This video is part of a series called Foundational Finance, where we’ll go over the basics you need to

know to get up and running in investing and begin to speak the language of finance.

Foundational Finance is a part Retirement Planning Academy,

a free course I offer on Realize Your Retirement.com.

Today’s video covers stocks, what they are, how they provide returns to investors,

and how people commonly invest in them.

A stock entitles the owner of the stock to a

share in the current and future earnings of a company.

Which is why a one item of stock is called a share.

Owners of stocks are known as shareholders.

Stocks are also known as equities.

Those of us in finance will interchangeably use the terms,

which can be confusing.

So just know they mean the exact same thing.

Because stocks represent a share in the current and future earnings of a company,

their value is determined by the success of the company.

They don’t really offer any contractual payments

or protections for a return on your investment.

Finally, the goal of a public company should be to maximize the investment returns of its shareholders.

Unfortunately, it doesn’t always work that way in reality,

but in an ideal world, management’s interest should align 100%

with the interest of shareholders.

Here’s how a shareholder’s returns work.

Stocks can yield a return on your investment via two mechanisms,

price appreciation

or dividends.

In this example,

the price of our stock increases from $25 to $30.

To calculate our return we’ll take the ending

price of $30,

subtract out the original price of $25,

and divide the entire thing by the original price.

So, $30 minus $25

equals $5.

$5 divided by $25 is 20%.

So the investor’s return would be 20%.

First, let’s cover what a dividend is.

Companies generally have two options.

Reinvest earnings into the company via things like research and development,

marketing, acquiring other companies to expand into new markets.

Or if companies see only a small return on investment on

internal projects,

companies will issue dividends

when they can provide more value to shareholders by paying them cash.

So a dividend is a cash payment from to company to shareholders.

Dividends are completely optional, many companies never issues dividends because they believe

they can achieve higher returns by reinvesting

their cash.

In this example, the price of the stock once again increases from

$25 to $30, but this time there is also a $2 dividend.

So, $30 minus $25 equal $5.

$5 plus $2 equals $7.

And finally $7 divided by $25 gives us an investor return of $28%.

As you can see the dividend offered a higher return over the price appreciation alone.

If you look at the stock market over the last 100 years, you’ll see that dividends

often make up a large portion of the total return an investor receives from a company.

So, how do you invest in stocks?

Stocks are traded on stock exchanges such as the

New York Stock Exchange and the Nasdaq.

On exchanges stocks can be purchased for individual companies.

Stocks can also be purchased in groups via mutual funds or exchange traded funds., commonly called ETFS.

Mutual funds and ETFs will either buy stocks based on certain criteria

they have set

or they buy stocks based on whether they are in an index.

For example, the widely reported S&P 500 Index

tracks the largest 500 stocks by total market value in the United States.

The Dow Jones Industrial Average tracks the 30 stocks

deemed to best represent the major industries in the United States.

When people refer to what the US market is doing,

they are usually referring to one of these widely followed indexes.

Another widely followed index is the MSCI EAFE,

which tracks large companies in developed countries in Europe, Asia and the Far East.

So an S&P 500 index fund would simply hold the same stocks that are in the S&P 500 Index.

Other funds may choose specific criteria when selecting stocks in an effort to either reduce risk

and increase returns.

In the event of a liquidation bankruptcy,

the company’s assets are sold

and used to pay the claims of lenders and shareholders.

They are usually are paid in this order:

The first paid are the debt holders, such as those who have bought bonds.

They are paid as much of the balance of the debt they are owed

as well as any interest they are owed.

Next, if there are any funds leftover,

holders of preferred stock are paid their dividends.

Finally, common stock holders are paid out whatever remains.

When you buy a stock you generally buy a common share of stock.

Because common stock shareholders are the last on the list to receive any money in the event of the liquidation of a company,

they bear the most risk.

However, they also receive the greatest reward if a company does well.

Bondholders and preferred stock owners are only paid interest or dividends,

but don’t have a share in future profits of the company.

Common stock holders are offered the greatest upside potential and the greatest downside potential.

If you’d like to learn more about the basics of finance, watch these other videos in the Foundational Finance series.

If you want to learn more about investing sign up for my free course Retirement Planning Academy

by visiting RealizeYourRetirement.com

Inside we’ll discuss how annuities actually work,

how value investing and tactical asset allocation can help you reduce risk and increase potential returns,

how to maximize your social security,

how to make smart retirement planning choices,

and get access to exclusive tools and calculators that I’ve built just for members.

To sign up for this free course just go to RealizeYourRetirement.com