Stocks, company shares or equities, are a key part of many investors’ plans to grow their money. They also come with a significant amount of risk, so it’s important to understand them well before you invest. Here’s what you need to know.
The primary purpose of stocks is to generate a return on investment (ROI) that exceeds the ROI of other major asset classes, like bonds and real estate. They do this by generating returns from the capital appreciation of the underlying companies. This happens when the value of a company increases over time, which may be due to the success of the company’s products or services, or from the economic growth in the country where they operate.
Another way that stocks can make money for shareholders is by distributing dividends, which are payments made by the company to its shareholders based on its profits. These payments are a percentage of the profits, and they’re typically taxable. Companies are not required to pay dividends, but those that do generally find that it boosts their stock price, which may in turn increase the amount of profit they can earn on future sales of their shares.
When a company wants to raise more capital to design new products, hire additional employees or expand into new markets, they may issue additional shares of stock. This process is known as a capital-raising event, and it makes the company’s shares available to people outside of the corporation. These shares are then traded on a regulated exchange, such as the New York Stock Exchange or Nasdaq. Publicly-traded stocks are a popular choice for investors because they can easily buy and sell them. This helps to diversify an investor’s portfolio and reduce the potential impact of near-term market volatility.
While stocks have a history of high returns, they can be volatile and are subject to near-term market volatility. This volatility can make it challenging to build a stable long-term portfolio, so it’s essential for investors to keep their risk tolerance and capacity in mind.
For example, if you have a limited amount of capital to invest, short-term trading techniques might not be the best fit for your portfolio. Instead, consider investing in a mutual fund or exchange-traded fund (ETF), which invests in hundreds or thousands of different companies. This approach offers instant diversification from the start and may be easier for beginners to manage.
Companies can be broken up into categories based on their total market value, which is commonly referred to as “capitalization.” Large-cap stocks make up about 65% to 75% of the entire market, while mid- and small-cap stocks each represent about 10% to 15%. In general, larger-cap stocks are more stable, while smaller-cap stocks have more growth potential. However, these distinctions are not always precise, and the boundaries between one grouping and another can shift over time.