From building wealth to planning for the future, stocks can play a role in many financial strategies. Understanding how stocks work is the first step in using them to reach your goals.
A stock is fractional ownership of a company. When you buy stock, you become part owner of the business, along with all the other shareholders.
When a privately held company needs money for expansion or operations, it has several options. It can borrow the money, but that involves taking on debt and paying it back with interest. Or it can issue shares on a stock exchange or in the private markets.
By selling stock, the company gets the funding it needs. By buying stock, shareholders may get a say in how the company runs and own a piece of all future cash flows from the business.
Often, when you own common stock in a business, you get a say in major decisions. For example, you can vote on who sits on the board of directors and whether the company should take part in a merger.
Stocks are bought and sold on a stock exchange such as the New York Stock Exchange (NYSE) and in the private market, where individual and institutional investors can negotiate purchases and sales of company ownership. The “stock market” includes stock exchanges and marketplaces where other investments are traded.
Have you ever wondered how people actually make money from those mysterious things called stocks? You’re not alone! I’ve spent years figuring out the ins and outs of stock investing, and I’m excited to share what I’ve learned in simple terms. If you’re looking to grow your wealth through stocks but aren’t sure how it works, you’ve come to the right place.
The Two Main Ways Stocks Make You Money
Let’s get right to the point – stocks make you money in two primary ways:
- Price appreciation – When the price goes up and you sell for more than you paid
- Dividends – Regular payments some companies make to shareholders
That’s it! But of course, there’s more to understand about each method
Making Money When Stock Prices Rise
The most common way people make money from stocks is by buying shares at one price and selling them later at a higher price. It’s basically the “buy low, sell high” strategy you’ve probably heard about.
For example
- You buy 10 shares of Apple at $200 per share (total investment: $2,000)
- The company performs well, and the stock price rises to $300
- You decide to sell your shares
- You receive $3,000 from the sale
- Your profit is $1,000 (minus any taxes you’d need to pay)
This is the simplest way stocks make you money, but timing can be tricky. Markets go up and down constantly, and predicting exactly when to buy or sell is nearly impossible. That’s why many successful investors focus on the long-term growth potential of companies rather than trying to time the market perfectly.
Earning Money Through Dividends
The second major way stocks make you money is through dividends. These are regular payments that some companies make to their shareholders out of their profits.
Here’s how dividends work:
- You own shares in a dividend-paying company
- The company announces a dividend payment (usually quarterly)
- You receive a payment for each share you own
- You can either spend this money or reinvest it to buy more shares
For example, if you own 100 shares of a company that pays a $1 annual dividend per share, you’ll receive $100 in dividend payments over the year.
Not all companies pay dividends. Younger, fast-growing companies often reinvest all their profits back into the business instead of paying dividends. More established, stable companies are more likely to pay dividends.
The Magic of Compound Returns
One of the most powerful aspects of stock investing is compounding – where your returns generate more returns over time.
Let me show you how powerful this can be:
- If you invest $10,000 in stocks that grow at an average annual rate of 8%
- After 10 years, you’d have about $21,600
- After 20 years, you’d have around $46,600
- After 30 years, you’d have approximately $100,600
That’s the magic of compounding! Your original $10,000 turns into over $100,000 without you adding another penny. The longer your money stays invested, the more dramatic the compounding effect becomes.
Understanding Stock Ownership
When you buy stock, you’re literally buying a piece of a company. You become a partial owner of that business. This means:
- You’re entitled to a portion of the company’s profits
- You may have voting rights on major company decisions
- The value of your investment depends on how well the company performs
As the company grows and becomes more valuable, your slice of ownership also becomes more valuable. That’s why researching companies before investing is so important – you want to own businesses that have good prospects for future growth.
Different Types of Stocks and How They Make Money
Not all stocks make money the same way. Here are the main types:
Common Stocks
- What most people own
- Offer potential price appreciation
- May pay dividends (not guaranteed)
- Come with voting rights
Preferred Stocks
- Pay fixed dividends
- Dividends are guaranteed before common stockholders
- Usually don’t have voting rights
- Less potential for price appreciation
- Preferred stockholders get paid first if the company liquidates
Growth Stocks
- Companies expected to grow faster than average
- Usually reinvest profits rather than paying dividends
- Potential for significant price appreciation
- Often more volatile (bigger ups and downs)
Value Stocks
- Companies trading below what investors believe they’re worth
- Often pay dividends
- May have less dramatic price swings
- Potential for price appreciation as the market recognizes their value
The Realistic Returns You Can Expect
Over the long term, the stock market has historically returned an average of about 10% annually before inflation. After adjusting for inflation, that’s about 7-8% per year on average.
This means that $1,000 invested in stocks 30 years ago could be worth nearly $8,000 today! But remember, this is an average across all stocks in major indexes like the S&P 500, which tracks about 500 of the largest U.S. companies.
Some important points to keep in mind:
- Not every stock will deliver these returns
- Some companies will fail completely
- Others will far exceed the average
- Returns are never guaranteed
- The market can be extremely volatile in the short term
Investment Strategies: Trading vs. Investing
There are two main approaches to making money with stocks:
Trading
- Buying and selling stocks frequently
- Trying to profit from short-term price movements
- Requires significant time, knowledge, and often luck
- Higher potential costs (taxes, fees)
- More stressful and risky for most people
Investing
- Buying and holding stocks for the long term
- Focusing on the underlying business quality
- Less time-intensive
- Often more tax-efficient
- Historically better results for most people
Most successful individual investors take the long-term approach rather than trying to time the market through frequent trading.
Reducing Risk: Diversification is Key
One of the biggest mistakes new investors make is putting too much money into a single stock. If that company fails, you could lose a significant portion of your investment.
