When you invest in stocks, you buy small percentages of publicly-traded companies. The shares you buy represent fractional ownership of the company and come with voting rights in shareholder meetings, and the potential to receive profits from dividends and capital gains when the company does well. Including stocks in your investment portfolio can diversify your investment strategy and provide strong long-term returns. However, there are benefits and drawbacks to consider, especially if you’re new to investing.
When companies need money to expand, develop new products and more, they raise it by selling stock shares on the public market. Shares are the smallest units of ownership in a company, and the price of a share is determined by supply and demand. As a result, the price of a share can go up or down, and even large, stable companies have lost money in one out of three years on average.
Over time, if a company continues to perform well, its stock will rise in value. However, over the short term, a stock’s price is influenced by investor demand and a host of other factors, such as a sudden economic slowdown or a bad news headline.
As a general rule, when there are more investors who want to buy a stock than those who want to sell it, the stock’s price will go up. Investor demand is often based on the company’s performance, future expectations, government regulations and other issues. A stock’s price is also determined by the earnings per share ratio, which compares a company’s current stock price to its past or expected future earnings.
Investors can buy or sell shares on a stock exchange, such as the New York Stock Exchange and Nasdaq, or through a brokerage house. Exchanges charge a fee for each transaction and impose minimum bid and ask prices. Brokerage houses hold your shares for you and pay custodians to protect them from loss, theft or misplacement. They may also offer trading advice and other services for an additional fee.
As a general rule, stocks with higher dividend yields are less volatile than those with lower yields. However, a high-yielding stock can be vulnerable to a falling stock price and a cut in its dividend payments. You can avoid this risk by choosing blue-chip stocks, which are usually large and stable companies such as Apple and Coca-Cola, and by avoiding speculative small-cap and emerging-market stocks.