Investing in Stocks

A common part of nearly every investment portfolio, stocks are an opportunity to participate in the success of public companies. But stocks also carry a lot of risk, and they’re subject to near-term stock market fluctuations that can make it hard to know what to expect. Investors buy or sell stock for a variety of reasons including to grow the value of their investments over time, to potentially profit from shorter-term stock price moves, or to generate income by holding dividend-paying stocks.

Most investors buy stocks to gain exposure to the growth of companies whose products or services they use. As the profits of those companies increase, so do the prices of their stock shares. Historically, stocks have returned a greater rate of return than other assets such as bonds or real estate. However, this historical average masks considerable volatility and the potential for significant losses.

When an investor purchases a share of stock in a company, they become a partial owner of the company, along with other shareholders. Depending on the company, this may entitle them to voting rights in major corporate decisions and/or to receive cash dividends. Some stocks, such as preferred shares, don’t entitle the holders to voting rights or to cash dividends, but rather offer a priority claim on the company’s assets and earnings over common stockholders.

Companies sell their stock to raise money for various reasons, such as to invest in new products or services or to pay off debt. They then list their stock on the public market, where it can be bought and sold by investors. Generally, the largest companies have the highest market capitalizations. Smaller, less established companies have lower market caps. The smallest companies, with very little or no earnings, are known as “penny stocks.”

Stocks can be volatile and unpredictable. They’re often affected by short-term stock market movements, macroeconomic trends, regulatory changes and investor sentiment. Over the long term, however, a diversified portfolio of stocks can provide solid returns.

In addition to offering the possibility of strong, long-term returns, stocks can help investors offset some of the effects of inflation by boosting their purchasing power. On average, the annual compound after-inflation rate of return on stocks has been 6.8 percent over the past two centuries.

The key to achieving those returns is diversification. A well-diversified portfolio of stocks typically includes a mix of growth, value and dividend-paying stocks. It’s also wise to limit the number of stocks held in any one company, and to hold stocks from a broad range of industries and geographic regions. This helps reduce the risk that a sharp economic decline or regulatory change could depress the value of your holdings. In the end, it’s important to weigh your risk tolerance and financial goals against the potential rewards before deciding whether to invest in stocks. 1

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