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Advantages of owning a stock:
- Get share of the profit
- The importance of being a shareholder is that you are entitled to a
portion of the company’s profits and have a claim on assets. Profits
are sometimes paid out in the form of dividends
(especially for large companies like coca-cola).
The more shares you own, the larger the portion of the profits you get. Your
claim on assets is only relevant if a company goes
bankrupt.
In case of liquidation, you'll receive
what's left after all the creditors have been paid.
- Achieve Capital Gains - Most
small companies reinvest profits back into the company, so you may not receive
dividends, but the price of the stock will most likely go up if the company is
growing. Then you can sell the stock for profit. Microsoft, for example,
hasn't paid out any dividends until recently since it became public in the
early 1980's. But price of the stock has grown exponentially from a few cents
per share to around $24 (adjusted for splits).
Click here
to see the chart>
- No Dirty work to do -
The management of the company is hired by board of directors to run the
business.
Shareholders not being able to manage the company isn't too big a deal.
After all, the idea is that you don't want to have to work to make money,
right? But if the management is doing a poor job, shareholders can vote to have
the management removed--well, this is the theory anyway. In reality,
individual investors like you and I don't own enough shares to have a
material influence on the company. It's really the big boys like large
institutional investors and billionaire entrepreneurs who make the
decisions.
- Limited Liability - Another
extremely important feature of stock is that you are not be personally liable in the
case of the company not being able to pay its debts. Other type of ownership such as
sole proprietorship and
partnerships
are set up so that if the company goes bankrupt the creditors can come
after the partners (shareholders) personally and sell of their house, car,
furniture, etc. Owning stock means that, no matter what, even if a company of which you
are a shareholder goes bankrupt, you can never lose your personal assets.
- Better success rate - If you
were to start your own business, the likely hood of you succeeding is very
slim. You can sleep better when you own shares in a successful company like
Altria Corp (formerly Phillip Morris). What are the chances of Altria going
out of business? Not likely, can it happen? Sure! if people stop smoking, stop
eating cheese and stop washing their clothes and utensils. Altria makes almost
every consumable products imaginable. So, they are going to make money every
time people smoke, cook, clean and wash dishes, etc.
- Tax Deductability - Unlike
gambling in a casino or a racetrack, if you experience any loss with a stock,
you can take a write off against your regular income. Off course, losing money
is not a benefit but if you are in a high tax bracket and your combine federal
and state tax is around 40%, then being able to deduct losses on your income
tax is great. Let's assume you have a loss of $5,000, you can deduct $3,000
(current yearly limit on deducting against ordinary income) of it on the year
you incurred loss on your tax return (saving you $1,200 in taxes) and carry
over the $2,000 loss on to next year's tax return (saving you another $800 in
taxes) for a total savings of $2,000 in taxes.
Disadvantages of owning a stock:
- Significant time to
research and track a stock - Even though
you don't have to think about running a company, you do have to know
quite a bit about the company you're investing in. You need to take the
time to research about the company and ask questions like "what products
does it sell and who are the customers?", "what much debt does the company
have and will it be able to pay it?", "what are its prospects for future
growth and profitability?", etc. You need to monitor your investment after
you have acquired stock in the company as long as you hold that stock. You
also must make decisions to sell a stock without emotions because when
your money is on the line, emotions undermine your ability to make sound
long-term decisions. If you don't have the time nor knowledge to pick
stocks, you might want to consider investing in stocks mutual funds
managed by expert portfolio managers (see our
mutual funds section).
-
You may lose your investment - By becoming a shareholder in a company , you assume the risk of the
company not being successful. Just as a small business owner isn't
guaranteed a return, neither is a shareholder.
It must be emphasized that there are no guarantees when it comes to
individual stocks. Some companies pay out dividends, but many others do not.
And there is no obligation to pay out dividends even for those firms that
have traditionally given them. Without dividends an investor can make money
on a stock only through its appreciation in the open market. On the
downside, any stock may go bankrupt, in which case your investment is worth
nothing.
- Less claim on assets than
creditors - If you own shares in the company that goes bankrupt and
liquidates, you don't get any money until the banks and bondholders have been
paid out. Shareholders are the last people to get paid. You can earn a lot if
a company is successful, but you can also stand to lose your entire investment
if the company isn't successful. Although you do take the risk of losing
money, there is also a bright side. Taking-on greater risk means a greater
return on your investment. This is the reason why stocks have historically
outperformed other investments such as bonds or savings accounts. Over the
past two centuries, an investment in stocks has historically had an average
return of around 11 percent.
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Why
does a company issue stock?
Why would the founders
share the profits with thousands of people when they could keep
profits to themselves? The reason is that at some point every
company needs to raise money. To do this, companies can either
borrow it from somebody or raise it by selling part of the
company, which is known as issuing stock. A company can borrow by
taking a loan from a bank or by issuing bonds. Both methods fit
under the umbrella of "debt financing."
On the other hand,
issuing stock is called "equity financing." Issuing stock is
advantageous for the company because it does not require the
company to pay back the money or make interest payments along the
way. All that the shareholders get in return for their money is
the hope that the shares will some day be worth more. The first
sale of a stock, which is issued by the private company itself, is
called the initial public offering (IPO). If you want to know more
about how stocks are created, check out our IPO tutorial. |
Next-->>
Different kinds of Stock
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