What Can Be Gained & Lost in a Stock Market?
The stocks of thousands of public companies trade on exchanges around the world. Individuals, corporations, foundations and even public sector organizations have direct or indirect investments in these stock markets. They measure the pulse of the economy: Gains and losses affect investment portfolio values, consumer spending patterns and business decisions.
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Gains
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Investors gain in three ways in the markets: an increase in stock prices, corporate restructuring and dividend payments. Stock prices go up for several reasons, including high investor demand for certain stocks (like the demand for dot-com technology stocks in the late-1990s), superior earnings performance and specific market news (for example, an oil and gas exploration company announcing a new discovery). Gains also result from corporate restructuring actions, such as mergers, buyout offers and divestitures of assets or business units.
Cash or stock dividends also represent gains. Cash dividends are paid from a company's after-tax profits. Stock dividends are fractional or whole shares paid to shareholders, usually as a result of corporate restructuring actions. For example, an investor holding 10 shares receives $10 if a company declares a $1 per share cash dividend. If the company declares a 10 percent stock dividend instead, the investor receives one additional share [10 shares times 10 percent].
Losses
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Investors suffer losses when a company's stock price declines steadily. The reasons for this happening include poor profit performance, missed product shipment deadlines, loss of major customers, senior executive turnover, changing customer preferences and increased competition. Economic downturns and the U.S. Federal Reserve increasing short-term interest rates are some of the reasons for stock market declines. Losses can also result from margin trading, which allows investors to borrow money from the brokerage to buy stocks. However, if stock prices decline sharply, investors might have to sell their stocks at significant losses to repay the borrowed funds. Speculating on stocks without adequate research or falling prey to stock market scams might also lead to losses. The stock of a company that is in bankruptcy protection stops trading, which could wipe out the entire investment.
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Tax Implications
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Stock market gains and losses have tax implications. A capital gain or loss is the difference between a stock's selling price and its cost basis, which is the average purchase price. Capital gains and losses are classified as long term or short term: stocks held for more than one year qualify as long-term investments; otherwise, they are short-term investments. Short-term capital gains are taxed at the regular income tax rate. According to the Internal Revenue Service, for 2010, the maximum long-term capital gains tax rate for most people was 15 percent.
Considerations
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The U.S. Securities and Exchange Commission counsels caution when investing in stock markets. Stocks are not betting chips in a casino: Investing requires diligent research, careful planning and patience. Investors should think long term and refrain from reacting to daily stock market gyrations. Investors can use online brokerages to manage their own investments or rely on financial planners for guidance.
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References
Resources
- Great-West Retirement Services: Making Sense of Market Volatility (PDF)
- U.S. Federal Reserve: Stock Market, Selected Statistics
- U.S. Securities and Exchange Commission: Market Indices
- U.S. Securities and Exchange Commission: Stock Market Fraud "Survivor" Checklist
- U.S. Securities and Exchange Commission: Circuit Breakers and Other Market Volatility Procedures
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