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What exactly is a stock?

Stock is security which represents ownership of a part of a company. It is also known as equity. The stockholder is entitled to the profits of the company. In other words, a stockholder is eligible for the company’s assets and profits to the proportion of stock they own. 

Companies issue shares for multiple business reasons. Often most companies raise funds to operate the business. The two types of stocks are preferred and common.

Companies issue stocks through an Initial Public Offering (IPO). After the IPO, the stocks are listed on the stock exchange. Interested investors can buy and sell stocks on the stock exchange.

Is it good to invest in stocks?

Stock investment comes with significant risk that an investor should be aware of. Especially in the short term, stocks are prone to high volatility due to dynamic market conditions. In the long term, historically, stocks have given significant returns. However, they do not guarantee returns.

Over the years, there were many highs and lows in the stock market. Therefore, investors need to be cautious while investing in stocks. Only investors with high-risk tolerance can consider investing in stocks.

There are other investment avenues where one can invest based on their investment horizon and risk levels. For example, mutual funds offer good diversification. Mutual funds invest in multiple stocks and professionals manage them. Therefore, these eliminate the risk of exposure to just one stock. However, these are not risk-free investments and also do not guarantee returns.

Do I have to pay taxes on stocks?

Yes. Returns from stock market investments are taxable. The returns are known as capital gains. Capital gain is the increase in the value of the asset since the time of purchase. Investments in equity or equity-related instruments are taxable.

Investments with a holding period of less than 12 months attract short term capital gains tax. The gains are taxable at 15%.

On the other hand, investments with a holding period of more than 12 months attract long term capital gains tax. The gains above INR 1,00,000 in a year are taxable at 10%.

What are the disadvantages of stocks?

Following are the disadvantages of investing in stocks:

Significant Risk: Stock market investments are high-risk investments. During unfavourable market scenarios, an investor could lose their entire investment. Stocks are highly volatile investments. Therefore, it is advisable to invest with caution.

Timing: It is almost next to impossible to time the market. The volatile nature of the stocks makes it difficult to hit the bull’s eye. Buying low, selling high is a good strategy. However, buying them at the lowest and selling at the highest is not very easy.

Knowledge: Stock investing requires in-depth research about the company and the market as well. Studying the financial statements, annual reports, comparing the historical performance, sector analysis, etc. is a tedious job. Therefore, unless one can do all the research before investing, stock investing is a gamble.

Emotions: Seeing the stock movements, investors often buy at high prices with an anticipation that the prices would go up (out of greed). Also, they end up selling at low and making losses with an expectation that the price may fall further (out of fear). Price fluctuations are frequent. However, it is essential not to get carried away by them.

Stockholders are paid last: In a scenario where the company goes out of business, first, the preference stockholder and bondholders or creditors are paid. And in the last, the common stockholders are paid.

What is the difference between a stock and a share?

When shares of a company are issued to the public and get listed, then shares are converted into stocks. Both stock and share are interchangeably used. However, there are a few differences between the two.

Stock is the ownership or collection of shares of one or more companies. On the other hand, share refers to ownership of a single company. Shares represent the proportion of ownership in a company. At the same time, the stock is an aggregation of shares in a company.

Two different stocks of an organization may not have the same value. At the same time, two different shares of the same company have the same value. A share has a nominal value and has a numeric value attached to it. A stock doesn’t have a nominal value attached to it. Shares can be fully paid up or partially paid up. Stocks are always fully paid up.

Let’s take, for example, Ms Kiara has invested in shares of company A. She is the owner of the shares. However, if Ms Kiara has invested in several other companies, she has ownership of the stock.

Is a stock an asset?

Yes, stocks are assets. However, they are financial assets rather than real assets. Financial assets are those assets that are easily convertible to cash. Financial assets do not have a physical existence. One cannot see or touch them. Real assets are tangible assets with a physical existence—for example, a piece of land, commodities, buildings, factories and trucks.

Financial assets have higher liquidity than real tangible assets. One can purchase a stock easily at lower costs than any other real assets.

There are some instances where financial assets invest in real assets. The underlying asset of a financial asset sometimes can be a real asset. However, this doesn’t make the financial asset a real asset. Some examples of financial assets investing in real assets are gold ETFs, REITs or commodity ETFs.

Published on October 2, 2020