Today, many people shy away from buying investments, even though many want to do so. It’s true that investments can offer you a wide range of benefits, giving you the ability to make your money go further. Yet, for this to happen, you need to make wise decisions based on the amount of risk you wish to take. One of the most common ways to invest is in stocks. Do you know enough about them to add them to your portfolio? Here’s what you need to know.
Defining Stocks – What Are They?
It’s rather common to hear about stocks. Every day on the news or online, you hear about changes in the stock market. Yet, you have no idea when to invest or how to take advantage of it. Stocks are an important investment method because they provide you with a way to hedge your bets based on what you expect the market to offer. That sounds complex, but we’ll break it down here.
A stock is a type of investment in a company. More precisely, when you buy a stock, you are buying a very small piece of ownership in a company. The more stocks you own, the larger your percentage of the company is. While stocks no longer issue paper certificates, they still are a legally binding component of ownership that you have within that business.
Companies often use stocks as a way to raise money. If they want to expand, for example, they may issue stocks to help raise the funds to do so. Yet, companies do this on a more limited basis because they are giving away ownership in their company. The key benefit to companies is that they are able to raise funds to use for many reasons, but at the same time, they are not taking on any debt in doing so.
Because stocks present such an opportunity for businesses, many do this as they gain a reputation. Yet, just because a company is selling stocks does not mean they are a good risk factor for you to take on. More on that in a moment.
Let’s Break Down Stocks – Here’s How They Work
Companies issue stocks to raise money. They can use that money for any needs they have. They can issue as much stock as they like, but as they do so, they are giving away more and more components of ownership to the company. Let’s say you want to help the company. You buy stocks. The funds from the stock purchase help the company to grow and expand. As a result, the company performs well. You, then, also see results. Here’s how that works.
When a company decides it wants to use stocks to raise money, it will issue shares. Let’s say they issue 100 shares. Companies will usually keep the majority of shares to themselves for the business owner to maintain. That keeps the business owner in charge of the company as a majority owner. They decide to sell the rest. Let’s say they decide to sell 40 shares.
Each share represents a specific amount of value and ownership in the company. It’s not always equal to one percent and usually is much less than this. The company usually sets a specific goal to reach when it launches its stock. It hopes to charge a specific amount for each share it sells. In doing so, the company is able to raise the amount of money it needs to raise to achieve its goal.
Owning shares in a company is powerful. Over time, you can purchase numerous shares – as long as the company continues to issue them – or you can buy them from third parties. Owning a share means you are a part owner in the company, though you may not have access to all information and insight into the business.
It does give you some key advantages, though. As a part owner, you have some ability to voice your opinion about how the company should be run. You can do that in shareholder meetings and in owner votes that take place over major decisions. You can also decide who sits on the board of directors, or the component of the business management structure that makes big decisions for the company.
Most often, people don’t play a significant role in these situations. Most never play a role in day-to-day operations. However, the more shares you own, the bigger your influence is.
It’s not easy to own a large number of shares in a business. That’s because companies often issue millions of shares over a period of time. That dilutes the ownership pool significantly. It means it is harder for any one person to have a large amount of the company’s ownership shares.
But, How Do You Make Money with Stocks?
Owning a company sounds like a good thing, but that doesn’t put money back into your pocket. The key to remember about stocks is that they are a risky investment. You only make a profit on them when your shares grow in value. And, the only time that happens is when the company does well financially. If you’ve followed the stock market at all, you know that many factors can contribute to this.
For example, a company’s owner may be investigated for claims of harassment. A company that manufactures a product overseas may no longer be able to operate due to tariffs. These factors are far-ranging, but all impact the way companies perform on the stock market. What’s more, it is not always the underlying financial security of the company that makes these swings in the market take place. Rather, it is the perceived risk that investors – those buying and selling those stocks – believe is there.
Here’s an example. Let’s say you own stock in a company that makes electronics. Yet, the company is reliant on a supply of rare earth metals from the Middle East. You hear that the country selling these earth metals to the tech company you have invested in is no longer accessible. War broke out, for example. This could mean that the electronics company can no longer make the products they need.
In this moment, the company hasn’t changed anything, and the company’s revenue is still the way it was. However, this new perceived risk sparks fear into those owners who have this stock in their portfolio. They decide to get rid of it because they are worried about the outcome of the new political strife. They sell off their shares, which causes the value of the stocks to start falling because there’s less demand for them. Now, those shares are worthless.
