
I can't speak for others, but here are the five main reasons I choose to invest in my own business rather than invest in other businesses:
- Stocks Too Risky: For me, earning high returns without having to work for it falls into the category of "Too Good To Be True." When someone claims the stock market's historical average is a 10%-12% return, they can never tell me how many investors lost all of their money. All I know for sure is that to attempt to earn 10%-12% on my investments; I'm going to have to accept an uncomfortable level of risk.
- More Control: As a sole proprietor I have complete control over the company. Owning stock does not allow you any control over what the company does or how it treats its customers.
- Increased Percent of Profits: I get to keep 100% of the profits. While stock owners can raise a fuss about not getting dividends, it's totally up to the company's board of directors as to whether or not they decide to share profits with stockholders.
- More Peace of Mind: Because I chose my business based on how well it's suited to my talents, abilities, genuine interests, values, and personality traits, I love my work and believe in it's value to others. Stockholders don't get to see employees getting fired or laid off, or how large companies don't seem to care what their actions, products, or cost of products do to individual customers (alcohol, tobacco, gambling, drug, and credit companies, etc.). From my perspective, most large companies seem to care more about the bottom line than they do about their fellow human beings.
- Greater Returns: Because I work at keeping my expenses low and have worked hard to become completely debt-free, I can earn much higher returns (financial and emotional) with far less risk.
Once you find a work that you love, the last thing you will want to do is to risk losing it. So for me, the risk of losing my savings in the stock market would also put me at risk of being forced out of what I love doing and into something I have to do. Therefore I choose to reinvest a portion of the profits back into my own business, and then invest the rest in minimum risk investments (namely CD Laddering).
How is Your Company Doing?
What's that? Do you say you don't have your own business? I beg to differ. Your life, just like my life, is a business in and of itself. We both have the same amount of time available in a day, and we both have time, talents, skills, and abilities that we use to serve others in exchange for income. If you choose to only serve an employer instead of customers, that's up to you. The question is, are you happy about your choice?
If you are not happy with serving an employer, then the only way to change that is to give yourself the financial freedom you need to build your own business during the time you're not at work. The lower your bills and expenses, and the less debt you have, the more freedom you will have to discover and pursue a work that you love and can believe in.
Throughout this site I have been divulging bits and pieces of the steps I took to go from being trapped by debt in a job I hated, to having the financial freedom to work at something I truly love, and in the time and place of my own choosing (you can read my story here). When you boil it all down, the process is as simple as doing the opposite of what most people are doing.
Before Investing in Stocks
If you are one of those people who can sleep at night while someone else is in control of your destiny, then my advice would be to only invest in stocks once you have a fully funded, government insured emergency fund (3-6 months of household income) and you have paid off all of your high-interest debt.
If you're making minimum payments on 18% credit card debt, then it makes no sense to me as to why you would want to risk losing your hard earned money in exchange for the remote chance to earn a mere 10% return -- so invest in your debt first.