Stocks are a type of security that gives stockholders a share of ownership in a company. Stocks also are called “equities.” Unlike bonds where you simply loan your money to a government or business and expect a repayment of your principal and interest, when you invest in a stock, you are becoming an owner of that company, with all the risks and potential rewards that come with it.
The risk is that there is no promise of any particular return on your money, or even if you’ll get your money back. If the company behind the stock goes out of business, you could lose your entire investment. On the other hand, if the company discovers a cure for cancer or creates a new product that everyone wants, you stand to do very well.
How do Stocks work?
When a company wants to expand, rather than borrow money by issuing bonds, it may sell shares of ownership in the form of stock. When a company first offers stock it is called an Initial Public Offering (IPO), and proceeds from the sale go to the company. After that, however, shares are bought and sold among individual investors on the various exchanges (NYSE, NASDAQ, etc.) in what is known as the secondary market. When you buy a stock on the secondary market the money you pay does not go to the company, but rather to the individual investor who already owns but has decided to sell their shares. Now, simple supply and demand take over. If there are more buyers than sellers, the price of the stock will go up. Conversely, if there are more sellers than buyers, the price will go down. The number of buyers versus sellers fluctuates based on investors’ opinions of the future prospects for that company.
How do you know which stocks to buy?
While there are no guarantees with any stock investment, the investor’s goals will largely dictate which types of stocks may be appropriate. Like people, companies go through life cycles. Younger, start-up companies may offer explosive growth potential that may be appropriate for some investors, but also carry higher risk. Older, more mature companies are often more stable and may even return some of the company’s profits back to shareholders in the form of dividends, which may be appropriate for investors seeking income
As an asset class, stocks have historically provided higher returns over longer time periods than cash equivalents or bonds, but due to their daily volatile nature, are best considered long-term investments.
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The information presented here is for educational purposes only and should not be considered financial, tax or investment advice. Please consult a qualified professional.
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