Have you been in a gathering and they were talking about owning stocks and you were wondering what they were talking about?
Or maybe you were researching investment opportunities and came across stocks but had no idea what they mean; this article will hopefully address all your questions.
Let us start from the beginning.
What are Stocks?
A stock, which is also referred to as Equity, is a type of financial security that symbolizes the ownership of a part of a corporation. In essence, the owner of such stock is entitled to a certain percent of the corporation’s assets and profits equivalent to how much stock the owner possesses. Units of stock are referred to as shares.
To put it simply, stocks are a means to build wealth. They are a means of investment that means you own a share in the company that issued the stock.
Stock is the medium through which an average man invests in some of the most successful companies in the world. On the flip side, stocks are a way to raise money to fund growth, products, and other initiatives by companies.
Depending on the percentage of stocks you possess as an investor, you get a right to vote at crucial stakeholder’s meetings if you choose to exercise it but the main reason that investors own stock is to receive a return on their investment and this can be in two forms:
- The stock’s price appreciates, which means it goes up. You can decide to sell the stock for a profit if you so wish.
- The stock pays dividends. Many of these successful companies pay Dividends (payments made to shareholders from the company’s profit, typically paid semi-annually or annually) but not all.
The average annual stock market return that has been consistent for a while is 10% but it sometimes falls to 7% or 8% due to inflation. Some companies still fall lesser than this average percent, some pay higher while some do not pay at all.
That is why it is advisable that an investor should not buy stocks in just one company, rather, build a well-rounded portfolio that can boast of stocks in many companies across varying industries and geographical locations.
As earlier mentioned, companies sell shares to raise money for various reasons including funding new products or product lines, expanding operations to new frontiers, investing in growth, or to pay off debt.
One of the processes through which a company issues its stock is known as Initial Public Offering (IPO) and once a company’s stock is released to the market, it can be purchased and sold among existing and new investors.
In most cases, if you decide to buy a stock, you will most likely be buying it from another investor who is looking into selling and not directly from the company itself.
Likewise, when you want to sell your share of stock, it will be bought by another investor who is willing to purchase.
In the stock market, trades (stock exchange) are conducted in two ways; either a Broker represents you as an investor or you make use of online Stockbrokers (a platform that connects the buyers and sellers of stocks, thereby effecting exchanges) As an investor, you’ll need a brokerage account to buy stocks.
Remember that while stocks generally have a history of high returns, they also come with their fair share of risks, that is, your stock may go down in value at a given time.
This can come to be when stock prices fluctuate for reasons such as general market volatility or specific internal events such as a product recall.
Essentially, the goal of owning stocks is for the value of the company and its stock to increase while you are an investor.
Main Types of Stocks Every Investor Should Know
When a company sells shares of stock to the public, those shares are issued as one of two main types of stocks: Common stock or Preferred stock. Also, stocks are classified by company size, industry, company style, and location.
1. Common Stock: Gives the owners the right to vote at shareholder meetings and gives them the right to receive dividends.
2. Preferred Stock: Doesn’t give the investors the right to vote but they receive dividend payments before the common investors do, they also have priority over common investors in the case of a bankruptcy of the said company or if the company’s assets are liquidated. They have a higher claim on assets and earnings than the common investor and the stock price doesn’t fluctuate the way the common stock does. On the flip side, they are also less prone to gaining value. Therefore, preferred stock is the best choice for investors who are mainly concerned about income rather than long-term growth.
Other types of stocks (in which common and preferred stocks can be found) are:
3. Blue-chip Stock: Gotten from the poker game where the most valuable chip is the blue one, it characterizes shares in large, well-established companies with a steady history of paying out dividends regardless of the economic situations. Such companies’ stocks are the ‘sweetheart’ of investors because there is a tendency to grow dividend rates faster than the average rate of inflation. An investor gets to increase his income without necessarily having to buy another share.
4. Company Size: Companies are generally classified into three buckets depending on their size, they are; Large Cap (with a market value of $10 billion or more), Mid Cap (with a market value between $2 billion and $10 billion) and Small Cap (with a market value between $300 million and $2 billion).
5. Location: Stocks are often classified by geographical locations. If you are a die-hard investor, you can decide to expand your investment frontiers to emerging and international markets apart from your local country.
6. Style: In terms of growth stocks, investors are typically willing to purchase a high number or quantity of stock (for bigger returns) from companies that are either growing quickly or have the potential to do so. In terms of value stocks, on the other hand, such companies involved are mature, well-established companies that have already grown and do not have much room for expansion. Yet, they can be good choices for investors seeking more price stability and positive exposure to stocks due to their long-used, well tested, and trusted business models.
7. Industry: Companies are also classified by sectors. For example, stocks in the same industry – let’s say technology – may move together in response to market or economic events. That is why it is advisable to diversify across different sectors when investing.
