How do stocks make you money ?

How do stocks make you money ?

There are two main methods of making money on stocks and a few ways to maximize those profits. When you buy a stock, you are buying a tiny piece of a company and if that company is successful, you will get your share of the profits! 

1. Capital Gains

This is the most common way for individuals to profit in the stock market. Buy low, sell high is the conventional wisdom.

The process: You purchase one stock for example (₹100) and later sell it at a higher price (₹150). Therefore your capital gain is ₹50.

Factors that drive capital gains include increased earnings by the company, successful new product launches, or positive feelings about the company's future from investors.

2. Dividends

Some companies pay their stockholders a percentage of their profits based on ownership in the stock. This is done as a way to reward their shareholders.

The process: If you own 100 shares of a stock and the company declares a dividend of ₹5.00/share then your brokerage account will receive ₹500. Usually, these payments are made quarterly or once a year.

Reasons that companies provide dividends: Most companies that provide dividends are established companies with steady cash flows and not too many large expansion projects to fund (such as utility companies and large banks). They typically have reached a level of stability where they are able to pay dividends regularly and will generally continue doing so until there are no more cash funds available.

How do stocks make you money ?

Alternate Options for Increasing Wealth

There are alternative methods to increasing wealth through stocks, in addition to simply holding them.

Compounding (Dividend Reinvesting): When a dividend is issued, an investor can choose not to spend that cash and instead reinvest it in the purchase of additional shares of the same company. When this process occurs over a period of ten to twenty years, it will generate a very large total return on an initial investment due to compounding interest on interest.

Stock Splitting & Bonus Shares: A company may choose at times to grant shareholders additional shares (bonus shares) or may split a single share into two shares. Although neither of these actions will increase the overall value of an investment immediately upon completion, both can increase the attractiveness of shares to potential new investors (by making them more affordable), ultimately providing a platform for a potential future increase in share price.

Diversification: By investing in multiple companies, rather than in just one, an investor can create a diversified investment portfolio or "basket of stocks" (such as an Index Fund or Exchange Traded Fund [ETF]). This approach helps mitigate the risks associated with any single stock, as the overall return on the investor's total portfolio can remain positive even if one stock were to fail, due to the gains realized on other investments in the portfolio.

Quickly Assess Your Reality

Historically, stock markets outperformed both bank savings accounts and gold over an extended period, but that does not mean you will always "win".

Volatility: There may be fluctuations in price due to a downturn in economic conditions or external forces/outside of your control.

No Guarantees: Dividends are completely voluntary (and not legally required) to be paid by publicly traded companies. Therefore, even if they start to decline, you will still receive your principal investment back if the company fails.