Sure, you know what the stock market is, and you’ve heard time and time again that you should be investing. If you’re sitting on the sidelines of the stock market, you aren’t alone.
Even with the recent bull market (which basically just means stock prices are rising), Americans, especially younger generations, are investing less than they did a decade ago. But, in the past 10 years, investing has become easier than ever thanks to changes and advances in investing technology that have increased accessibility.
So, if you’ve been putting off investing, maybe it’s time to change that. Investing could potentially give you the opportunity to grow your wealth. Historically the S&P 500 has averaged an approximately 7% annual return, when adjusted for inflation.
Keeping your money in cash is inherently less risky than investing it, but you could be losing out on potential returns by letting your money stay stagnant.
Part of what makes investing seem so intimidating is the boundless financial jargon that surrounds it.
If words like capital appreciation and dividends leave you glassy-eyed and longing for clarity, we’ve got your back. Understanding a few basics will make investing seem more approachable.
While there are a variety of assets to invest in, perhaps the most frequently discussed are stocks and shares. Understanding these two concepts could shed some light and potentially demystify investing.
Stock vs. share: What’s the difference?
The distinction between shares and stocks can be a little hazy as the two words are frequently used interchangeably. The difference between the two may be subtle, but understanding the difference between a stock and a share may provide a more nuanced look at investing.
Essentially, a stock is the actual asset you are investing in. An asset is something that has “economic value and can act as a store of wealth.” A share is the unit of measurement for that asset. So, a stock tells you what you are investing in, and a share tells you how much of that stock you own. Let’s dig into some more detail.
What are shares?
Think of shares like a small portion of a company. So, if a company were a pie, a share would be a slice of said pie. The more slices, the more shares. When a company sells stocks, a share is usually the smallest whole piece of the company an individual investor can own.
A company’s worth, or overall value is called the market capitalization, which is also referred to as market cap. To find the market cap of a publicly-traded company, multiply the price of the stock by the number of outstanding shares, which are the number of shares currently owned by shareholders. This can also be referred to as shares outstanding and the exact number can fluctuate over time.
Changes in the number of shares available can occur for a variety of reasons, for example, if a company decides to release more shares to the public, the number of shares would increase.
The number of shares could also increase if a company decides to complete a stock split. A stock split is typically a decision made by the board of directors of a company to adjust the price of their stock without changing the overall value of the company.
If a company’s stock price gets too high, say over $1,000, this can make it difficult for some investors to purchase and limits the availability of buyers. A 10-for-1 stock split for instance, would exchange one share worth $1,000 into 10 shares each worth $100. Your total investment value remains the same, but your shares go up.
What are stocks?
Stocks, which are also referred to as equities, are a type of security that give investors a stake in a publicly-traded company. A publicly-traded company is one that trades on stock exchanges. Privately owned companies are not traded on the stock exchange.
When you buy stock, you are buying a share or shares of a publicly-traded company. As a shareholder, you own a small piece of the company.
Generally, people buy stocks in the hope that the company will earn money, and as a result, the individual investor will earn a return. There are two ways to earn money through stock ownership.
The first is through dividends. When a company is profitable, they can choose to share some of their profits with their investors through dividend payments.
Typically, companies pay dividends on a specified schedule, although they can be made at any time. If the payments are unscheduled they are sometimes called special or extra dividends.
The second way to earn money when you buy a stock is through capital appreciation, which is when a stock’s value increases. If the value of a stock rises from the time it was purchased to the time it was sold, the profit made is referred to as the capital gain. If stock is sold at a price lower than the one at which it was purchased, the loss is referred to a capital loss.
There are two broad categories of stocks: common and preferred. Common stocks typically give the owner voting rights at shareholder meetings. These types of stocks also usually earn dividends.
Preferred stockholders, on the other hand, don’t usually have voting rights but do earn dividends. Usually, the dividend payments are received by preferred stockholders before common stockholders receive payment.
If a company goes bankrupt, preferred stockholders generally have priority over common stockholders if the company’s assets are liquidated.
If a shareholder has voting rights, they can typically vote on things that influence corporate policy, like who sits on the board of directors. The number of shares a shareholder owns is usually related to the influence that shareholder has. Say, for example, Investor A owns 50 shares of a specific company’s stock and Investor B owns 100 shares in the same company.
While both Investor A and B are shareholders in the same company, when it comes to voting rights, Investor B has twice as much influence because he or she owns twice as many shares as Investor A.
