A stock is a share of a company’s assets and earnings. People who own shares are often referred to as shareholders. Stocks are one of many ways to invest to create passive income and returns on principal.
How do Stocks Work?
Since shareholders partially own companies they invest in, they are entitled to a portion of the business’ earnings and assets. When a company performs well and their earnings increase, so does the value of the stock in most cases. Investors can buy individual stocks, or buy stocks through mutual funds and/or ETFs.
Types Of Stocks
The two primary types of stocks are common stock and preferred stock.
- Common: These types of stocks are the most common and they allow investors to partially own a company. Common stock shareholders also have voting rights and are sometimes paid dividends. However, when a company has to liquidate assets, common shareholders are usually one of the last groups to get paid.
- Preferred: Similar to common stock, preferred stock allows investors to have a stake in a company. The main difference is they have priority on the distribution of assets and earnings. This is especially true when a company has to liquidate its assets. That said, preferred stock shareholders often don’t have voting rights.
Common and preferred stocks can be further categorized based on their characteristics.
- Cyclical & Non-cyclical: When a stock’s share price is vulnerable to the peaks and troughs of economic cycles it is known as a cyclical stock. Non-cyclical stocks are the opposite and are from companies that provide essentials consumers will need irrespective of the state of the economy. For this reason, they tend to perform well during slower economic times.
- Dividend: Some stocks pay a portion of their income to shareholders and these are known as dividend stocks. Companies may pay their shareholders dividends, monthly, semi-annually, annually, or quarterly.
- Defensive: Some stocks perform relatively well irrespective of market conditions. Known as defensive stock, this category of stocks are usually from established companies that have performed well consistently and withstood market downturns over an extended period of time.
- Domestic and International: Investors can choose to buy stock within the U.S. or dabble in international stock. Domestic stocks are from companies headquartered in the U.S, while international stocks are from companies outside of the country. Both can be beneficial and in a balanced portfolio, one may find a mix of domestic and international stock.
- Penny: For investors interested in taking more risk, penny stocks can be attractive. They are inexpensive stocks held in companies that are considered low-quality or high-risk. The appeal is investors can sometimes yield higher than usual returns but they’re also susceptible to fraud and loss.
How to Buy Stock
The first step to buying stock and becoming a shareholder in a company is to have a brokerage account. This is because stocks are bought and sold electronically via stock exchanges. There are some companies that sell stock directly to investors, however.
The next step after setting up a brokerage account is to decide on what types of stock to invest in. An investor can choose to handpick their stocks, which requires extensive research. On the other hand, they may decide to use a robo-advisor, which automates the reprocess and chooses the stock for an investor based on their investing goals.
For those who decide to do the former, they’ll need to find the ticker symbol for the stock they’re interested in buying. Ticker symbols are a series of letters that represent the stock on the stock exchanges, be it Nasadq or the New York Stock Exchange.
The final step is purchasing the number of desired shares. When buying and selling stock it’s also important to do tax planning because when the value of stock rises and investors sell to make a profit, it can trigger a tax bill. This is especially true when not investing in a tax-advantaged account like an IRA or 401(k).
An investor may decide to build out a portfolio with a mix of stocks that span across different sectors and countries. The ultimate goal should be to build a balanced and diversified portfolio to ensure when some stocks aren’t performing well, there are ones in your portfolio that are.
If getting started with stocks feels daunting and confusing, consider reaching out to a finance professional to guide you through the process.
