What is a Stock and Why Buy Stocks?
What is a stock?
Stock is an equity investment. What does that mean for you? Proud ownership of a company you believe is a good investment. So if you invest in a stock, you have an ownership stake in the corporation that issued it, or offered it for sale. The size of that stake depends on the number of shares you own compared to the total number available.
Why buy stock?
Ownership has its privileges
As a shareholder, you have some basic rights. You can vote for or against the candidates who've been nominated to the company's board of directors. They're the people who set company policy and choose the chief executive who runs the business. You can also vote for or against proposals the directors or other shareholders make to influence what happens at the company and how it is managed. You also have the right to sell your stock at any time - although you may choose to hold onto it for years.
But in reality, shareholder rights probably aren't the reason you buy stock. The reason is to make money by investing in companies you believe will make money. In the language of investing, you're seeking a positive return.
Here are some ideas to consider when thinking about a positive return:
- The company that issued the stock may pay a dividend, or portion of its earnings, to its shareowners on a regular basis. You can reinvest the dividends to build your portfolio (and actually, we'll do that automatically for you, for free) or you can use it as income.
- A stock's price may go up while you own it. If it does, you can sell some or all of your shares for a profit if you want to, or you can hold onto it, which increases the value of your portfolio. Investing in stock has risks, though. You may have a negative return rather than a positive one.
Here are some of the possible risks you face:
- Companies aren't required to pay a dividend even if they have a profit. And companies that normally pay a dividend may reduce it or eliminate it entirely if times are tough. It's their decision, even if investors don't like it.
- Sometimes stock prices go down instead of up, so you could lose money if you sold when your stock's price dropped. Why do prices go down? Sometimes the whole stock market loses steam. Sometimes a company hits a rough patch. Sometimes investors get nervous and sell.
- If a company goes out of business, as some do, you could lose everything you'd invested in its stock - if you hadn't sold your shares in time.
If you can lose money, why would you risk buying stock? The reason is that over time, stocks as a group - though not every stock on its own - have produced higher returns than other types of investments. One key idea here is "over time." Time tends to level out the ups and downs. If you get caught in a "down" at a time when you need your money, you could find yourself in a pretty bad spot. Of course, there are no guarantees that the particular stocks you pick will produce higher returns, or any return at all on your investment.
What is market price?
Most investments don't have a fixed price. Similar to the "market price" for the catch of the day at your favorite eatery, the price you pay to buy, or the price you receive when you sell, is determined by how interested other investors are in owning that security. That's the rule of supply and demand. If there's a lot of buying and a fixed number of shares, a stock price will move higher. And, if there's a lot of selling, the price will drop.
Sometimes prices change by just a few cents during a trading day, sometimes by a few dollars, and sometimes by more. The pace of change is called volatility. The more volatile a security's price, the more potential there is for a positive return, but the risk of loss is larger too. In fact, that's a key principal of investing. Risk and return often go hand-in-hand.