Stocks are ownership interests in companies. They’re traded through a public stock market like the New York Stock Exchange or Nasdaq. As an investment, stocks offer the potential for long-term growth, can yield dividends and allow shareholders to vote on key governance issues. They’re an important part of most people’s investment portfolios. However, they also carry substantial risks, and many investors lose money by investing in stocks.
If you wanted to start a cupcake business, you might raise money by selling shares of the company to friends and family members. Each share represents a fraction of the company’s value. The goal is that the company’s value grows while you own the shares, and you sell them for a profit. Stocks work in a similar way, but at a much larger scale.
The primary reason people invest in stocks is to generate a return on their investments that outpaces inflation over time. They can also make money by taking advantage of shorter-term stock price fluctuations, or they can seek income from dividends. But despite their importance, many people find it difficult to understand and make sense of stocks.
For one, the terms used in the market often seem to speak a different language than the ones you use at home. The jargon can be overwhelming, and it’s easy to get caught up in the day-to-day fluctuations of the market, especially when you’re just starting out. This article aims to help clear the air and give you a better understanding of what stocks are, how they work and how they fit into your overall portfolio.
When you buy a share of stock, you’re purchasing a stake in the company that issues the stock. A company’s total value is known as its market capitalization. Each share of stock represents a fraction of the company’s market capitalization, so if you own one share, it means you own 1% of that company.
A common stock category is blue-chip stocks, which are large and established corporations with a reputation for stability and reliability. Companies issue stock to raise funds and attract investors, and the value of the shares can rise over time as the company grows and earnings increase.
Typically, stocks pay dividends to shareholders based on their profits. But not all companies pay dividends, and some don’t pay them at all. Younger, rapidly expanding companies may choose to reinvest their profits into the business in the hopes of boosting future growth and earning even higher dividends.
In addition to market capitalization, stocks can be classified by sector and size. Large-cap and mid-cap stocks represent the largest companies in an industry, while small-cap and microcap stocks represent smaller businesses. Finally, penny stocks are shares in very small companies that are often volatile and usually don’t pay dividends. Generally, investors prefer to build well-diversified portfolios that include large-cap, mid-cap and small-cap stocks. This approach has been shown to strengthen long-term returns and reduce near-term risk. However, investors should always keep their goals and tolerance for risk in mind when building their portfolios.