Stocks are a common component of many investment portfolios, providing a vehicle for growth that offers higher returns than bonds and cash alternatives. But stocks can also be volatile, and sudden market drops can be painful to investors. This makes it important to determine your risk tolerance and investment horizon before investing in stocks, as well as to diversify your investments across multiple asset classes.
A share of a stock represents a fractional ownership of a company and gives you a claim on the company’s assets and earnings. This is unlike a bond, which operates like a loan that must be paid back with interest. Stocks are one of the most popular ways for companies to raise additional financial capital and expand their operations by selling shares to public investors. Stocks are also very liquid assets, meaning they can be sold or bought very quickly and easily. This liquidity is an advantage compared to other less liquid assets such as real estate or long term debt instruments.
The price of a share of a stock fluctuates, based on the supply and demand for the particular security in the market. This is often influenced by the overall market performance and by news events. Stock prices have historically risen on average above inflation, but the exact rate of return depends on the type and size of stocks held by an investor. This is due to the “efficient market hypothesis,” which states that the stock prices reflect all available information about a company at a given time.
Stocks can add a significant amount of growth potential to your portfolio, especially when you select companies with strong revenue growth and solid track records. You can also invest in companies that pay dividends or have a high potential for capital gains, which are profits from selling shares at a higher price than you initially purchased them for.
If you own common stock, you have voting rights at shareholder meetings and a say in company policies, board decisions, mergers, acquisitions and more. Preferred stockholders generally don’t have the same voting rights, but they do have a higher claim on a company’s assets and earnings than common stockholders do.
There are many different types of stocks to consider, including those ranked by their market capitalization, which is a measure of the total value of a company’s shares. Small-cap stocks typically have a lower risk profile than large-cap stocks, and mid-cap stocks offer a blend of both risk and return.
The goal of investing in stocks is to achieve long-term, above-inflation returns. This can help you avoid the effects of inflation, which erodes the purchasing power of your money over time. The long-term average annual stock market return has been around 10%, though this number falls to 7% or 8% after taking into account inflation.