Stocks are a core element of nearly every investment portfolio. They provide investors with opportunities to grow their wealth and achieve financial goals, like retirement. But stocks also come with a fair share of risks. That’s why it’s important to carefully consider your risk tolerance and invest wisely, starting as soon as you have enough money to do so.
A stock represents a partial ownership stake in a company. Investors buy shares when they think a business will prosper in the future. The value of a stock can go up or down depending on a variety of factors, including market conditions, company performance and global events.
Companies issue stocks to raise capital from investors and use it for a variety of purposes, including paying off debt, investing in growth and expanding operations. They may also reinvest dividends to increase the company’s profitability and stock price. The type of stock — common or preferred — held by shareholders determines the rights and benefits associated with their investment.
Some public companies pay dividends to their investors. Others reinvest the profits they earn and hope that their stock will rise in value, so they can sell it for more than they paid.
Stocks can be grouped by industry and geographic region to create investment categories. Investors can choose to focus on companies that are headquartered in their home country, or they can expand their investment opportunities by adding international stocks. This can help diversify a portfolio and reduce the impact of fluctuations in local economies.
Several metrics determine a company’s stock price, including revenue growth and earnings per share (EPS). Revenue growth gives analysts an indication of how well a business is performing and can affect demand for its products. EPS, on the other hand, tells investors how much they are paying for each dollar of the company’s past or future earnings.
In addition, the economic environment can influence a stock’s value. If people are spending less, sectors like information technology, consumer discretionary and telecommunications may experience lower stock prices. Conversely, if people are spending more, industries like utilities, health care and consumer staples may see their stocks increase in value.
Once an investor decides to purchase shares, they place a stock order with their brokerage firm. The order will contain the amount of shares they would like to buy and at what price. This order is executed once there are more buyers than sellers, at which point the stock’s price rises. The inverse is true for stocks, as they can fall in value when there are more sellers than buyers.
Besides the potential for profits in the form of dividends and share appreciation, stocks can help diversify an investment portfolio by providing exposure to various economic trends. For this reason, careful investors avoid establishing highly concentrated positions in one or a few individual stocks and instead build diversified portfolios with a wide range of companies across different industries and regions. This has historically been shown to boost long-term investment returns and reduce downside risk.