Stocks can be an immensely valuable part of an investment portfolio. Owning stocks in different companies can help investors build their savings, protect their money from rising inflation rates, and grow their wealth over time. As such, investing in stocks has become very popular over the years. In this article, we take a look at why people invest in stocks, and the types of stocks people can invest in.
What are stocks?
Stocks, also known as equity, are a security that represents the ownership of a fraction of the issuing company. Units of stock are known as shares, and they entitle the owner to a proportion of the corporation’s assets and profits, equal to how much stock they own.
Stocks are typically bought and sold on stock exchanges. They are also the foundation of many individual investors’ portfolios. Stock trades must conform to government regulations which are meant to protect investors from fraudulent practices.
Types of stocks
There are two main types of stocks – common and preferred. Here, we have explained the main difference between the two different types of stock below.
Common stocks
When most people talk about stocks, they are usually referring to common stocks. The vast majority of stocks are issued in this form.
Common shares represent a claim on profits and confer voting rights. Investors typically get one vote per share owned to elect board members who oversee major decisions made by management. Stockholders, therefore, have the ability to exercise some form of control over corporate policy and management issues when compared to preferred stockholders.
Common stock often tends to outperform bonds and preferred shares and has the biggest potential for any long-term gains. That said, if a company does poorly, the stock value will go down, making it risky for investors.
When it comes to company dividends, the company’s board of directors will decide whether or not to pay out dividends to common stockholders. If a company misses a dividend, common stockholders are given less priority when compared to preferred stockholders. Common stockholders are also last in line for the company’s assets in the case of insolvency. This means common stockholders will not receive any money until after preferred shareholders are paid out.
Preferred stocks
One main difference of preferred stocks is that they do not come with any voting rights. So, when it comes time for a company to elect a board of directors or vote on any type of corporate policy, preferred shareholders have no voice in the future of the company. Preferred stocks actually function similarly to bonds as investors are usually guaranteed a fixed dividend in perpetuity. This is different from common stock, which has variable dividends that are declared by the board of directors and are never guaranteed.
Preferred stocks have a par value which is affected by interest rates. When interest rates rise, the value of the preferred stock declines, and vice versa. The value of common stocks is regulated by the demand and supply of the market participants.
If a company is liquidated, preferred stockholders have a greater claim to a company’s assets and earnings. Preferred stockholders also get priority over common stockholders. If a company misses a dividend payment it must first pay out preferred shareholders before paying out common shareholders.
Why people should invest in stocks
Investing in stocks can bring several benefits and opportunities to individuals. Here are some key reasons why people choose to invest in stocks.
Diversification
Investing in stocks allows individuals to diversify their investment portfolio. By owning shares of multiple companies across different sectors and regions, investors can spread their risk and reduce the impact of any single company’s performance on their overall portfolio. As the old saying goes, do not put all your eggs in one basket.
Ownership of companies
When people invest in stocks, they become a partial owner of the company’s shares they hold. This ownership can provide individuals with various benefits, such as the right to vote on corporate matters, receive dividends, and participate in the company’s growth and success.
Potential for long-term growth
For the most part, stocks have shown the potential to generate significant long-term returns. Over time, the value of well-performing stocks can rise and appreciate. This allows investors to gradually grow their wealth and potentially even outpace inflation.
Liquidity
Stocks are considered relatively liquid investments, meaning they can be bought and sold easily on stock exchanges. This liquidity provides flexibility and allows investors to quickly convert their holdings into cash if needed.
Dividend income
Some stocks pay dividends, which are a portion of the company’s profits distributed to shareholders. Dividend-paying stocks can provide investors with a regular income stream, which makes them attractive to those seeking income in addition to potential capital appreciation.
Access to professional management
Many individuals prefer to invest in stocks through mutual funds or Exchange-Traded Funds (ETFs). This is because these investment vehicles pool money from multiple investors together to be managed by a professional fund manager. This allows individuals to take advantage of professional investment expertise, research, and portfolio diversification. It is also a great way to passively manage investments without needing to do too much research.
Flexibility and control
Investing in stocks allows investors to make decisions based on their investment goals, risk tolerance level, and market analysis. Investors have the freedom to choose the stocks they wish to invest in, determine the amount of capital they allocate, and make decisions on buying, selling, or holding based on their own research and analysis.
Highly accessible
Stocks offer plenty of investment options for individuals with varying budgets. With the availability of fractional shares and low-cost brokerage platforms, investors that have limited capital can still find ways to participate in the stock market if they so choose. Some brokers allow investors to buy and sell stocks commission-free, and others may not even require any account minimums. This way, they can build their investment portfolio over time without needing a huge upfront cost.
Potential to make money
Most investors generally intend to buy low and sell high. They invest in fast-growing companies that will appreciate in value over time. That is attractive to both day traders and buy-and-hold investors. While the first group intends to take advantage of short-term trends the latter group expects to sell the company’s earnings and stock price grow gradually over time.
How to buy stocks?
Most often, stocks are typically bought and sold on stock exchanges, such as the NASDAQ or the New York Stock Exchange (NYSE). After a private company goes public through an initial public offering (IPO) its stock will become available for investors to buy and sell on an exchange. Typically, investors will use a brokerage account to gain access to a stock exchange and purchase or sell stocks. The exchange will list the purchasing price (the bid) or the selling price (the offer). The price of the stock is mainly influenced by supply and demand factors in the market, among other variables.
Bottom line
On the whole, the upside potential of investing in stocks outweighs the risk for most people. Investing in stocks is a great way to grow your wealth over time, but it is important to recognise that the stock market is highly dynamic and volatile – which can be a risk and a boon. As such, it is important for investors to do their research and make informed decisions before investing in stocks. As always, it is a good idea to consult with a financial professional before making any significant investment decisions.