Stock markets have become one of the most lucrative options to build wealth. A lot of us have already invested or are planning to invest in stock markets. But how many of us actually know where the money goes when we invest or buy stocks of a company? Let’s find out!
In this article, we will discuss all stocks such as what they actually are, why should you own them, where does your money go when you invest in stocks, what happens to your money when the value of your stock drops, what does owning a stock involve and all about buying and owning stocks that rise and fall. So let’s start:
What is a stock?
Stocks are the general term representing a slice of ownership of one or more companies.
Stocks are, surely, the way by which ordinary people can invest in some of the biggest and most successful companies in the world. A lot of people and investors choose this way to build wealth. In fact, the chance to earn a good return on investment is one of the main reasons why so many investors choose to invest in stocks.
The investor gets to essentially own a little piece of the company whenever they own a stock. The money goes indirectly to a company, through an investment bank, when the investor purchases that stock as a part of the company’s IPO (Initial Public Offer)
When it comes to the company’s part, stocks are a good way to raise capital to fund many new initiatives such as products, innovations, etc.
What is the difference between a stock and a share?
The difference between a stock and a share is that “stocks” are the general term representing a slice of ownership of one or more companies, and “share” has a specific meaning and represents ownership of a particular company.
Why should one own stocks?
Basically, buying a company’s stock means buying ownership in a company, as told before. Stocks generally provide a good return on investment, especially in the long run. An investor can expect a return of about 10% on his investment, which, considering inflation, can drop to 8%.
Building a diversified portfolio which involves buying stocks in companies across different countries and industries seems to be a wise decision rather than investing in just one company, considering that not every stock has the same kind of return and fluidity.
Returns on stocks come in many different ways irrespective of the type of company the person decides to invest in. Some of them are:
When you sell the stock for more than what you paid for, it fetches you a profit because the stock value goes up, i.e., it appreciates over time.
Stocks can also pay you a dividend, which is basically payments made to shareholders out of the company’s profit. Stocks usually pay monthly, quarterly, semi-annual or annual dividends, but you have to keep in mind that not all stocks pay dividends.
What happens when you buy a stock?
Where does the money go when you buy a stock?
When traders buy stocks, the money from the trading account goes to the broker’s pool account. Then the money from the broker’s pool account goes to the clearing corporation. Finally, the money will reach the seller of the stock at the price the trader bought.
So now that we have a basic idea of what stocks are and why one should own them, it’s time that we take a deeper look at where one’s money goes when one invests in a stock.
Normally, a company decides to sell shares when they need money for their business. They can invest in different enterprises or initiatives such as funding new products or portfolios, expanding production, or spending on other things such as marketing or research.
The company first issues shares via an IPO (initial public offering), which the investors can buy or sell once they’re available on the market.
The shares can be exchanged between buyers and sellers after they’ve been issued on the market. This is known as a secondary market where the money goes to another investor selling their shares.
The investor receives money from a buyer via an intermediary, generally known as a broker, when they want to sell their shares.
What happens when you sell a stock?
When traders sell stocks, the money from the trading account goes to the broker’s pool account. Then the money from the broker’s pool account goes to the clearing corporation. There is an actual buyer who will purchase these stocks, and the trading house absorbs the sale and reimburses you at the current market price.
So when traders buy stocks, they are not buying them from the company; they buy them from other existing shareholders. When traders sell their stocks, they do not sell them back to the company because they sell them to some other investor.
What happens to the money when the value of a stock drops?
Let’s take a simple example to support the statement.
So two people want to trade stocks: x and y
Let’s say that x bought a share from y for 20 rupees. After a certain amount of time, the share’s value started to drop, and x sold the stock back to y for 10 rupees. So in this transaction, x lost 5 rupees, but y made 10 rupees.
Unlike this example, the stock market is much more complicated. There are a lot of stocks and a lot of participants. Different people have different cost bases.
The stock market, like derivatives, isn’t a ‘zero-sum game.’ A lot of people buy stocks keeping in mind that someday another party will pay more for it. And this thought process works as there is no expiration date for the stock market.
The interesting part is that people are always either on the winning or losing trade to a certain degree. So the answer to this simple question is that the money is with the person who sold you the stock.
What involves owning a stock?
A majority of people invest their money in common stock, which also comes with voting rights and includes dividends.
Other types of stock work differently, such as preferred stock. One should remember that owning a stock and owning a share in its profits or losses are two sides of the same coin. That means that the owner doesn’t have a say in the company’s managerial decisions, and they also won’t be provided a desk at the company’s headquarters.
Stocks have a good history of providing excellent returns to investors, but they come with a risk. An investor owns stock with a goal that the company’s value (also, the stock) should go up as long they own such a stock. However, the investor should also keep in mind that, due to the market being very volatile or due to certain conditions or mishaps in the company, the stocks’ value can also go down in value. This is one of the main reasons why the investor needs to pay a good amount of attention to the market and the company’s activities because even the smallest issues such as a crisis or a wrong communication can affect the value of the stock of that company.
Generally, a lot of investors prefer to go long term for the stocks they invest in. The result is that the overall value of that portfolio would go up over time. Many long-term investors also prefer going for Mutual Funds, through which they can indirectly own stocks. The benefit? Mutual Funds tend to offer pool investment funds that ensure diversification to a certain level.
What about buying stocks that rise and fall?
With all the following information, you must’ve come to know that the stock market is not as simple as one thinks. One should always be on their toes to be successful in trading stocks and should always be aware of the market conditions and the strategies of the companies they invest in. This helps the investors to make better decisions, resulting in a higher return on investments.
Now that you have an idea about the stock market, it’s time to go out there and start investing!!