How to Invest in Stocks


Stocks—also called company shares or equities—are one of the fundamentals of many investors’ wealth-building plans. But understanding how they work and what different types are can be challenging.

The easiest way to think about stocks is as a piece of ownership in a company. Public companies sell shares of their business to everyday investors in order to raise money and grow the company. When a company does well, its value rises and you can make money by selling your shares at a higher price than you bought them for. Over the long haul, stocks have historically offered more potential for growth (capital appreciation) than other investment options like bonds and real estate.

But just because stocks are a popular and widely accessible investment option doesn’t mean they are risk-free. In fact, it’s not uncommon for stocks to tumble and even lose value when a specific event shakes investor confidence or the economy slows down. That’s why it’s important for any investor to carefully consider their risk tolerance before diving in and purchasing stocks.

If you have a diversified portfolio that includes stocks from various sectors, it’s likely you’ll be better protected against big market declines. This is because the performance of different sectors tends to vary in predictable ways based on the overall economic conditions. For example, when the economy struggles, stocks in consumer discretionary businesses like information technology and telecommunication services may suffer because people tend to cut back on spending in those areas. But other sectors that must continue to spend to grow, like utilities and health care, tend to perform better in economic downturns.

Stocks are usually divided into several categories based on their size, or market capitalization—the total value of all outstanding shares of the company. The largest and most established stocks are known as blue-chip stocks, while smaller companies are generally considered small-cap or mid-cap. Still more speculative, low-priced stocks are often called penny stocks. Large-cap stocks are the most stable and offer the best chance for long-term growth.

Besides allowing you to invest in the success of publicly-traded companies, stocks can also bring in additional income in the form of dividends and capital gains. Dividends are regular payments that a company makes to shareholders when it earns a profit. Profits from the sale of shares at a higher price than you initially purchased them for are referred to as capital gains.

Finally, stocks are a very liquid asset, meaning you can buy or sell them quickly and easily, assuming you’re in the right financial position to do so. You’ll likely incur a trading cost—a fee charged by a broker for each purchase or sale—and you might have taxes to pay, depending on the amount of your profits and whether they are long-term capital gains.

It’s possible to build a portfolio of individual stocks, but this can be a costly approach, especially if you invest in a small number of them. It’s usually a good idea to stick with broad-based index funds and exchange-traded funds, or ETFs, when starting out.

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