Stocks are an investment vehicle that can help you expand your wealth. They are an investment into a company that can help you earn substantial returns and even dividends over time. Your investment allows you to own a portion of the private corporation, making you a part-owner of that company.
One of the ways investors make money off stocks is through selling the shares higher than the price they originally purchased. But be aware, if a company does not perform well, your stocks can see a decrease in value.
How Do Stocks Work?
When a company is looking to raise money, it can choose to go public and offer shares of its business. Once the company is public and their stock is on the market, investors can purchase the stock and have fractional ownership in the company.
What Is a Stock?
A stock is a share, or small piece, of a company. To help illustrate stocks, imagine a large sheet cake. This is the company. Then imagine the cake is cut up into lots of tiny square pieces. Each piece represents a stock, and if you purchase a piece, you become a fractional owner in the company.
Why Do Companies Issue Stock?
There are numerous reasons that a company chooses to issue stock, all of which are related to funding their business. Companies issue stocks to get out of debt, launch new products, expand or build new facilities, or even expand their market territory.
There is not a set reason why a company would issue stock, but it is commonly referred to as equity financing. The shareholder (stock owner) provides the company money. In return, the company typically provides a portion of the company profits to the shareholder and depending on the stock you may also receive voting rights.
Why Should You Own Stock?
Owning stock comes with various rewards. The primary reason that investors use stock as an investment vehicle is because of the return on their investment. There are two ways that you can earn money on your stock, either through price appreciation or through dividends.
If you are looking for a long-term investment strategy, stocks are a great solution. The average stock market return is 10%, meaning that if you invested $1,000 today, in thirty years you would have over $8,000. But don’t be fooled, just because stocks historically have a high rate of return, some stocks run the risk of failing. That is why you should have a well-rounded portfolio that includes stock in numerous companies and industries.
Do You Have Equity In a Company When You Own Stock?
Owning stock in a company is a type of equity. However, you should look at the big picture. For large corporations, think Apple (AAPL) and Exxon Mobil (XOM), having $1 million worth of shares is still relatively small potatoes and minimum equity. One share is obviously considerably less.
Having equity in the company does not mean that you have a say in the company’s management and how it reacts to most situations. It also does not give you a discount on any goods and services from the company. However, there are some benefits that come with owning stock with a company.
What Privileges Do You Have When You Own Stock?
As a shareholder, you have certain rights, including invitations to shareholder meetings where you can weigh in on certain issues that impact the company. While this is all very appealing, owning stock does not mean you will get to sit right next to the CEO during shareholder’s meetings. There are thousands, sometimes even millions, of other shareholders that will likely be invited to the meeting as well.
Beyond shareholder meetings, you may also receive special incentives to further invest in the company and some stocks even pay dividends.
Are There Fees Associated With Owning Stocks?
When you buy or sell stocks you will incur a fee. This fee is a commission to the broker who facilitates the trade. Fees for trading stock can vary depending upon the brokerage you use. Full-service brokerage typically charges more than a discount brokerage, yet it comes at a cost.
A discount brokerage firm typically requires you to research and select your own investments. Alternatively, a full-service brokerage will provide you with advice based on their own independent research, which is why they collect higher fees.
Stock Categories
Before you dive into investing in stock, you should understand the different categories and classifications of stocks.
Common Stocks
A common stock provides partial ownership in a company. This allows you to participate in shareholders meetings and provides dividends that vary in amount.
Depending upon the success or missteps of the company, the dividend may even be missed. If the company sells, common stockholders have the right to a share of the value of company assets, after they pay off any creditors, owners of preferred stock, and bondholders.
Preferred Stocks
Unlike common stocks, preferred stocks do not typically include stakeholder voters’ rights, but they do pay a fixed dividend. This results in a predictable pay off, but shareholders do not get to share in the company’s changing wealth.
Market Capitalization Stocks
Market capitalization is the value of all shares that a corporation has outstanding. It is measured by multiplying the outstanding shares by the share price.
Large-Cap
Large-cap corporations have market capitalizations of $10 billion and more. Approximately 70 percent of stocks are large-cap stocks. This includes common names such as Google, Coca-Cola, and General Electric. Large-cap stocks are so big that it becomes harder to achieve massive growth like you might see in smaller cap stocks. However, they routinely pay out dividends.
Mid-Cap
Mid-cap corporations have market capitalization between $2 and $10 billion. Companies that fall into the mid-cap category tend to have a trusted operating history with moderate earnings growth.
Small-Cap
Small-cap corporations have market capitalization between $300 million and two billion. The small-cap stocks are vastly different from large-cap stocks.
They are typically younger companies that are looking to achieve aggressive growth to build to mid-cap and eventually large-cap status. Since they have the potential for exponential growth, they tend to offer higher returns for investors.
