Stocks are an essential part of many investors’ plans to build wealth over time. They offer a potential return on investment that can exceed other important asset classes, such as bonds or real estate. But stocks also come with some risk and are more volatile than other types of investments, so it’s important to consider how they fit in your overall investing plan. A financial advisor can help you find ways to diversify your portfolio with stocks that fit with your personal goals and risk tolerance.
The word “stock” means ownership shares in a company. When a company goes public, it sells shares to investors in what’s called an initial public offering (IPO). Each share represents fractional ownership of the company. Once the IPO is completed, the company’s shares can be traded on the secondary market—also known as the stock exchange—where their price rises or falls depending on a variety of factors.
These factors include everything from a company’s sales and growth prospects to the health of the overall economy and global markets. As a result, stock prices often correlate closely with the overall economic environment. For long-term investors, this may be a great advantage of stocks—stocks can grow in value in tandem with the economy, while other investments like cash and government bonds tend to depreciate in value over time.
Individual stocks can be divided into multiple categories, based on how large the company is or whether it pays dividends to shareholders. Some common stock categories include technology, consumer discretionary and telecommunications, energy, utilities, health care, and many others. These different classifications make it easier to diversify your portfolio by focusing on companies in various industries and regions of the world.
It’s also possible to divide stocks by the type of earnings they generate. For example, some stocks pay regular income in the form of cash dividends, while others provide only capital gains as a result of increasing share prices. Some companies, especially smaller ones, may not even generate any revenue at all. Investors can further diversify their stocks by focusing on specific geographic areas, such as the United States or Europe.
Investors can buy and sell individual stocks in their brokerage accounts, or they can invest in mutual funds and Exchange-Traded Funds (ETFs), which are pre-arranged “baskets” of stocks that trade on the stock market. Typically, these mutual funds and ETFs come with management fees, but some brokers also offer commission-free ETFs, which can help reduce the cost of investing.