The two ways stocks generate money

People make money from stocks in two ways: capital gains when the stock price rises and you sell it for more than you paid, and dividends when the company distributes a portion of its profits to shareholders. Most individual investors focus on capital gains — buying a stock at $50 and selling it at $75 — but dividends provide ongoing income without selling. Some stocks pay dividends regularly; others do not pay any at all.

The timing and tax treatment of each method differ. A capital gain is only realized when you actually sell the stock; until then, any increase in price is an unrealized gain on paper. Dividends are paid on a schedule set by the company — often quarterly — and arrive in your brokerage account as cash or additional shares, depending on how you set it up. Neither method is automatic or may provide; stock prices can fall, and companies can cut or eliminate dividends.

Your actual return depends on how long you hold the stock, how much the price moves, the dividend rate if any, and the fees your broker charges. A stock that rises 20 percent in one year but costs you 2 percent in trading fees nets you 18 percent. A stock that pays a 3 percent dividend but falls 10 percent in price leaves you down 7 percent overall.

Key Takeaways

  • Capital gains happen when you sell a stock for more than you paid, and you only owe tax on the gain when you actually sell.
  • Dividends are cash or stock distributions paid by companies to shareholders on a regular schedule, usually quarterly, and do not require you to sell.
  • Your total return is the combination of price appreciation and dividends, minus any trading fees or taxes owed.
  • Stock prices can fall as well as rise, so there is no may provide you will make money on any individual stock.
  • Different stocks have different risk levels and dividend policies, so the method that works depends on your time horizon and how much volatility you can tolerate.

Capital gains: buying low and selling high

A capital gain occurs when you sell a stock for more than you paid for it. If you buy 100 shares at $50 per share ($5,000 total) and sell them at $75 per share ($7,500 total), your capital gain is $2,500. You do not owe tax on that gain until you sell; the gain is only "realized" at the moment of sale. Until then, it exists only as an increase in the value of your holdings.

The size of your gain depends on the price movement and how long you hold the stock. A stock that rises 5 percent in a month generates the same percentage gain as one that rises 5 percent over five years, but the shorter holding period means your money was tied up for less time. The tax you owe on a capital gain depends on how long you held the stock: gains on stocks held for one year or less are taxed as ordinary income at your regular tax rate, while gains on stocks held longer than one year may have access to for lower long-term capital gains rates.

Capital gains are not may provide. A stock can fall in price, leaving you with a loss instead. If you sell at a loss, you can use that loss to offset gains from other investments, which can reduce your overall tax bill. Many investors hold losing stocks hoping the price will recover, but holding a losing position ties up money that could be invested elsewhere.

Dividends: income without selling

A dividend is a payment a company makes to its shareholders from its profits. Not all companies pay dividends; many growing companies reinvest all profits back into the business. Companies that do pay dividends typically do so quarterly, though some pay monthly or annually. The dividend is usually expressed as a dollar amount per share or as a percentage of the stock price, called the dividend yield.

If you own 100 shares of a stock that pays a $0.50 quarterly dividend, you receive $50 each quarter ($200 per year) without selling any shares. You can take that cash as income or reinvest it to buy more shares through a dividend reinvestment plan, or DRIP. Over time, reinvesting dividends can significantly increase your total return because you earn dividends on the new shares as well.

Dividends are taxed in the year you receive them, even if you reinvest them. may have access to dividends — those from U.S. companies held for at least 60 days around the dividend date — are taxed at the long-term capital gains rate, which is lower than ordinary income tax. Non-may have access to dividends are taxed as ordinary income. A company can cut or eliminate its dividend at any time, so dividend income is not may provide.

How trading costs and taxes reduce your returns

Every time you buy or sell a stock, your broker charges a fee, though many brokers now offer commission-free stock trades. Even without a commission, you pay the bid-ask spread — the difference between what buyers will pay and what sellers are asking. On a stock trading at $100, the spread might be $99.99 to $100.01, a tiny amount on one trade but significant if you trade frequently.

Taxes also reduce your net return. If you make a $2,500 capital gain and owe 15 percent in long-term capital gains tax, you keep $2,125. If you receive $200 in dividends and owe 37 percent in ordinary income tax (your marginal rate), you keep $126. Tax-advantaged accounts like 401(k)s and IRAs let you defer or avoid taxes on gains and dividends, which is why they are often used for stock investing.