Companies typically issue stock to raise capital (money or other financial assets). Usually, the goal is to grow the business or launch a new product, but the money could also be used to pay off debts or for another goal.
How are stocks categorized?
Categorizing stocks between preferred and common is a helpful distinction. According to the National Bureau of Economic Research, there were 3,627 firms listed on U.S. exchanges in 2016.
With so many options it can help to categorize stocks a bit further. Growth stocks, value stocks, income stocks and blue-chip stocks are some of the most common categories for stocks. Note that some stocks may fall into more than one of the below categories.
Growth stocks are stocks that are growing faster than the market average. Growth stocks don’t usually pay dividends, so investors looking at these types of stocks are hoping to make money through capital gains when the shares are sold.
In today’s market, growth stocks are often tech, biotech and some consumer discretionary companies (these are companies that sell goods or services that aren’t considered essential by consumers).
A value stock that offers a strong earning potential in return for the initial cost of investment is often considered a value stock. These stocks often have a lower price-to-earnings ratio.
Often times, value stocks will be less expensive than stocks from similar companies within the same industry. Basically, a value stock is one that is cheaper than the company’s performance indicates it could be.
Income stocks are those that consistently pay dividends. Income stocks can be found across most industries but are most typically found within “real estate…energy sectors, utilities, natural resources, and financial institutions.”
A dividend yield is a financial ratio that illustrates the annual dividend in comparison to the stock price.
Blue-chip stocks generally come from established companies with a proven history of growth. These stocks typically pay dividends. Amazon, Starbucks, Apple, Disney and Nike are all usually considered blue-chip stocks.
Investing in stocks
When it comes to investing, you have options. Typically, investing in individual stocks is done through a brokerage account. There are a few different types of brokerage firms and brokerage accounts, but the basic idea is usually the same — after opening and funding the account, you can buy and sell stock.
There are full-service brokerage firms, discount brokerage firms and online brokerage firms. The firm that’s right for you will depend on how you plan to trade. Full-service firms typically offer some financial guidance, but can be more expensive than some of the other options.
Discount firms may be better for an experienced investor who likes to research and trade stocks. Some firms will charge fees for trades, so read the fine print on the account you choose to open.
The investing can fully begin after the brokerage account has been opened. Part of investing is researching options. You wouldn’t buy a car without test driving it, would you? While you can’t test-drive a stock, carefully evaluating the company can provide insight that can help inform your decision to invest.
The Securities and Exchange Commission (SEC), which regulates stock markets in the U.S., requires all publicly traded companies to disclose their performance by releasing quarterly reports.
These filings can be a helpful tool for investors. They share key information for determining the success of a company, things like the company’s profit and loss, as well as expenses.
In addition to documents released by the company, you may be interested in supplementing your research with some analysis and reporting — which, thanks to the internet, is easier than ever to access. Before trusting just any investment advice, make sure it’s a trustworthy source. Some analysis sites are free and others charge a fee.
As an investor, it can also be helpful to keep up with the latest happenings in the market. Many outlets have an app where you can usually set up push notifications, and some may allow you to opt-in for daily round-up emails of popular stories and news items. Outlets like MarketWatch, CNBC and The Wall Street Journal are widely respected, but there are even more options.
The biggest takeaway here is to be familiar with a company before investing in it. If you’re new to investing, you may want to stick with companies you know and brands you are familiar with. This could be one way to avoid the hype that often surrounds the stock market.
What about risk?
In the long term, stocks can offer a great potential for return. But, there is inherent risk involved in the market. While the markets have historically performed well over the long-term, there is always the chance that stocks you’ve invested in can lose value.
The ups and downs of the stock market are inevitable and can be difficult to predict. While there are strategies to minimize risk, when it comes to investing it’s impossible to eliminate it completely.
Are there other options?
Trading individual stocks isn’t the only option for investing. One alternative is to invest in a mutual fund, which is a managed investment that pools money from a number of different investors. The money is then invested in a variety of securities, including stocks and bonds.
One big benefit mutual funds offer is diversification. Even buying just one share of the mutual fund will invest you in all of the assets in the portfolio. A mutual fund can either be actively managed by a financial professional, or passively managed.
Another option is an ETF, which stands for Exchange Traded Fund. ETFs have some similarities to mutual funds since they also give investors access to a broad range of securities by bundling a group of assets and investments into one fund. ETFs are typically passively managed.
Original source: Mediafeed.org