Stocks are a key part of many portfolios, offering growth potential and higher returns than bonds or cash alternatives. But they also carry greater risk, and you should make sure to build a diversified portfolio with stocks that reflects your investment horizon, tolerance for volatility and financial goals.
A share of a company’s ownership represents a fractional cut of the corporation’s earnings and assets (and sometimes dividends). Investors who own stock can profit as the company grows, expands and gains value over time. But they also face the risk of losing some or all of their initial investment. The value of individual shares can rise or fall, depending on market conditions and corporate decisions, which is why many investors hold a diversified portfolio that includes stocks in different sectors and companies.
Companies raise money by selling stock on the public market, a process called an initial public offering or IPO. Then the company can use that capital to grow and expand, which ultimately benefits its shareholders. Stocks can be common or preferred, and the type of stock you own determines your rights and privileges as a shareholder. For example, common stockholders typically have voting rights and may receive dividend payments while preferred stockholders do not.
Most stocks are traded on a public exchange or marketplace, called the stock market, where buyers and sellers negotiate prices through an auction process in which the seller sets an offer and the buyer makes a bid. The price is then determined by supply and demand, which can be influenced by many factors including market conditions, the news and the performance of other companies in the same sector.
The ebb and flow of stocks can be volatile, but over the long term they have historically provided higher returns than other investments. They can also provide a hedge against inflation, which is when rising prices erode the purchasing power of your money over time.
While stocks can help you achieve your long-term financial goals, it’s important to understand that investing in them is a risky proposition. A stock’s market price can fluctuate wildly, and you can lose some or all of your initial investment. As a result, you should invest only money you can afford to lose and diversify your portfolio with other asset classes such as cash and real estate.
As a general rule, stocks with the highest potential return come with the greatest level of risk. So do your research carefully before buying any stocks. Start by looking at screened lists of stocks that match your criteria, then dig into further research on the companies and industry in which they operate to gain a fuller understanding of what you’re getting into. Unless you’re very experienced, we recommend working with a licensed broker to buy and sell stocks. They can help you develop a comprehensive financial plan and invest in stocks that are aligned with your goals. They can also help you navigate potential investment pitfalls and take advantage of tax-efficient opportunities.