The stock market is a place where anyone can buy and sell fractional ownership in a publicly traded company. Stocks, also known as equities, offer potential for growth through share appreciation and dividend payments. Stocks make up a significant part of most portfolios, offering the prospect of higher returns than bonds or cash alternatives over the long term. But they can be more volatile than other asset classes and may be subject to more risk.
Companies issue stocks to raise money for a variety of reasons, including paying off debt and financing growth plans they can’t or don’t want to finance with new loans. In return, shareholders—also called owners—are entitled to a proportional cut of the company’s earnings and assets. Shares can also be sold to raise cash or to diversify an existing investment.
A company’s stock price is determined by supply and demand, influenced by a wide range of factors, including news, events and economic reports. Stock prices rise and fall based on these factors, influencing investor sentiment and creating a “emotional roller coaster.” Because of this, it’s important to take the time to understand the risks of investing in stocks before you begin.
The performance of a stock is not guaranteed and the amount an investor receives depends on a variety of factors, including the amount invested, the duration of the investment and the overall market conditions. Historically, large domestic stocks have provided an average annual return of about 10%, but this figure can fluctuate significantly year-to-year.
Many investors choose to hold a mix of different types of stocks, focusing their investments in larger, more established companies. However, you can also invest in smaller companies, which are often classified by their market capitalization—the value of the company’s shares divided by the number of outstanding shares. Smaller companies are often referred to as “mid-cap” or “small cap.”
Alternatively, stocks can be grouped into industries or sectors to create more diversified portfolios. Companies within sectors will tend to react in similar ways to changes in the economy, so diversifying this way can help mitigate the impact of a bad economy on your returns.
The type of account you use to hold your stocks is a key factor in determining how much of your portfolio should be allocated to equities. For example, retirement-saving accounts like 401(k)s and individual retirement arrangements (IRAs) typically allow you to invest pretax funds and defer taxes until you withdraw the money.