8. Economy: National economies are inclined to trail cycles of development and reduction with phases of opulence and collapse. To these regards, we have Cyclical stocks and Non-cyclical stocks:
- Cyclical stocks consist of shares of companies in industries like manufacturing, travel, and luxury goods. For such companies, an economic decline can remove customers’ ability to make important procurement swiftly. When economies are strong, however, a rush of demand can make these companies bounce back in a truly short time.
- Non-cyclical stocks, also known as Secular or Defensive Stocks, can’t boast of those big sways in demand. A good example would be grocery store chains in the sense that no matter how good or bad the economy is, people still have to eat. Non-cyclical stocks tend to fare better during a market recession, while cyclical stocks often outperform during strong bull markets.
9. IPO Stock: These are stocks of companies that have, in recent times, gone public through an Initial Public Offering. Investors are always on the look-out for such stocks because they can get in on the ground floor of a promising business concept. On the flip side, they can be volatile or unpredictable, especially when there’s disagreement within the investment community as regards to their prospects for growth and profit. A stock by and large maintains its rank as an IPO stock for a minimum of a year and for as long as two to four years after it becomes public.
Types of Investors
An average man is entitled to purchase stocks in the stock market. However, each investor has personal motives for the purchase of stock, and this largely depends on such an individual’s trading personality.
In essence, your trading personality depends on how much risk you can put up with, what form of research you are agreeable to do, your perception of where the economy is headed, and the time limit you’ve set for your investment. Regardless of the individualism of investors, trading styles narrows down to a few distinct types which are considered below:
- Active Investors: Such investors are up to date on their stocks’ performance, they also tend to carry out a lot of research and keep up with the daily financial news. They pay close attention to changes in trends, no matter how minute and they carry out stock exchange (buy or sell) based on those trends. They do not necessarily buy one day and sell the next day, but they are neither long-term investors. This individual is a keen investor who is careful in making decisions that pertain to investments. They also become brokers in the long term and help others buy and monitor their stocks.
- Passive Investors: This type of investor is characterized by the following.
- Does not try to go for the biggest possible gains every time.
- Prefers reasonable gains with a lower level of stress and a lower level of commitment.
- Most times invest in mutual funds that can be managed by money managers with full rights to make buy-and-sell decisions.
- Tend to hold investments for more than a year.
- Tends to set structures for the addition of more stocks to their portfolio.
- Speculators: This type of investor is on the look-out for opportunities to make some quick cash-out. They achieve this by scouring the market for stocks that are on the edge of going up due to an imminent deal. They look for and pay rapt attention to any information on mergers that could positively affect a company and quickly buy up stocks of such companies. They also do not hold on to stocks for a long time but tend to sell them after making a little profit, reasoning that they can always repeat the process of buying and selling avidly, thereby outperforming the market.
- Retirement Investors: An investor with the aim of retirement will most likely not approach investing aggressively and will not be income-oriented. Rather, they tend to involve in investments with moderate risks during midlife and then switch to dividend stocks that produce income during retirement.
Core Advantages of Investing in Stocks
- Investment Profit: One of the main advantages of investing in the stock market is the opportunity to grow one’s money. The stock market has a reputation for a rise in value even though the prices of individual stocks rise and fall daily. Therefore, investing in diverse stocks will help one to build wealth by leveraging on the growth in different sectors of the industry, likewise, investments in growing, stable and well-established companies bring profits to the doorstep of investors.
- Easy Purchase: Through the existence of the stock market, the purchase of stocks has been made easy. It can be purchased through a broker, financial planner, or by individual investors online (some online brokers offer free commission for their stock exchange). It is easily accessible too; once you set up a brokerage account, you can purchase stocks in minutes.
- Dividend Income: Some stocks provide income in the form of a dividend, but this does not apply to all stocks. Those that provide dividends give yearly payments to investors and this is regardless of if the stock has lost its value or not, when the stock is eventually sold, the dividend represents the income on the profits gotten. This benefits retirement investors the most as it can help to fund a retirement plan, also, the more you grow your investment portfolio, the more you earn.
- Ownership: When you buy stocks of a company, you automatically have a stake in the company. Investing in the stock market gives you the advantages accrued to a business owner. Your ownership gives you the right to vote in certain business decisions. You also get to receive a yearly report, thereby staying updated on the activities of the company.
- Diversification: A stock market provides the benefit of diversification for investors interested in various fields of investment products such as bonds, real estate, etc. Stock market investments change value separately from other forms of investments. Stocks also add risk to a portfolio and the probability for huge, fast profits thereby aiding investors in evading risk-averse or overly conservative investment approaches.
Some Disadvantages of Investing in Stocks
- High-risk Investment: There is no form of investment that does not come with its fair share of risks but more of these risks are linked to common stocks; their prices are volatile, fluctuating irregularly. It is also difficult sometimes to evaluate the performance of the company invested in even if they are doing well due to the sudden altering of values of stocks that occurs from time to time. Worse, if the business goes bankrupt, you can forget your investment. This is so because if such a company does poorly, investors will sell which will result in the plummet of stock prices. Also, as an investor, when you sell, you will lose your initial investment.
