Capital Gains and Losses
/If you’re here, you’ve read my previous article, an introduction to investing - and you’re ready to start digging under the surface. Let’s get right to it.
I briefly mentioned the two primary ways investors make money from stocks: dividends and capital gains. To understand dividends, you need to remember that buying a stock means you are buying a portion of a company - you’re a partial owner. And just like any other owner of a business, your goal is to make money from what the business does. Afthttps://www.theplrsite.com/wp-content/uploads/2019/01/depositphotos_110738614-stock-illustration-high-quality-red-grunge-round.jpger a specified amount of time (it differs from company to company), companies look at how much money they’ve made from doing what they do. Have they made a profit - that is, have they made more money than they’ve lost? If so, that profit is divided up into as many portions as there are stocks and paid back out to everyone who owns stock. Not all companies pay dividends, and even those that do (Coca-Cola, for example) tend not to pay all that much. We’re talking a dollar of dividend every 3 months for a $100 stock - a very slow way to make money!
That’s why the majority of the gains from stocks come in the form of capital gains. Luckily for us, the concept of capital gains, as well as capital losses, is super intuitive. To explain it in a sentence, investors make capital gains when they buy an asset (like a stock, real estate, etc.) and then sell it for a higher price. For a pictorial explanation, see below.
Over the historical long run, investors have almost always made money on capital gains - buying a stock and holding for a long time before selling it has an extremely good chance of at least modest gains. In fact, there’s never been a 17-year period in American history where stocks haven’t, as a whole, shown growth (giving their investors capital gains), and there’s never been a 30-year period since 1861 where investors in stocks have made less by way of capital gains than bond investors.
There are more than a few important caveats to keep in mind, though. Even if the stock market as a whole shows growth, individual stocks have, do, and will continue to go down from time to time - there’s always an element of risk. Investors who buy a stock and then have to sell it for a lower price make capital losses, rather than gains. Indeed, most investors who are young and impatient to make money quickly fall into the capital loss-making category. And because individual companies as well as entire industries can go from winning to losing, it’s just as important now as it was in 1861 to keep your investment portfolio diverse and full of high-quality companies. Actually knowing where to look and how to find a high-quality, diverse company is a discussion for another article. But for now, especially if you’re under 18, keep your money in a secure savings account so that, when the time comes, you’ll have the money to invest in addition to a hunger to make capital gains.
If they had stickers like these on the stock market, we’d all be rich.
Three topics to explore if you found this article easy: long vs. short term capital gains, dividend vs. capital gains taxes, discounted cash flows.
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Picture:
https://i.kym-cdn.com/entries/icons/facebook/000/029/959/Screen_Shot_2019-06-05_at_1.26.32_PM.jpg
"Stonks." Meme. i.kym-cdn.com/entries/icons/facebook/000/029/959/Screen_Shot_2019-06-05_at_1.26.32_PM.jpg.
"High Quality." www.theplrsite.com/wp-content/uploads/2019/01/depositphotos_110738614-stock-illustration-high-quality-red-grunge-round.jpg.
Curriculum: Wells Fargo Bank. "Capital Gains and Losses." Hands on Banking Instructor Guide, 2013.