A stock, or share of ownership in a public company, represents a claim on a company’s earnings and assets. That’s why the stocks of successful companies often rise over time. Stocks are an important part of most people’s investment portfolio. But they come with risk, too, and it’s essential to understand how they work before investing in them.
Stocks have historically provided a higher return on investments than other asset classes, like cash, bank certificates of deposit (CDs), gold and Treasury bonds. That’s why many investors want to include them in their portfolios. But stock prices also fluctuate, making it difficult to know how much a specific stock is worth at any given moment. This volatility, or price fluctuation, is due to a wide range of factors, from overall market performance and economic conditions to individual company news and events, such as product recalls or communications crises.
To invest in stocks, you’ll need to open an investment account with a financial institution. Once you’ve done that, you can choose to work with a broker, which is someone who handles stock market transactions on behalf of their clients, or you can purchase shares through an exchange. The major exchanges are the New York Stock Exchange (NYSE) and Nasdaq, although there are more than 60 worldwide. You can also buy shares through mutual funds and exchange-traded funds, which are funds that mimic or track the performance of a certain stock market index.
Investors can also build a diversified portfolio by buying individual stocks. But this can be complicated and requires a significant amount of research. Many people who buy individual stocks also work with a stockbroker, which is someone who can handle market transactions on their behalf.
There are different types of stock, including common stocks and preferred stocks. Common stock gives shareholders equal voting rights in a company and can be traded on the public markets, known as the stock exchanges. Preferred stocks give owners a priority in receiving dividends and liquidation proceeds before other types of shareholders.
Companies issue stocks to raise money and grow their business. When they sell the stock, their value can increase and they can be sold for more than what they paid to issue them. This is called a capital gain. Capital gains can help you grow your wealth over time, but they are not guaranteed.
Most stocks pay dividends, which is a share of a company’s profits. But younger, fast-growing companies may choose to reinvest their profits rather than distribute them to shareholders. That can boost the value of their stock, but it doesn’t guarantee a positive return on your investment. In fact, companies that reinvest their profits frequently miss their growth expectations and have low or negative returns on their equity, which can cause the price of their shares to fall. That’s why it’s important to diversify your portfolio with a mix of stocks, including both large and small-cap stocks.