- Emotional Roller-coaster: Stock prices tend to rise and fall second-by-second. Investors most likely buy high, out of greed and sell low, out of fear. The best thing to do is to avoid obsessively paying of attention to the price fluctuations of stocks and just check in from time to time.
- Time Factor: If you are running solo as an investor, then you must be prepared for huge infringement on your time. Why? Because of the enormous research that goes into investment; research on each company and its potential level of profitability, reading, and accurate interpretation of financial statements and annual reports, you must also be ready to follow daily news about the company you invested in. Also, you will have to put optimum supervision on the stock market as a market crash or correction affects even the most successful companies.
- Little/No Control: Purchasing stocks from a company can be very tricky as your success in investing largely depends on the outstanding performances and policies of said company or its lack. Since there is a severe limit to what information you are privy to, you would have to look to other sources in terms of research. Also, you are subject – as a shareholder – to the stakeholder’s decision. Your success or failure depends on the decisions and actions of the stakeholders. Therefore, it is important to perform due diligence before any investment is made. The only way to have some sort of control is to purchase a significant number of shares to gain a majority in the investment. For example, if a company puts out 100 units of stocks and you buy 20 which translates to the fact that you have 20% share in the company. The limit, however, to this is that not everyone will be able to afford this, moreover, most companies keep a tight rein on the stocks put out to the general public in order to keep the strong control of existing shareholders.
Want to Invest in Stocks? Step by Step Guide to Getting Started
For a newbie, the stock market and its process can be intimidating. Stocks are quite different from certificates of deposits, savings accounts, or money market funds because of their principal value rise and fall.
Therefore, to carve a niche in the investment world, one must be adequately armed with the necessary information and extensive research must be carried out. Also, such a person must have a tight rein on their emotions. That is why it is vital to learn the basics of investing in stocks.
- Assess Your Present Situation: The first thing to do before investing at all is to ensure that your general financial standing can accommodate a new activity without necessarily hurting other financial commitments. Ensure that your finances are duly organized and there is room for investment. To this regards, you’ll need to put the following factors into due consideration; employment (ensure that your source of income is secure enough to allow an investment), debt (don’t invest to clear outstanding debts, you might have more piled up on the present ones), family situation (ensure that your family is well catered for and there’s no extra mouth to feed on the way before you invest).
- Goal Setting: It is advisable to set goals for this investment before making it as it will guide you on the type of investor to be and possible expectations. The three questions that will guide you in achieving these are;
- Are these investments for a retirement plan?
- Are these investments short-termed (5-6 years away)?
- Will you have exclusivity of access to the money?
These questions will guide you in the decision-making process; they are personal questions every investor should consider.
- Money Reserve: Before investing your money, which comes with risk, ensure you have some put away that will not be subject to any risk whatsoever, either in the money market, savings account, or certificates of deposits. The purpose of this action is so that you can have an emergency fund that can cater to your financial needs in the advent of a momentary income disruption or if your investment takes a nosedive.
- Open an Investment Account: Overall, you need to have an investment account to invest stocks. If you want to do it yourself, you will need to open a brokerage account but for those who are looking into getting help, you’ll open an account through a stockbroking firm. In both cases, you get to open an account with a low amount of money, some providers even offer zero account opening.
- Open a Retirement Account: The best place to begin investing is in a retirement account because they stand for and ensure long-term investment, besides, they are tax-immune and are typically funded through salary deductions. This retirement account can be a 401(k) plan through your employer or an Individual Retirement Account (IRA) if there is no employer plan if you are self-employed.
- Start with Mutual Funds or Exchange-Traded Funds (ETFs): For starters, it is better to begin with mutual funds or ETFs rather than diving straight into stocks. The reason is that funds are professionally managed and will take away the responsibility of stock selection from you. All you are required to do is open an account with one of the various available ETF trading apps (usually commission-free). Then, go ahead to determine how much money you want to invest in a certain fund or group of funds. Another advantage of mutual funds is that you do not have to worry about diversification since each fund holds diverse stocks.
- Be Long-term Focused: The best thing to do – which is also the hardest – after investing is to conveniently forget it, do not look at them. Unless you are looking into becoming a guru in daily trades and subsequently becoming a broker yourself, it is best to avoid checking on the performance of your stocks obsessively.
- Manage your Stock Portfolio: While it is not advisable to fret over the state of your stocks, fluctuations, and whatnot, there is still a need to check in on your stocks from time to time. This is to ensure that funds and/or stocks are still in tandem with your investment goals.
Remember, investing in stocks is a great way to build wealth, either for the present time or for your future but the investment is also always a risk, so it is important to try to invest wisely.