Investors make money on stocks in two ways: dividends and capital gains.

Dividends: Dividends are payments that companies make to shareholders with part of the companies’ profits. Different types of companies have different dividend policies, and these policies can change from year to year.

Capital gains: Investors purchase shares in companies in the expectation that the price of the shares will increase. This increase in share value is known as capital gain. Capital gains are generally taxed at a lower rate than dividends: capital gains are the preferred type of earnings. The following are descriptions of the different types of capital gains.

Realized capital gains are gains that are realized when shares of an asset are sold. Unrealized capital gains are known as “paper gains” because the asset has yet to be sold, and the gains have not yet been realized.

Short-term capital gains are gains that apply when stock is owned less than one year. Long-term capital gains are gains that apply when stock is owned more than one year. Making the distinction between short-term and long-term capital gains is important because shares owned longer than one year are taxed at a lower rate than shares owned less than one year.