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 these, 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 exactly is a stock?
A stock represents your investment — called a share — in a company. By purchasing stocks, you become part owner of the company. As part owner, you are entitled to receive some portion of the company’s assets and earnings. How much of an owner you are is determined by the number of shares you own 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% owner of the company.
Types of stock
Most companies issue two different types of stock: common and preferred.
Common stock represents ownership in a corporation. Shareholders don’t have a say in the day-to-day operations of the company, but they may exercise some control by voting for the board of directors, voting to acquire other companies and weighing in on other important decisions. Common stock may fluctuate in price and value. The company typically pays a dividend to shareholders.
If the company doesn’t pay a dividend, then any profits are reinvested in the company’s business. If you’re like most shareholders and own common stock, then you’re at the bottom of the priority list for ownership structure. This means you are the last to receive any possible payout from the company in the event of bankruptcy — after creditors, bondholders and preferred stock owners.
Preferred stock also represents ownership in a corporation. However, preferred stockholders normally don’t carry the voting rights that are given to common stock owners. You do have a higher claim on the company’s assets and earnings than common stock owners. If you own preferred stock, you would get paid before any dividends are paid to the individuals who hold common stock. That’s because this type of stock combines the features of debt (bonds), in that it pays fixed dividends and equity (stocks). Like common stock, preferred stock has the potential to fluctuate in price and value.
Why invest in stocks?
Stocks can be an important part of any portfolio. As you build your portfolio, you’ll want to know what you’re investing for, since stocks 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 far better for long-term investing.
Talk to your financial advisor to learn more about how stocks may fit in with your investment goals.
The advice provided is for informational purposes only. Contact a financial advisor for additional guidance.