Stocks are a cornerstone of many portfolios, and can provide significant growth potential when a long-term investment strategy is used. But understanding how stocks work and what different types of stocks offer is important before investing.
A share of stock represents a tiny slice of ownership in a company. The value of a company rises or falls depending on the success or failure of its business, which can be reflected in the share price. Companies issue stock to raise funds for operations. When a company’s stock is listed on a public exchange, it can be bought and sold by investors, just like any other product on the market.
Because they are an ownership stake in a real-world business, stocks typically offer higher returns than bonds or cash alternatives. But they also come with risk, and price volatility can cause them to lose value at any time.
The value of stocks tends to increase when the economy grows, because companies are expanding and becoming more profitable. This growth can be reflected in the price of shares, which can then increase the total value of your investment.
In addition to their potential for price appreciation, stocks often pay dividends. Dividends are a portion of a company’s profits that is paid to shareholders, and can help supplement your income, especially if you choose companies that regularly make payments. Not all companies, however, pay dividends; and many smaller, faster-growing companies do not offer them.
Stocks are usually purchased for long-term investments, such as retirement, and should be considered part of a well-diversified portfolio. Because the value of stocks may fluctuate, it’s not a good idea to trade or sell them frequently.
It is also important to consider your own goals and the level of risk you are comfortable taking. For example, financial planners often recommend paying off high-interest debts before investing, because the interest payments could outweigh any potential investment returns.
Another factor to consider is how tax efficiency can affect your investments, particularly in nonqualified accounts. In general, taxes on stocks are lower than on most other investments, including most bonds and mutual funds, but it is important to understand how your particular account type can impact how you manage your equity positions.
The value of a company’s stock can rise or fall for any number of reasons, from economic conditions to the news and opinions of investors. But if you stay invested over the long term, history suggests that stocks can provide some of the best returns among all the asset classes.