Stocks, company shares, equities: they go by many different names, but they’re all a fundamental part of most investors’ plans to build wealth. The best way to start investing is by opening a brokerage account, but before you do that, you’ll want to have a clear understanding of what stocks are.
In simple terms, a share of stock represents fractional ownership of an asset-rich corporation or company. The type of stock you hold (common or preferred) determines your rights and benefits as an owner. For example, common stockholders usually get voting rights in matters related to corporate policies and board decisions, mergers and acquisitions, and more. Preferred stockholders, on the other hand, don’t have those same rights. Some companies even issue multiple classes of stock, each with its own set of voting rights. For instance, Google’s parent company, Alphabet, has three separate share classes: Class A stock (GOOGL) gets one vote per share, class B stock gets 10 votes per share, and class C stock doesn’t receive any voting rights.
Over the long term, stocks can deliver impressive returns. The S&P 500 index, for example, averaged a 7% annual return over the 30 years ending in 2009. That’s compared to the Barclay’s U.S. Aggregate Bond index, which averaged a return of 6% per year over the same period.
However, it’s important to remember that stock prices can fluctuate. A stock’s price may rise or fall on a day-to-day basis because of factors that are both broad and specific, like the economy and investor sentiment. But over time, a business’s sales and profits typically determine its share price.
For that reason, some people choose to invest in growth stocks — also known as growth opportunities — which are associated with companies that investors think trade at a higher price than their actual earnings or potential. The hope is that a growth company will eventually catch up to its expectations, which can lead to big gains for shareholders.
Other investors choose to invest in value stocks — or value plays — which are associated with companies that investors believe trade below what they’re actually worth, based on their earnings. These stocks tend to be safer investments than growth stocks, but there’s no guarantee that they’ll increase in value.
Before you buy any stocks, it’s important to understand your risk tolerance. Gauge your level of comfort with the inherent uncertainties involved in investing — and make sure that you have enough money on reserve to cover potential losses.
Once you’ve established your risk tolerance, it’s time to figure out how much you can afford to put toward stocks each month. To do that, consider your income, expenses, investment goals, and financial cushion. If you have enough cash, it’s time to open a brokerage account. This is an online account offered by most investment firms that allows you to buy and sell assets, such as stocks and mutual funds. The process involves providing some personal information, such as your Social Security number and name, address, and phone number. You’ll also be asked to provide your investment objectives and risk tolerance.