Stocks, company shares or equities are a key component to many investors’ plans to build wealth. But that doesn’t mean they’re easy to understand. In fact, for many newcomers to investing, stocks might feel like a foreign language.
So, if you’re thinking about adding stocks to your portfolio but feel intimidated by the seemingly complicated jargon or intimidating price fluctuations on the screen, we’ve got some good news. We’re here to help break down what stocks are and how they work.
Stocks represent partial ownership of a publicly traded company and give stockholders claim on the company’s earnings, assets and other financial claims. When the value of the business rises, so does the stock price. When the value falls, the stock price drops. Companies issue stock in order to raise cash to pay for things such as product development and expansion into new markets. This infusion of capital can be beneficial for a company because it allows them to borrow money at lower rates than they would if they repaid existing loans, while still providing the funds necessary to grow their businesses.
A company’s stock prices can also rise because they are influenced by earnings growth. Earnings are the primary source of a company’s profits and if a company is consistently growing, the demand for its stock — and therefore the price of the stock — will increase. This is why long-term investing in quality companies with steady growth prospects can be very profitable.
Unlike bonds, which operate like debt, stocks offer the opportunity for higher returns because their values are tied to the performance of the company. However, that increased risk also means there is the potential for greater losses should the market or a company experience a downturn.
The stock market is a place where buyers and sellers can negotiate the price of a share of a publicly-traded company at any given moment. The supply of available shares is matched with the demand from buyers in order to establish an effective price. This process takes place in real time and the prices of stocks can rise or fall at any given moment depending on a variety of factors, including the economic outlook and individual investor sentiment.
Investors who own common stock often have voting rights and may receive dividend payments. Other classes of stock, such as preferred shares, may not come with voting rights but are typically entitled to a larger claim on the company’s assets and earnings than common stockholders.
It is possible to buy individual stocks through a broker, but many investors choose to invest in mutual or exchange-traded funds (ETFs) instead. These vehicles typically invest in hundreds of different stocks, which helps to diversify the portfolio and reduce the risk of relying on one particular company for investment income. This is a great option for beginners to get started with investing, but we recommend determining your financial goals and risk tolerance before jumping in feet first.