Definition
A stock represents partial ownership in a company. When you buy a company’s stock, you’re essentially buying a small piece of that company, known as a share. Stockholders can benefit from the company’s growth and earn dividends. Still, they also share in the risks, including the possibility of losing their investment if the company’s value declines.
What is a stock?
A stock is a financial instrument that signifies ownership in a corporation and represents a claim on part of the corporation’s assets and earnings. There are two main types of stock: common and preferred.
Types of stocks available in the market
- Common stocks: These give shareholders voting rights but lower priority for company assets and earnings. The significant rise and fall in Apple’s stock price after product launches and earnings reports is an example of common stock performance influenced by company activities and market sentiment.
- Preferred stocks: Typically, these do not provide voting rights but offer a higher claim on assets and earnings. An example could be a utility company offering preferred stocks with a fixed dividend, which does not widely fluctuate like common stock but provides steady income.
How do stocks work?
When a company wants to raise funds, it can issue stocks. Buying a stock means you are purchasing a small portion of the company. If the company does well, the value of your stock can go up. You might also receive dividends, a portion of the company’s profits.
So, when Amazon announced expansion plans into new markets and its stock price increased, investors who owned Amazon stocks saw the value of their investment grow.
Risks and rewards of investing in stocks
- Rewards: Potential for high returns; ownership in a company.
- Risks: Stock values can fluctuate widely; potential for loss.
For example, investors in Netflix stocks enjoyed substantial growth when the company expanded globally and increased its subscriber base. On the other hand, the plunge in stock prices for companies in the travel industry during the COVID-19 pandemic would have been bad news for anyone who owned stock in those sorts of companies.
The role of stocks in an investment portfolio
Stocks are a key component of many investment portfolios. They offer growth potential and can help investors keep ahead of inflation over the long term. However, they are typically riskier than bonds or savings products.
Stocks in a portfolio are like spicy ingredients in a meal – they can add flavour (growth potential) but also make it unpredictable (higher risk).
How to start investing in stocks
To start investing in stocks, you can open an investment platform account, choose your stocks, funds, ETFs or other investments and decide how much you want to invest.
Of course, you can use Compare + Invest’s handy articles, tools and calculators to help you on your way. We have platform comparison tools, details on individual platforms and digital apps, and heaps of articles on getting started with investing.
Understanding stock market fluctuations
Stock prices fluctuate based on company performance, economic conditions, and market sentiment. Investors need to be prepared for this volatility and invest with a long-term perspective.
Stock prices changing is like a boat on the ocean. Sometimes it’s smooth sailing (stable market), and sometimes it’s rocky (volatile market). The key is to be prepared for both.
With significant drops and rises, the stock market’s reaction to the announcement of Brexit negotiations is a real-world instance of how political and economic news can cause market variations.
Market timing risks
Market timing in stock investing, which involves predicting and reacting to market movements, is fraught with risks like misjudging market trends and incurring higher costs, often leading to suboptimal returns. Additionally, it risks missing out on significant market upturns, which can be crucial for overall investment growth.
During the early stages of the COVID-19 pandemic, many investors, anticipating a market crash, sold their stocks in early 2020. However, despite initial declines, the market rapidly recovered faster than many anticipated. Those who sold their stocks during the dip, expecting further declines, missed the following substantial rebound gains.
Conclusion
Investing in stocks is a popular way to potentially grow wealth over time. While it comes with risks, understanding them and adopting a diversified investment approach can help you harness the benefits of stock ownership.
Considering the complexities of the stock market, seeking professional financial advice is advisable for personalised strategy and disciplined investing, aligning with long-term financial objectives.
