A key component in most investment portfolios, stocks represent ownership stakes in publicly-traded companies and give you the potential to earn returns from two main mechanisms: capital appreciation and dividends. Stocks are purchased and sold on regulated exchanges, such as the New York Stock Exchange (NYSE) or Nasdaq.
The simplest way to think about stocks is that they’re shares in a business, and when you own those shares, you are partial owner of the company and have a claim on the company’s earnings and assets. As the company grows and earns more, your share price may rise and you may be able to sell them for more than what you paid.
However, there are important distinctions to make between stocks and owning a business. One is that you won’t have as much say in day-to-day decision making if you own stock in a company. Instead, the management team and all employees work on behalf of shareholders to build value. Another difference is that, because of the size and volume of stock investments, stocks are typically bought and sold through a market-based mechanism rather than by direct negotiation between you and the company.
In the United States, stocks are generally sold on public stock markets, which are regulated by the Securities and Exchange Commission (SEC). Companies raise funds by selling shares to investors, who in turn invest their money to generate returns from two main mechanisms: capital appreciation and distributions.
Companies can also raise funds through private markets, but in general these are less liquid and often have lower return potential. When a company issues its first share offering to the public, it’s known as an initial public offering (IPO). The issuance is usually backed by a full valuation of the company’s current and future worth, which gives investors confidence that they’re investing in a quality business with growth potential.
Stock prices fluctuate based on marketplace supply and demand, as well as economic conditions and investor sentiment. A strong economy, positive outlook and stable interest rates tend to drive demand up, while uncertainty and negative economic conditions may cause demand to drop.
Individual stock prices can also shift if the company’s earnings performance is stronger or worse than expected. Those factors can lead to significant market volatility, which may result in short-term losses.
The primary reason most people invest in stocks is to generate long-term returns that exceed those available from more conservative investments like bonds and cash. They can also help grow their portfolios in tandem with the economy, as stocks tend to increase in value when the economy is growing.
Investors can manage risks associated with stocks by diversifying their holdings across multiple sectors and industries. This helps reduce their exposure to risk, which can strengthen their overall returns. Ultimately, though, you should consider your personal goals and financial situation before deciding how much to allocate to stocks. An Edward Jones financial advisor can help you develop a comprehensive financial plan that includes your desired investment allocation.