Stocks are an important part of any investment portfolio because they can help you grow your wealth and potentially offset inflation by providing returns that outpace the rate of rising prices. But they can also be volatile investments, meaning that your share price may rise or fall. The unpredictability of stock market returns can be nerve-wracking for investors, particularly those who have a low risk tolerance. The best way to avoid the pitfalls of investing in stocks is to understand what they are, how they work, and how to incorporate them into your overall financial plan.
A stock represents a fractional ownership stake in a business. Public companies issue stocks to raise money, and investors who think the company will succeed buy the shares. The type of share (common or preferred) held determines the rights and benefits shareholders receive, which include dividend payments and appreciation in share value. Shares are traded on a public market known as the stock exchange. This market is regulated by the Securities and Exchange Commission (SEC) and individual state regulators.
In the short term, a stock’s price fluctuates based on the demand for it and the supply of it in the marketplace. However, over time, a stock’s performance is fundamentally tied to the success of the company that issues it. A growing business will see its share price rise, while a shrinking business will likely see its share price fall.
Investing in stocks provides opportunities to participate in the growth of businesses you like, or in companies that align with your values such as sustainability, social justice or diversity. In addition, many stocks pay dividends, which can be taxed at lower rates than regular income taxes, especially when invested in a non-qualified account.
Investors can buy and sell stock quickly in the open market, making it easier to adapt your portfolio to changing financial goals or markets conditions. This liquidity also means that you can diversify your portfolio with other assets such as bonds, real estate or cash.
Stocks offer the potential for higher long-term returns than most other investment products, including bonds and CDs. As a result, they have historically outperformed other asset classes over the long term.
The risk of losing your original investment in a stock is generally considered to be higher than other types of investments. The value of a stock can fall below your initial purchase price, resulting in a capital loss. It can also rise above your initial purchase price, resulting in recouping the original investment with a profit.
In the long run, stocks can provide returns that outpace inflation, helping you preserve your purchasing power over time. However, stocks can also lose value over the long term, due to fluctuations in the market or changes in a business’s performance. Consequently, it’s best to consider stocks as part of a well-diversified portfolio and carefully weigh the risks and rewards before investing in them. For more information about incorporating stocks into your overall portfolio, speak to your financial advisor.