Investing basics: What is a stock?

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Getting started with investing means understanding the options available to you. Stocks, bonds and mutual funds are the most common investments that typically make up an investment portfolio. Of those, stocks have historically outperformed most other investments over the long run. If you’re just getting started with investing, here’s what you need to know about stocks and why they can be an important option in your portfolio.

What is a stock?

A stock is a type of security that signifies ownership in a corporation. It gives you, as owner of the stock or the shareholder, a claim on part of the corporation’s assets and earnings. Simply put, the shareholder is a part owner of the company. Ownership is determined by the number of shares a person owns compared to the number of outstanding shares for the company. For example, if a company has 1,000 shares of stock outstanding and you own 100 of those shares then you are a 10 percent owner of the company.

Types of stock

Most companies issue two different types of stock: common and preferred. Each has their own characteristics.

Common stock represents ownership in a corporation. Shareholders don’t have a say in the day-to-day operations of the company. Shareholders may exercise their control by voting for the board of directors, voting to acquire other companies and by weighing in on other important decisions. The company may, but is not required to, pay a dividend to shareholders.

If the company doesn’t pay a dividend then any profits are reinvested in the company’s business. Shareholders that own common stock are on the bottom of the priority list for ownership structure. They are the last to receive any possible payout from the company in the event of bankruptcy.

Preferred stock represents ownership in a corporation. Preferred stock owners have a higher claim on the company’s assets and earnings than common stock owners. Preferred stock owners get paid before any dividends are paid to the individuals that hold common stock.

Dividends can be a fixed amount or be based on a benchmark. So, the amount paid out could vary and are paid monthly or quarterly. Preferred stock owners normally don’t carry voting rights. This type of stock combines the features of debt (bonds), in that it pays fixed dividends, and equity (stocks). It also has the potential to fluctuate in price and value.

Why invest in stocks?

Stocks can be an important part of any portfolio. They do bear a greater risk than mutual funds or bonds. However, with greater risk comes the potential for a greater reward. Over the long term, stocks tend to increase in value more than other types of investments. At the same time, they also tend to be more volatile in the short term, making them better for long-term investing. In addition, stocks carry a limited liability; the most that you can possibly lose is the amount you invested in the stock to begin with. 

The advice provided is for informational purposes only. Contact a financial advisor for additional guidance.

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