Domestic & International Stocks
Keeping your investments diversified between domestic and international stock can help temper the volatility of the U.S. stock market. As the saying goes, don’t put all your eggs in one basket. That holds true when it comes to investing.
Half of the market cap throughout the world is located outside of the United States. When you utilize the power of diversification, you will reduce your risk and help optimize your portfolio.
Growth Stocks
Growth stocks are shares in companies that are anticipated to have a significant growth rate that is above average for the market. Typically, they do not pay out dividends, but investors can see money earned through capital gains when they sell their shares. Investing in growth stocks can be risky. If the company is not successful, investors will take a loss when it comes time to sell.
Value Stocks
Value stocks appear to have a lower price relative to the financial performance of the company. Their low price-to-earnings make them cheaper to buy than stocks with higher price-to-earnings. People typically invest in value stocks in hopes that the fallout from the market was an overreaction and that the price will eventually rebound.
Dividend & Non-Dividend Stocks
When a company does not pay a dividend on their stock, they are typically reinvesting the money into their growth. What this means is that over time, the price of the share should appreciate, so when an investor decides to sell they will see a high rate of return on the initial stock investment.
Dividend stocks, on the other hand, benefit shareholders through regular income from their investment while they hold the stock. Companies that have a track record for paying quarterly dividend payments are typically large-cap, which may not offer exponential percentage gains in the stock market that younger companies might. They do, however, provide steady stable returns on investment over time.
Cyclical & Non-Cyclical Stocks
The economy fluctuates for various reasons. With the economic fluctuations, business cycles are inevitable. When spending is up and when spending is down, these business cycles can make or break wealth depending on if they are moving up or down.
Those that are impacted by these business cycles are called cyclical stocks. Stocks that remain stable or barely phased by these cycles are called non-cyclical stocks. Seventy-five percent of stocks follow the market trend and are cyclical.
Blue Chip Stocks
Blue chip stocks have a reliable track record that has been proven to perform well. They are shares within well-known, large companies that have a history of growth, provide consistent dividends, and see regular stock price increases.
Penny Stocks
Penny stocks have increased in popularity in the last few years. While savvy investors can make quick profits off penny stocks, many will end up seeing losses. The allure of big returns has attracted many new investors, but with the volatility involved you should understand the risk before investing your hard-earned money.
Penny stocks are vastly different than most other stocks. They are called penny stocks because they trade under $5 per share. The companies you purchase stock in will be relatively new and not established. They likely have not established a track record and do not pay dividends.
How To Buy Stock
If you want to get started with buying stocks, you’re not alone. Every day investors are turning to the stock market after they learn how to trade stocks.
The first thing you will want to do is your research. Understand the rules and best practices for buying stock and take time to understand your risk tolerance. Clearly define your goals and make sure you have a strategic plan including the amount of capital you are willing to invest.
Utilizing Stockbrokers
While it is completely possible for you to go it alone, your investing life will be a lot simpler if you work with a stockbroker. Instead of buying stock shares directly from the company, a stockbroker buys and sells shares on behalf of their clients.
Stockbrokers are typically paid commission and work within a brokerage firm. There are discount and full-service broker options to choose from. Take a little time to determine what you are looking for out of your stockbroker before deciding on what type of broker fits your needs.
Where Are Stocks Traded?
The stock market is the public market that exists for buying, selling, and issuing stocks for fractional ownership in a company. Domestically, stocks can be traded on various exchanges including the Nasdaq or the New York Stock Exchange.
Benefits and Risks of Stock Ownership
Investing in your future wealth is never a bad thing if you go into it with a clear understanding of potential risk. Stock ownership is a great way to experience generous returns over time, but with the reward also comes risk that you should be aware of.
Benefits of Stock Ownership
Investors that are willing to put in the time and effort to invest in stock can see high returns within their portfolio. They can also see income from dividends that can pay off in the long run.
Stocks are also easily diversified. You can invest in various stocks in numerous countries which gives you growth opportunities as you mitigate your investing risk.
Risks of Stock Ownership
With the good comes some potential risks, and with stocks if you pick the wrong one you can see the loss of your capital. If you are easily shaken, market fluctuations can cause some investors to panic instead of riding out the economy.
Should You Invest in Stocks?
Chances are, if your company provides you with a 401(k) plan, you are already investing in stocks! But if you are ready to expand your personal wealth beyond your retirement savings, stocks are a fantastic option. Be sure to start with your research. Investing in stocks is a great way to begin your investing journey, which is needed if you want to grow your wealth!
There are guides who can help you along your way if you need them. Don’t hesitate to find a financial advisor that can help not only guide your investing decisions, but also make sure your portfolio is diversified for all your financial targets.