Stocks, or shares of ownership in publicly-traded companies, are one of the most important assets to hold in an investment portfolio. Over the long term, public companies grow their revenues and profits, which causes their stock values to rise. Stocks are also a great way to diversify economic exposure and can provide attractive returns compared to bonds. But stocks are risky, and they can lose value rapidly.
The price of a company’s stock is determined by supply and demand, based on the immutable laws of economics. When there are more buyers than sellers of a particular stock, the stock’s price goes up. The opposite is true if there are more sellers than buyers, and the stock’s price declines. This is a key reason that many experts recommend a diversified investment approach to minimize the risk that one bad decision will ruin your portfolio.
Investors can purchase individual stocks by opening an account with a brokerage firm. Some investors choose to invest in mutual funds or exchange-traded funds (ETFs) that contain hundreds of individual securities. Others use a robo-adviser, which uses algorithms to determine which stocks are likely to outperform the market and automatically buys and sells those securities on their behalf. Whatever strategy you use, be sure to build a narrative about the company in question and its ability to generate sustainable long-term returns.
When a company first issues shares to the public, it’s known as undertaking a primary distribution. Most companies issue stock to raise money for business operations. Some of that cash may be distributed in the form of dividends, but other companies prefer to reinvest profits back into their businesses, retaining the capital. In either case, shareholders can make money on their investments by reinvesting dividends or selling shares when the price of the stock rises.
Stocks are a crucial part of most investors’ portfolios, but there are several risks to consider before buying shares. Stocks are a popular asset to hold because they’ve provided a historically high rate of return, even after accounting for inflation. But the stock market has almost always fallen before recessions, and stocks are volatile in the short run.
There are endless metrics and ratios that investors can use to evaluate a company’s financial health, but a stock’s real value is only revealed in the context of its overall business story.
Stocks are listed for sale on a stock exchange, such as the New York Stock Exchange (NYSE, or “Big Board”) or NASDAQ. The NYSE has the largest volume of trading, but there are several other exchanges worldwide. The market’s underlying rules, regulations and conventions can vary greatly from country to country, but the basic concepts are similar. The stock market is a fascinating place to observe the law of supply and demand at work in real time.