A stock is a share in the ownership of a public company. Companies raise capital through the sale of shares to investors, who then use that money to expand the company’s operations, create new products and services or hire employees. The stock market is a central part of modern economies. As financialization has deepened, it’s become more common for stock markets to be seen as not just platforms for raising capital but also as key parts of millions of Americans’ retirement and investing strategies.
Over the long term, stocks tend to provide higher returns than bonds or cash. However, that’s not guaranteed. Stocks can also decline in value, making them a volatile part of an investor’s portfolio. For that reason, it’s important to understand the risk involved in investing before adding it to your mix of assets.
The price of a stock fluctuates, but it primarily depends on demand from buyers and sellers. If many investors want to buy a stock, the price goes up and entices existing shareholders to sell at a profit. If there aren’t enough investors interested in buying a stock, its price will go down.
Stocks are classified by a variety of criteria, including the size of the company. Large-cap stocks are the most popular and usually have the highest potential for growth. Mid-cap and small-cap stocks are less likely to grow as quickly, but still have some upside. Very small-cap stocks, also known as penny stocks, may have little or no earnings and are highly speculative.
Another way to categorize stocks is by how much they pay out in dividends, or the amount of cash that investors receive for owning the shares. Dividend payments can boost a company’s overall return potential, but they also come with risks. Some stocks pay out a regular, predictable dividend while others only offer occasional distributions or none at all.
Finally, stock prices can be influenced by the general economy and by individual events that could impact the profitability of particular industries or companies. The price of oil, for example, might rise or fall based on global political and economic developments.
To determine how much you should allocate to stocks, it’s helpful to develop a comprehensive financial plan that considers your investment horizon and the level of risk you’re willing to take. You should also compare the return potential of stocks with other types of investments, such as real estate and bonds.