Stocks are a key component of many investors’ portfolios. They’ve historically delivered better returns than other prominent asset classes like bonds, real estate and cash alternatives. Whether you’re saving for retirement, planning for college or just interested in growing your wealth, it’s important to understand the basics of stocks and how they differ from one another.
A stock is an ownership share in a company. Corporations issue shares as a way for everyday investors to participate in the company’s growth, product development and other initiatives. Investors in turn receive regular dividend payments (a portion of the company’s net income). The value of a stock rises or falls with the company’s earnings experience.
Depending on the type of stock, shareholders may have different rights and benefits. Common stock represents partial ownership in a company and gives investors the right to vote on decisions that affect the company. Preferred stock is similar, but it has priority over common stock in the event of a liquidation, or bankruptcy.
The primary reason most people invest in stocks is their long-term potential to generate a higher return than other assets like bonds and cash alternatives. Over the last 20 years, large domestic stocks have produced an average annualized return of 9.5 percent.
As with any investment, there are risks associated with holding stocks. One of the biggest risks is that stocks can be volatile, meaning their prices move up and down a lot in a short period of time. Another risk is that a company could be acquired or go bankrupt, which could impact the value of your shares.
But, if you’re willing to diversify your portfolio with a mix of stocks and other assets, you can help minimize those risks. And there are a number of ways to invest in stocks, including through your 401(k) or IRA account or through a brokerage account.
Stocks come in a variety of forms, including growth and value stocks. Growth stocks are associated with companies that trade above what they’re worth based on their earnings. The hope is that their performance eventually catches up to expectations, and the shares will increase in value.
In contrast, value stocks are associated with companies that investors think are trading below their true worth based on their earnings. These stocks are typically larger, more established companies with good financial histories and a history of paying dividends.
Investors also invest in stocks by buying bundles of them called mutual funds or index funds. These bundles are managed by finance professionals and offered in places like your 401(k) or IRA accounts, as well as through brokerage accounts. In general, these funds offer lower management fees than individual stocks. They’re also diversified so you can benefit from both income and price appreciation.