It’s frustrating to be unable to control many aspects of stocks like this. Yet, it is possible for you to learn and research companies to help minimize these risks to yourself.
Let’s step back and talk more about stock values.
How to Determine Stock Value
The value of any stock is dependent on many factors. Generally, the performance of the company is the biggest factor in determining if the stock will increase in value or decrease. For example, if the company does well and sees revenue growth, this will increase the value of the stock because the company is performing well. That leads investors on the market to buy more of the stock.
On the other hand, when the company makes a mistake or has a bad quarter, people want to sell the stock on the market. As they do, there is less demand for it, and the value falls.
As noted throughout so far, stocks are bought and sold on the open market. There are various stock exchanges around the world. You can choose to invest in any company in any of these markets, depending on your goals.
What Is the Difference Between Stocks and Bonds?
Stocks and bonds are two very different types of investments. As we noted with stocks, every purchase of a stock share means you are buying a portion of the company. That is not the same as what happens with bonds. With bonds, you are giving the company money to use as they need to. The company then pays you back over time with interest. There’s no ownership changing of hands here.
Because there is less volatility in the way bonds fluctuate in value, many people think of them as safer investments. They can be, but they are not guaranteed. It is possible for a company issuing bonds to default, enter bankruptcy, and to leave investors with nothing. This tends to happen less often.
The way bonds earn value is also very different. With bonds, the interest rate is set at the time of the purchase of the body. Some are fixed rates, and others are variable. The different with stocks, then, is that the market’s up and down movements are less impactful to the holder of the bonds than it would be for those who own stock.
What Type of Stocks Should You Buy?
There are numerous types of stock options available to you. Each one is a bit different in terms of the way they work. You should learn about each one. Here are a few examples.
What Are Common Stocks?
As the name implies, these are the most common form of stock. In this form, the company issues shares, and those who buy the shares are part owners of the company. With common stocks, the shareholders have voting rights for the company. In addition, some common stocks pay dividends, which means as the company does well, those who hold the stock earn a bit of profit from that value increase. You can also buy a collection of stocks, otherwise known as an ETF, to minimize single stock risk.
What Are Preferred Stocks?
Another more commonly invested in option is preferred stocks. Those who buy preferred stocks do not have the right to vote in most company meetings. However, most often, they do offer other types of benefits to the stock buyer. For example, sometimes, preferred stock owners receive dividends even if common stockholders do not. And, if the worst were to happen and the company goes bankrupt, those who own preferred stocks are able to get first access to any sale of the company’s assets.
What Are Growth Stocks?
Sometimes, you may hear about growth stocks. These are stocks that a company issues, like all others. What makes them different is that people – usually the brokerage you are working with – believes that the company is still growing. There’s still room for the company to grow in terms of expansion, earning more revenue, and developing new products.
What Are Value Stocks?
This type of term refers to a stock that seems to be priced at a lower value than what you, as the investor, believe the stock is worth. If a stock is selling for less than what figures such as sales and earnings show its value to be, this could lead to the stock being called a value stock. Here, you hope to see the value of the stock grow while you own it.
Common Questions about Stocks
It’s not uncommon to have questions about stocks. Here are some answers to common questions:
Are Stocks Risky?
All investments have some risk. Investors must determine what they see the future being in terms of how much risk a stock presents to know if it is too risky for them.
How Can You Buy Stocks?
Most people purchase stocks on the open market through a brokerage account or retirement accounts such as 401(k) or traditional IRA. There are numerous stock markets around the world. Companies can choose which stock markets to list their shares on for sale based on where they think they are going to get the best return.
Why Should Stocks Be a Part of Your Portfolio?
While stocks are never always a good idea, they are a benefit to many people. If you want to grow your portfolio – or investments – faster, you may want to take on more of the risk that stocks offer. If you buy the right stocks at the right time, this can cause the value to rise quickly, making them worthwhile. However, if you do not want to lose some money, it may be wise to hold off on investing in high-risk stocks. Your investor can help you make decisions about these risks based on what your goals are and what your risk tolerance is at any given time.
Which Type of Stocks Are Right for You?
It can be hard to say which form of stock investing is right for your needs. Rather, it is best for you to work with your brokerage or financial advisor who can help you make key decisions about your investments.