Why Should I Care About Stocks?
The rich really are different.
If you've ever watched a reality TV show, you already know that people with money make very different decisions (and use different Instagram filters) than the rest of us do.
One thing that makes them different? Ownership. While you're schlepping to work at the local greasy spoon to pay for gas, the rich are teaching their kids how to own that greasy spoon so that they can make money from you (and everyone else who works there). While you're exhausted and watching reality TV, Kim, Chloe, and Kourtney are building the media empire they own.
If you want to be middle class, you're going to be earning. If you want to be rich, you're going to be owning.
There are two ways you can own a company. You can toss on your suit, start your own company, and spend years taking on insane risks and sleeping under your desk to build your baby up to success…
…or you can just buy stocks and instantly own a piece of a company.
Creating Big Money from a Little Pack of Cash
Stocks are one of the simplest and most common ways to create wealth. All they are is a little piece of ownership in a company.
Let's say you do decide to start a company. You're going to be the first company in the world to create custom plugs for people who want to create holes in their ankles. Great. You need money to pay for the manufacturing of the plugs (and the lawyers to protect you from any mods gone wrong). Ten of your friends have enough guacamole one night to decide your company sounds amazing—and they all want in.
If you were to decide to offer bonds, each person could contribute $100. If Ankle Biters took off, you'd give then each $10 in interest a year, plus $100 back. If it turns out nobody wants holes in their ankles, your ten friends would probably regret their decision to front your company. But they'd also have the right to grab any assets related to your company (your gauges, your company laptop) and hawk it to get back the $100 they invested.
You end up with nothing (not even friends).
Stocks or Bonds?
But maybe you decide to sell stocks instead. You launch Ankle Biters as a public company instead. Each person still invests in $100, but now they own part of the company. How much do they own? Well, you'd have to know how much the company is worth to determine that. That's hard to do with a brand new company.
So like many new businesses, you just make stuff up. Your friends front you a total of $1,000 and you decide the company is worth $2,000. So your total capitalization is $2000, and you've gotten $1000 in "investment capital" bought in the form of equity (in this case, stocks). You own half the company: you're doing all the work of running the company and so have "sweat capitalization" (not as gross and smelly as it sounds); your friends own half the company.
Now if you go bankrupt and sell the rest of your business for $1000, your friends split $500 and you get $500 for your half. But what if people love the idea of putting holes in their ankles, just like you knew they would? In two years, you sell the company for $20,000. In that case, you keep $10,000 and your investors keep $10,000.
Maybe. If you'd structured everything as bonds, you'd have gotten just under $19,000 after selling because you'd only need to pay back the loans plus a little interest.
For your friends, buying stocks and becoming equity investors is a sweet deal. While you worked hard around the clock, they just handed you the cash and sat back until their investment ballooned. But they also took a bigger risk because they would have lost cash if you had gone under. You, on the other hand, would have only lost the time you spent working on your business.
The key thing with stocks is this idea of risk. Whether you buy stocks, bonds, or another investment, it comes down to one question: how comfortable are you with risk? If you're okay with more risk, you can invest in stocks and potentially get more gain for your cash. If you're the kind of person who sleeps with your lights on and worries about that scary noise in the dark (no judging), bonds let you make a smaller amount but reduce your chance of losing your shirt.