If you are looking to potentially make your money work for you, you may consider taking up stock investing. In this article, we explain what stocks are, the differences between the types of stocks there are, and how to buy them. Make sure to keep reading below to learn more about this topic.
What are stocks
A stock, otherwise known as equity, is a financial instrument that represents the ownership of a fraction of the issuing corporation. Units of stocks are called shares which entitles the owner to a proportion of the corporation’s assets.
Stocks are often bought and sold on stock exchanges worldwide, and they remain the foundation of many individual investors’ portfolios. Stock trades must conform to government regulations that aim to protect investors from certain fraudulent practices.
Understanding stocks
Corporations usually issue stocks to help raise funds to operate their business. In return, the holder of a stock, called a shareholder, may have a claim to part of the company’s earnings and assets.
A shareholder is generally considered the owner of the issuing company. This is determined by the number of shares an investor owns relative to the number of outstanding shares. This is then reflected in a percentage.
Types of stocks
There are two main types of stock – the common and preferred. While both of them are similar, there are some pretty fundamental differences between the two. We have listed out and explained them below:
Common stocks
Common stocks generally entitle the owner to vote at a shareholder’s meetings and to receive any dividends that are paid out by the company. They have the potential for higher long-term returns, and also come with voting rights (although this does not apply to owners of fractional shares). The liquidity of common stocks also depends on its trading volume.
On the flip side, dividends, if they are available, tend to be lower and variable. They are also not always guaranteed. Additionally, stock prices and dividend may experience more volatility when compared to preferred stocks. As such, shareholders and investors are more likely to lose their investments if the company winds up going bankrupt.
Preferred stocks
Preferred stocks on the other hand, are hybrid investments. As such, they share characteristics of both stocks and bonds. They can offer higher yields than many traditional fixed income investments, but they also come with different risks. As such, dividends are usually higher and fixed. Moreover, the share price experiences less volatility compared to common stocks. So, preferred shareholders are more likely to recover at least part of their investments if the company winds up going bankrupt.
However, the preferred stock also brings with it lower long-term growth potential. This can be detrimental for investors looking to make large gains in the market. Preferred stockholders also usually do not have any voting rights, although in return they do have high claim on earnings and assets than common stockholders. For example, owners of preferred stocks often receive dividends before common stockholders, and they have priority if the company ends up going bankrupt. Preferred stocks are also less liquid when compared to common stocks.
How to buy stocks
Although it sounds complicated in theory, buying stocks is actually pretty straightforward. Most often, stocks are bought and sold on stock exchanges, such as the NASDAQ of New York Stock Exchange (NYSE). After a company goes public through an initial public offering (IPO), its stock becomes available for all public investors to buy and sell on the exchange. Most often, investors use a brokerage account to purchase stocks that are on the exchange. The exchange will list the purchasing price (the bid) or the selling price (the offer). The price of the stocks is mainly influenced by the supply and demand in the market, among many other variables.
What is the difference between stocks and bonds
While the two financial instrumnets have similarities, they are actually quite different from one another. Stocks are generally issued by companies looking to raise capital to grow their business or undertake new projects. As such, there are important differences between whether somebody buys shares directly from the company itself when it is being issued in the primary market, or from another shareholder in a secondary market. All in all, when a corporation issues stocks, it does so in return for funding.
Bonds however, tend to vary in different ways. For starters, bondholders are creditors to the corporation. Therefore, they are entitled to interest as well as repayment of the principal invested. Creditors are also given priority over other stakeholders in the event of bankruptcy. They will be made whole first if a company is forced to sell its assets.
Conversely, shareholders tend to receive nothing when a bankruptcy occurs. As a result, this makes stocks inherently riskier investments than bonds. This is something that investors need to keep in mind if they are stuck deciding which investment option to choose from.
How risky is it to own stock?
Honestly speaking, all financial investments come with a degree of risk. This is an essential element that traders must remember. So, stocks, bonds, mutual funds, and exchange-traded funds (ETFs) can potentially lose market value if the market conditions move unfavourably. So, when you invest, you need to make decisions about what to do with your financial assets. This is because your investment value may rise or fall because of certain corporate decisions – such as whether to expand into a new area of business or merge with another company – or new market conditions. On the whole though, stocks generally outperform most other investment options in the long run. This is one reason that makes them so popular with investors and traders today.
How stocks fit in an overall portfolio
Stocks are a vital part of any portfolio due to their potential for growth and higher returns versus other investment products. In order to figure out how much you should allocate to stocks, you should first come up with a comprehensive financial plan that reflects your investment horizon. It should also take into consideration your risk tolerance level you are willing to accept in exchange for the potential benefits that stocks can offer.
You should also know that asset classes perform differently, and it is nearly impossible to predict which asset class will perform best in any given year. There are also many ups and downs due to volatility. As such, it is vital you diversify your portfolio. You can do this by investing in different instruments, or even in different sectors or industries of the same instrument. This way, if one instrument or sector is not doing well, youstill have other investments to prop up your portfolio.
