What Are Stocks? A Primer for New Investors - MagnifyMoney
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What Are Stocks? A Primer for New Investors

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Apple. Microsoft. Alphabet (the artist currently known as Google). It would be great to own a slice of these well-known companies, wouldn’t it? You could share in their gains and build your wealth in the process.

Well, you can when you buy stock. But what are stocks?

Stocks are securities that give you a fractional ownership stake in a company.

What is a stock?

Stocks, also known as equities, are an ownership stake in a company, however small it may be. When you buy stock, you’re buying fractional ownership units called shares. Prices fluctuate according to various conditions, including economic, social and the company’s performance.

When you own shares of a company (also called being a shareholder), you’ll likely be paid dividends — the portion of the company’s profits sent to stockholders. You’ll also sometimes receive voting privileges in corporate elections, like those for a company’s board of directors.

How do stocks work?

Companies issue stock to raise funds, often through an initial public offering (IPO). By offering shares of ownership in the company to investors, a company becomes publicly owned.

Once a company becomes publicly traded, anyone can buy or sell shares — including you. Stock prices will rise and fall over time as investors try to estimate its value. Some investors prefer to check the company’s business performance for an idea of what shares should cost, while others rely on analyst ratings and industry or economic trends.

Sometimes equities are repackaged into other securities which trade on stock exchanges as stocks do. Mutual funds and exchange-traded funds (ETFs) bundle stocks and other assets together, so you could also own small fractions of many different companies.

Key terms to know

The financial markets come with plenty of jargon. Instead of trying to understand them all, you can start with these key terms:

  • A dividend is a payout of a company’s profits to its shareholders, which you can receive as a cash payment or reinvest back into the stock.
  • Shares are simply the smallest unit of stock you can own.

Stocks can also be classified by their financial profile, such as:

  • Growth. Those that analysts predict will grow faster than the rest of the market.
  • Value. Those that analysts believe are currently trading at a price lower than the company’s long-term earnings and profit potential — hence, they’re a good “value” at their current price.
  • Income. Those that analysts believe present you with a relatively low-risk and pay regular, consistent dividends.
  • Blue-chip. Well-established companies with a proven track record of financial success.

Types of stock

While a single company only has one ticker, they can issue different share types.

Common stock

As the name suggests, common shares are… common.

When you own common shares — the type most everyday investors own — you receive voting rights in corporate elections, so you can help choose the company’s board of directors, for example. Common shares may also pay out dividends, which are another perk of ownership.

Preferred stock

Preferred shares are rarer than common shares, with some key differences between the two.

Preferred shareholders receive dividend payments that don’t change, so the company has to pay that set amount, regardless of the company’s profit or losses. Preferred stockholders also have the first claim to earnings and assets sold off in bankruptcy. However, preferred shares don’t entitle shareholders to vote, unlike common shares.

Ownership risks and benefits

Investing in stocks has its risks and benefits, as all assets do.

Benefits

  • Potential profit. If the share price is higher on the day you sell than it was when you bought it, you’ll earn a profit on your investment.
  • Dividend payments. Regardless of performance, dividend payments can add to your wealth in all market conditions.
  • Higher returns. Over the last several decades, the broader stock market value has risen significantly more than bond values have.

Risks

  • Potential losses. If the share price is lower on the day you sell than when you bought it, you’ll lose money on your investment.
  • Emotional trading. Without a trading strategy, emotional investing decisions (like selling in a downturn) can be costly.
  • Market volatility. If you live on a fixed income, you might prefer to buy more stable securities like bonds.

Differences between stocks and bonds

Companies use both types of securities to raise funds, but they’re two different financial instruments.

Whereas buying stock gives you a slice of equity ownership in a company, bonds represent a debt ownership stake. A company issues bonds as loan receipts. It promises that bondholders will earn the original value of their bond purchase plus interest over time.

While bond values can change over time, they tend to be less volatile than stocks. However, both securities tend to play a role in a balanced investment portfolio.

So, what are stocks? They’re your chance to own a slice of companies big and small. And while owning Amazon shares won’t give you the right to walk into Jeff Bezos’ office and gift all your friends free Prime shipping, you will be able to enjoy a few perks of ownership like voting rights and dividends.

Frequently asked questions

The best stocks to invest in depends on your investing goals. You should always do some research before you buy a company’s stock (or any other security). It’s also important to invest your money into a diversified portfolio: By spreading your risk across many different kinds of companies, your investments don’t have as much risk.

Investors on social media sites like Reddit encourage each other to buy and hold stocks in certain companies. A prominent example of the meme stock phenomenon happened in early 2021 when Robinhood traders inflated the value of companies like Gamestop and AMC. Meme stocks tend to be very volatile, and those stocks fell from their 2021 highs.

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