Stocks, also known as equities, are one of the key investment tools that investors use to build wealth. They work by giving companies a way to raise money from the public for expansion and other business purposes. Investors who buy stocks hope the value of their shares will increase over time, so they can sell them for a profit.
There are two main ways that stocks generate returns: capital appreciation and dividends. Capital appreciation occurs when the price of a share rises over time, which can happen as a company becomes more profitable, experiences a surge in investor confidence or expands its operations. This type of growth is typically reflected in higher annual stock market returns over the long term than those of bonds, which are largely driven by interest rates.
Stock prices are driven by supply and demand, which can vary based on investor sentiment, economic conditions and other factors. This can make it difficult to predict how a particular stock will perform in the short term. That’s why it’s important for investors to consider their financial goals, risk tolerance and asset allocation before making investments in individual stocks.
While stocks can be a great tool for growing savings and planning for long-term financial goals like retirement and education expenses, they’re not without their risks. They are one of the riskier asset classes, and their prices can fluctuate significantly in the short term due to a variety of factors, including economic events, market volatility and global crises. These fluctuations can be nerve-wracking, especially for those with lower risk tolerances.
Investors can diversify their portfolios by buying stocks in a variety of industries to mitigate some of the risks associated with investing in individual companies. They can also invest in different types of stocks to achieve their specific investment goals, such as growth or income.
There are several different types of stocks, but most investors own common stock, which comes with voting rights and may pay dividends. There are also preferred stocks, which may offer additional benefits such as priority for receiving dividends or liquidation proceeds.
In addition to the potential for growth, another benefit of stocks is their tax efficiency. Many brokerage firms now allow you to purchase fractional shares, so you can invest even if you don’t have enough money to buy a whole share of a particular stock. And in most cases, the profit from owning stocks (including any dividends received) is taxed at a much lower rate than income earned from most other investment assets.
Despite their ups and downs, stocks remain an important part of most investment portfolios. The average stock market return over the long term exceeds the returns on other asset classes, such as bonds, real estate and cash. However, stocks can be volatile and pose a risk to your wealth if you’re not diversified.