Often called stocks, equity shares or ownership stakes, this investment vehicle allows you to make money by sharing in the growth of companies. However, it also comes with the risk that the value of those investments can decline in value or even drop to zero. For this reason, it’s generally considered a long-term investment and is one of the main tools in creating a diversified investment portfolio.
Stocks are one of the most important assets that can help you grow your savings and reach financial goals like retirement and educational savings. But stocks come with a lot of potential risks, and the stock market can be very volatile. If you’re considering investing in stocks, it’s a good idea to talk with a financial professional and create a plan based on your unique situation, financial goals and risk tolerance.
How Do You Buy Stocks?
The first way to buy stocks is through a company’s initial public offering (IPO). Companies issue stock during an IPO to raise funds to expand, pay off debt or otherwise operate. After an IPO, the shares can then be traded on the secondary markets (the “stock market”), where their price rises and falls in response to a number of factors.
In general, when demand for a particular stock increases due to favorable news or earnings outlook, the share price rises. Conversely, when supply outweighs demand, the price drops. This is the basic principle of market trading and part of the process known as price discovery, where buyers and sellers determine the fair market value based on available information.
Companies use the cash raised from selling their stock to operate and expand, and shareholders can receive dividends, a portion of the company’s profits paid directly to them. A company’s ability to generate a steady stream of income is an important factor in evaluating a stock for investment purposes, as are its growth prospects and the stability of its business model.
There are many ways to classify a stock, such as by the size of the company, or by the industry in which it operates. Smaller companies are sometimes referred to as microcap or small cap stocks, while large-cap stocks represent the most established and well-known firms. Companies may also be categorized by their geographic location; for example, many companies in the United States are classified as domestic or foreign.
Over the long term, stocks have offered a higher return than other asset classes such as bonds. The S&P 500, a benchmark that tracks the performance of some of the largest U.S. corporations, returned an average of 7% annually from 1959 to 2009, adjusted for inflation.
This higher return is possible because the stock market tends to move in tandem with the economy. When the economy thrives, so do stock prices. But stocks also have the potential to decline in value, so it’s important to invest in a diversified portfolio that includes other asset classes.