As things get tighter economically, more people are eager to find out how they can invest their money to create wealth. They realise that their dreams and goals will be difficult to attain if they depend solely on their job income. Investing can be a ticket to financial freedom for those who are willing to learn and abide by the correct principles.

There are several different ways to invest, and it can be easy to get confused about the various options. One investment type that may seem a little mysterious to the average person is the stock market. I often get questions from readers who want to understand more about stocks and how they can use them to make money.

Let’s examine how stocks operate and clarify how this method of investing may be able to help you to achieve your financial objectives.

The purpose of stocks

Recently, we learned how to invest by lending money in the money market and bond market. With these investment options, you will receive an official IOU that tells you when you should get back the original sum you invested (your principal), and how much interest the borrower should pay at regular intervals, for using your money.

When you invest your money in stocks, you are not lending your money to an entity, but you are actually buying part ownership in a business. As a part owner in the business, you have a claim on a portion of the company’s assets and income. Shares are the physical or electronic certificates that represent your stock ownership.

Large companies need to have access to money to carry out tasks such as buying property, upgrading equipment and developing new technology. Borrowing money to finance these long-term objectives can be expensive, so raising capital by selling a small piece of the company may be a more attractive option.

A company can sell shares to private persons or institutions on a limited basis, or raise money from the general public on a wider scale. When a company offers public shares for the first time, it will organise a sale called an initial public offering (IPO). A document called a prospectus will be published, which gives facts about the business and encourages people to invest in the company.

The types of stocks

The total number of stocks issued by the company is called the shares outstanding. The number of shares held by an investor, in relation to the total number of shares outstanding, will indicate what percentage of the company is owned by the investor. For example, if you hold 5,000 shares in a company which has 500,000 shares outstanding, then you own a one per cent stake in the business.

There are two main types of stocks that a company can issue to the public. Most people are more familiar with the common stock or ordinary share, which allow investors to participate in shareholders’ meetings and vote on issues affecting the organisation. Common stockholders also have the first right to buy more shares directly from the company if they are issued in the future.

The other type of stock that investors can buy from a company is called a preference share or preferred stock. These shareholders will receive an income payment called a dividend at a fixed rate at a specified time. Common stockholders can also receive dividends, but these are not guaranteed and they are determined by the profit that the company makes.

While preference shareholders do not have voting rights at meetings, they have a priority claim over the common stockholders on the assets of the company. Some preference share issues also indicate a repayment date when the company will redeem these shares and give back the principal amounts to the investors.

The market for stocks

After it sells shares to the public for the first time, a stock company must register the stock on an exchange, which is an organised market for the sale of shares. The stock exchange facilitates the buying and selling of the stocks after the company has issued the shares, and allows more persons to participate in the ownership of the company.

In Jamaica, large companies which issue public stocks can be listed on the Jamaica Stock Exchange (JSE). In 2009, the JSE Junior Market was formed, which allows small and medium sized enterprises to raise capital from the public, and gives investors the opportunity to potentially reap higher rewards from these high-growth companies.

To invest in the stock market, you need to have an account with a stock brokerage company that will allow you to trade stocks on the exchange. Stockbrokers liaise between the issuing company and the original stock purchasers during the IPO, and also facilitate the buying and selling that takes place among investors in the secondary market.

Next week we will look at some of the risks that accompany stocks, and how you can make use of these investments to achieve your goals.

Copyright © 2011 Cherryl Hanson Simpson. No reproduction without written consent.

Originally published in The Daily Observer, October 13, 2011

Read an article about how I learnt to invest in stocks:

Don’t Let Fear Hold You Back From Investing

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Cherryl is a financial consultant and coach, founder of Financially S.M.A.R.T. Services. See more of her work at www.entrepreneursinjamaica.com and www.financiallysmartonline.com. Contact Cherryl