That’s why diversification – owning many different stocks – is so important. You can diversify by:
- Owning stocks in different companies
- Investing across various industries
- Including companies of different sizes
- Adding international stocks
- Using index funds or ETFs that own hundreds of stocks
Speaking of index funds…
Individual Stocks vs. Funds
You have two main options for stock investing:
Individual Stocks
- You select specific companies to invest in
- Requires more research and knowledge
- Higher potential returns (and losses)
- More time-intensive to manage
Stock Funds (Mutual Funds and ETFs)
- Professional management or index tracking
- Instant diversification
- Less research required
- More consistent results
- Lower time commitment
Many successful investors use a combination – perhaps putting most of their money in diversified funds while selecting a few individual stocks they believe in strongly.
How to Start Making Money With Stocks
Ready to start? Here’s a simple plan:
- Open a brokerage account – You’ll need this to buy stocks
- Set a budget – Only invest money you won’t need for at least 5 years
- Start with index funds – These provide instant diversification
- Add individual stocks gradually – As you learn more
- Reinvest dividends – To accelerate your compounding
- Stay consistent – Consider regular contributions regardless of market conditions
- Be patient – The biggest stock market gains often come in just a few days per year
Common Mistakes That Reduce Your Stock Profits
Watch out for these profit-killers:
- Frequent trading – Increases costs and taxes
- Chasing hot tips – Often leads to buying high and selling low
- Panic selling – Locking in losses during market downturns
- Inadequate research – Not understanding what you’re investing in
- High fees – Eating into your returns
- Impatience – Not giving investments time to grow
The Reality of Stock Market Ups and Downs
I gotta be honest with you – the stock market is not a smooth ride up. Your investments will sometimes lose value – maybe a lot of value. During major market downturns, it’s common for stocks to fall 20%, 30%, or even 50%.
But historically, the market has always recovered and gone on to reach new highs. That’s why your time horizon matters so much. If you need your money soon, stocks are risky. If you’re investing for decades, temporary downturns are opportunities rather than disasters.
Final Thoughts: The Patient Path to Wealth
Making money with stocks isn’t about getting rich quick. It’s about harnessing the power of ownership in great businesses over time. The most successful investors are usually the most patient ones.
Remember:
- Focus on quality companies or broad market indexes
- Reinvest your dividends
- Stay diversified
- Keep your costs low
- Be patient during downturns
- Think in decades, not days
By understanding how stocks actually make you money and following these principles, you’ll be well on your way to building wealth through the stock market. Just remember that investing is a marathon, not a sprint. Good luck on your investing journey!
What questions do you have about making money with stocks? I’d love to hear your thoughts in the comments!
Common mistakes when investing in stocks
When investing in stocks, avoid these common mistakes:
- Trading too often — Trading stocks through an online platform can feel like a game. It’s so easy, new investors often fall into the trap of trading daily. Remember, you generally get the best return from stocks over the long term. When you buy and sell frequently, your profits can get eaten up by taxes, fees and commissions.
- Emotional investing — Investment decisions should be made in the context of your goals, not in the context of an exciting day on Wall Street. Every day, we see stocks soar when emotional investors get excited. And we see them plummet when those same investors panic. Success comes from keeping a cool head in hot moments.
Maybe you’ve read about some stock market whiz kid who made millions overnight. While it is possible to buy low-priced stock and quickly sell it at a profit, it doesn’t happen often. We think the market is generally efficient and correctly prices stocks as new information about a company comes to light. Therefore, a long-term outlook and holding your stock for a long period of time is generally a better strategy to generate returns than day-trading, in our view.Your Edward Jones financial advisor will help you build a big-picture strategy. We focus on long-term investments in companies with a solid track record, strong financial health and management depth.We invest systematically, helping to grow the value of your stock portfolio over time. If you don’t need the income from your stock dividends immediately, we’ll help you use it to buy new investments.
How do you make money from stocks?
The reason to buy shares in a company is so you can profit from that company’s performance. There are two ways your shares can make you money.
Capital gains are the profits you make from price appreciation. Ideally, your stock will go up in value while you own it, allowing you to sell it for more than you paid.
Some companies pay out dividends. A dividend is a share of the company’s profits. Essentially, a company sets aside a portion of its cashflow and divides it among its shareholders.
Companies aren’t required to pay dividends. And even if a company has paid out dividends in the past, there is no guarantee it will keep doing so.
Expect to pay taxes on your investment income, no matter which form it takes. A lot of factors go into determining the tax rate on capital gains; for most people, it will be 15% or less. Dividends are taxed at your normal income tax rate.
Investing for Beginners – How I Make Millions from Stocks (Full Guide)
FAQ
How much money do I need to invest to make $1000 a month?
a month, you’ll need about $240,000 in a high-yield savings account earning around
APY, or around $300,000 in dividend stocks yielding about
annually.
How much will I make if I invest $100 a month?
If you invest $100 a month in good growth stock mutual funds at prevailing market rates from age 25 to 65, you’ll end up with about $1,176,000. The secret isn’t the amount. It’s that you didn’t miss a single month for 40 years. $100 can make you a millionaire when you’re steady, predictable, and disciplined.
What is the 7% rule in stocks?
The “7% rule” for stocks is a risk management strategy that dictates selling a stock when it drops 7% below the purchase price to limit losses and preserve capital. This rule, popularized by investors like William O’Neil, is based on the observation that even strong stocks typically don’t fall more than 7-8% below their ideal buy point. It can be implemented by setting a stop-loss order with your broker or through manual monitoring. Another related, but distinct, “7% rule” is a retirement planning concept where you assume a 7% annual withdrawal rate from your investments to determine how much you need to save for retirement, as explained in this YouTube video.
How much will $1000 invested be worth in 20 years?