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Stock investing tends to yield higher returns than putting your money in a savings account. But like any investment, stock trading has its risks. Starting with the basics, we’ll answer the question “What are stocks?” and then walk through the pros & cons of investing in stocks.
What is a stock?
A stock is a small ownership interest in a company. Companies sell stocks to raise money for expansion and development. Say a company is worth $100 million and issues 5 million stocks. Then each stock would be worth $20.
Every stock sold gives the stockholder (or shareholder) a small controlling interest in the company, although this interest is usually passive. Stockholders aren’t typically involved in the day-to-day management of a business. The exact rights that come with owning stocks vary depending on the type of stock a company issues. But shareholders may be entitled to the following:
- Voting rights at shareholder meetings
- Monthly, quarterly, annual or ad hoc payments (“dividends”) from company revenue
- Asset rights if the company goes out of business
Like any investment, the value of shares can rise and fall depending on the success and popularity of the company, the strength of the economy, industry-impacting news and other factors.
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Stocks vs shares
The terms “stocks” and “shares” can be used interchangeably, but there’s actually a subtle difference between the two.
- Shares are individual units of ownership in a single company. You can own a specific number of shares in a company, say, 100 shares of Shell.
- Stock refers to ownership interests in multiple companies. For example, you could own 100 stocks in Shell, Amazon, Apple and Procter & Gamble.
Benefits of stock investing
- Growth potential. People buy stocks hoping the value of their investment will grow. If a company performs well and its stock price goes up, the returns can be much higher than putting your money in a cash savings account. But success is not guaranteed.
- Dividends. If a company is profitable, it may disburse small payouts called dividends to shareholders. It’s like receiving interest on funds held in a savings account.
- Invest directly in companies you like. Unlike funds, which spread your investments across multiple companies, stocks give you the opportunity to pick the businesses you want to support with your money. You might want to support a startup business’s development or a company that you think is about to take off.
- Voting rights. Stock ownership often gives you the right to vote on important company decisions at shareholder meetings.
Risks of stock investing
- Your stocks may go down in value. If a company doesn’t perform well and you want to sell, you may not earn back what you paid to buy it.
- Losses from having an undiversified portfolio. It’s good to spread out (or “diversify”) your investments across lots of different companies. If an industry or investment type is suffering, the loss can be offset by gains in other investments you own. If you only buy stocks in a small number of companies, your investments may not be diverse enough to withstand short-term losses.
- You’re responsible for managing your stock portfolio. You decide what stocks to buy and sell and when to trade, so you need to research your options, track the performance of your stocks and make sure your portfolio is diversified. In contrast, funds only require that you pick the “type” of fund (for example, low risk or sector specific), but a manager is in charge of everything else.
Does every company have stocks?
No. Company owners may choose to “go public” and sell stocks to anyone, remain privately owned and sell stocks to a limited ring of investors or remain private and not sell stocks at all. While issuing stock helps companies raise money quickly, it also requires giving up some control to shareholder interests, so not all business owners want to go this route.
If 1 person is the only shareholder, they will own 100% of the company. However, many companies choose to sell shares to multiple investors, especially when there are plans to grow.
How many stocks can a company have?
There’s no maximum to how many stocks a company can sell. The amount of stocks varies between companies and may fall between 1 and millions of stocks. The number of stocks is not fixed forever. A company can start off with a relatively small number of stocks owned by its founders then sell more stocks later to investors.
Different types of stocks
There are 2 main types of stocks: Common stocks and preferred stocks. Common stocks come with voting rights, but preferred stocks do not. Both common and preferred stockholders could be eligible for dividends, but preferred stockholders will be paid first, so this type of share is generally regarded as less risky.
Deferred stocks are less common and only give shareholders the right to dividends after a certain period or when certain conditions have been met, for example, when the company hits a pre-defined goal.
How much is a stock worth?
Stocks in different companies will be worth different amounts, depending on the value of the company and how many stocks it has issued. This can change over time based on how the company performs.
How to buy stocks
- Online investment platform. Online investment platforms are usually the cheapest way to buy and sell stocks, although you may not have a lot of guidance on hand from investment professionals. Typically, you execute trades and monitor your investments through an online platform and/or mobile app.
- Traditional stockbroker. These are firms that buy and sell stock on behalf of clients. Usually you’ll be able to get advice from regulated professionals. Traditional stockbrokers are usually more expensive than online investment platforms.
- Regulated financial adviser. This is usually the most expensive way to buy stocks. A financial adviser can recommend specific investment strategies that suit your individual circumstances, taking into account all forms of saving and investing, not just stocks.
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How do I choose which stocks to buy?
- What type of company do you want to invest in? You could opt for big brands you’re familiar with or companies that match your values, such as those with a focus on sustainability.
- How established is a company? Long-established companies tend to be lower risk than startups, although this isn’t always the case.
- Are there any known risks? Check news headlines or recent company announcements for signs of risks within the company or the overall market.
- How volatile is the stock? A rapidly changing stock price stock price could mean lots of people are buying, thus potentially driving up the price beyond your budget. Or it could mean people are selling, which could be a sign that a company is no longer a good investment.
- Why do you want to buy stocks? We wouldn’t advocate buying shares off of mere hunches or just because there’s hype surrounding a company. Always do your own research before buying stocks.
If you’re a less experienced investor and want to keep an eye on things before buying, most trading platforms will have watchlists to help you monitor stock performance over time.
Diversifying your portfolio
Buying stocks in just one company, or even several companies, is a high-risk strategy. It’s wise to diversify your stock portfolio by investing in multiple businesses across different industries and sectors.
If you can’t afford to do this, then you might be better off buying shares in an exchange traded fund (ETF). This will be naturally more diverse as the money in the fund will be split across lots of different investments.
Alternatives to stocks
One alternative to investing in stocks is putting your money in a savings account. This is considered a low-risk option, because your money is not at risk and you can access it at short notice. However, the interest you earn may not keep pace with inflation during rough economic times.
Investment funds like mutual funds and ETFs pool together money from lots of individual investors and invest it in a wide range of securities. It’s a relatively simple way to help diversify your portfolio.
Bonds are like loans investors give to businesses or governments. Bonds pay interest for a fixed period of time, after which you receive your initial investment back plus the interest it has accrued. Some investment funds hold bonds as well as stocks.
Buying stocks can be an exciting way to grow your wealth. You can pick which companies you want to invest in and possible receive dividends. You may also be able to vote on important company decisions. Be prepared to spend time researching the companies you want to invest in, and remember to diversify your investments to help minimize the impact of short-term losses.
Frequently asked questions
More on investing
Your guide to how ETFs work and whether this type of investment is right for you.Read more…
Learning how to read stock charts and recognize chart patterns can unlock your success as a trader.Read more…
Owning a stock means you own part of a company and can potentially grow your wealth. But there is a risk of loss.Read more…
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