Account type matters. In a taxable brokerage account, you owe tax on capital gains and dividends each year. In a traditional IRA, you owe no tax until you withdraw money in retirement. In a Roth IRA, you owe no tax on gains or dividends at all, ever, as long as you follow withdrawal rules. The same stock in different accounts generates different after-tax returns.

Risk and volatility in stock returns

Stock prices move based on company performance, market conditions, interest rates, and investor sentiment. A stock can rise 50 percent one year and fall 30 percent the next. This unpredictability is called volatility. High-volatility stocks offer the potential for larger gains but also larger losses. Low-volatility stocks move less dramatically but may also grow more slowly.

Your ability to make money from stocks depends partly on your time horizon. If you need the money in one year, a volatile stock is riskier because the price might be down when you need to sell. If you can hold for 10 years, short-term price swings matter less because you have time to recover from downturns. Historically, stock markets have risen over long periods, but there is no may provide any individual stock will rise or that the market will rise in your specific timeframe.

Diversification — owning many stocks across different industries and company sizes — reduces the risk that one stock's poor performance will hurt your overall return. A single stock might fall 50 percent while the broader market rises 10 percent. A portfolio of 20 or 30 stocks is less likely to move that dramatically because gains in some stocks offset losses in others.

Comparing dividend stocks to growth stocks

Dividend-paying stocks and growth stocks represent different strategies for making money. Dividend stocks are often mature companies with stable earnings that return cash to shareholders. They provide regular income but may not appreciate much in price. Growth stocks are typically younger companies that reinvest profits into expansion rather than paying dividends. They offer the potential for large price appreciation but no current income.

A dividend stock yielding 4 percent might rise 2 percent per year, giving you a total return of 6 percent. A growth stock yielding 0 percent might rise 15 percent per year. Over 10 years, the growth stock likely delivers more total return, but the dividend stock provides income along the way. Your choice depends on whether you need current income or prefer to let your money grow.

Some investors use both. They hold dividend stocks for steady income and growth stocks for long-term appreciation. Others focus entirely on one approach. There is no single correct method; the right approach depends on your age, how much risk you can tolerate, and when you need the money.

Getting started with stock investing

To buy stocks, you need a brokerage account with a company like Fidelity, Charles Schwab, E-Trade, or many others. You fund the account with cash, then use that cash to buy stocks. Most brokers offer commission-free stock trades, so you can buy one share or 1,000 shares without paying a trading fee. Some brokers also offer fractional shares, which let you buy a portion of a stock if you do not have enough money for a full share.

Before you buy, research the company and understand what you are buying. Read the company's quarterly earnings reports, available on its investor relations website. Look at the stock's historical price and dividend history. Understand what the company does and whether you think it will grow or maintain its current position. Many investors start by reading books on stock investing or taking a free course to understand basic concepts.

Start small if you are new to stocks. Buying one or two stocks you understand is better than buying 20 stocks you do not. As you gain experience and confidence, you can expand your holdings. Many investors find that a diversified portfolio of low-cost index funds — which hold hundreds of stocks in a single fund — is simpler and often outperforms individual stock picking over time.

Frequently Asked Questions

Do I have to sell a stock to make money from it?

No. If the stock pays dividends, you make money without selling. You can hold the stock for years, collect dividends, and never sell. However, if you want to profit from a price increase, you must sell to realize that gain. You can also hold a stock that rises in price without selling and never realize any gain.

What is the difference between a stock and a dividend?

A stock is a share of ownership in a company. A dividend is a payment the company makes to shareholders from its profits. Not all stocks pay dividends. When a stock does pay a dividend, it is usually paid quarterly, and the amount depends on the company's profits and dividend policy.

How much money do I need to start buying stocks?

Many brokers allow you to open an account with as little as $1 or $0, though some have minimum deposit requirements. Fractional shares let you buy a portion of an expensive stock with a small amount of money. There is no legal minimum, but starting with money you can afford to lose is wise because stock prices can fall.

Can I lose money on stocks?

Yes. Stock prices can fall, and you can sell at a loss. If you hold a stock that falls 50 percent and never recovers, you lose money. This is why diversification and a long time horizon are important. Historically, the stock market has risen over decades, but there is no may provide any individual stock or the market overall will rise in your timeframe.

Are stocks or dividends taxed differently?

Yes. Capital gains on stocks held longer than one year are taxed at lower long-term capital gains rates. may have access to dividends are also taxed at long-term rates. Gains on stocks held one year or less and non-may have access to dividends are taxed as ordinary income at your regular tax rate. Tax-advantaged accounts like IRAs and 401(k)s defer or eliminate these taxes.