Stocks, in simple terms, represent a share of ownership in a corporation. Similar to bonds, stocks are securities. However, while bonds only allow investors to participate with the company as a lender who may or may not receive a return if the company closes, an investor has the right to receive dividends, and can get a share of the business if it is sold.
Individuals or companies that legally own one or more of a company's stocks are known as stockholders (or shareholders). You can find shareholders in both private and public trade companies. Companies and stockholders work in conjunction to raise money for the company. As a token of appreciation for the stockholder's investment, the company is expected to enhance shareholder value.
The History of Stocks
Stocks could be found back in the Roman Empire where it contracted services to private groups and received shares in those groups in return. The next record of stocks came from the Dutch East India Company in 1606 where joint ownership was able to help Europe's economic growth. However, modern-day stocks didn't make their way into the U.S. market until May 17, 1792 when brokers signed the Buttonwood Agreement outside 68 Wall Street in New York City. Then on March 8, 1817, the properties were renamed to New York Stock & Exchange Board.
Stock exchanges are corporations or mutual organizations that provide trading facilities for brokers and traders to trade stocks and other securities. They also offer facilities for issuing and redeeming securities (and other financial instruments), including shares, unit trusts, pooled investment products, and bonds.
There are major stock exchanges found all over the world; however, the major exchanges in the United States are NASDAQ, NYSE, and NYSE Amex Equities. NASDAQ, also known as National Association of Securities Dealers Automated Quotations, was the world's first electronic stock market, and currently trades for 3,800 companies and corporations, giving it more trading volume than any other exchange in the world.
The New York Stock Exchange (NYSE) is the largest stock exchange in the world, according to its U.S. dollar value. Known for its continuous auction floor, traders execute stock transactions on behalf of their investors for all companies registered to publicly trade. NYSE Amex Equities is formerly known as AMEX and was acquired by NYSE Euronext in 2008. It specializes in the trading of ETFs and hybrid/structured securities. Of the three major U.S. exchanges, it is known for having the most liberal policies, generally allowing smaller companies to trade, as compared to NYSE and NASDAQ.
Types of Stocks
There are numerous types of stocks available to suit various investor styles and needs. In general, stocks fall into two major categories: common and preferred.
Common stocks represent the basic equity ownership of a company entitling stockholders to vote for directors and other important company matters. Stockholders also get to participate in the appreciation of share values, as well as dividends declared from corporate earnings leftover after debt obligations and preferred stock dividends are taken care of.
Preferred stocks are slightly different from common stocks in that they carry characteristics of both bonds and common stocks. The reason they can be characterized similarly to bonds is because they can be purchased at a fixed percentage so that they guarantee a more stable return. However, because these stocks aren't debts, there are still risks involved, including the lack of a contract as you would receive with a bond. Also, if corporate earnings are low or the company goes bankrupt, you will not receive any portion of the liquidated assets until bondholders are paid.
Some preferred stocks include:
- Blue Chip Stocks. These are the stocks of well-established companies with stable earnings and no extensive liabilities. The name blue chip comes from the blue-colored chip in poker, which is usually most valuable.
- Income Stocks. These stocks offer higher dividends in relation to their market price. These stocks are good for investors who would like for their investment to grow over the years to help offset inflation.
- Penny Stocks. These are low-priced stocks that are traded over-the-counter (OTC). They are considered risky securities because they can be traded outside of major exchanges.
- Value Stocks. Investors typically view these securities as undervalued, which entices them to purchase because they feel the company will grow in the long-term, promising eventual high returns.
- Growth Stocks. These stocks appreciate in value and offer a high return because the associated businesses grow and increase the stock's value.
Advantages and Disadvantages of Buying Stocks
There are both advantages and disadvantages inherent in participating in the stock market. Some advantages include:
- Long-Term Performance. Because stocks fluctuate so much over the years, they typically out-perform all other investment options over a 10-year period.
- High-Quality Stocks Can Split. If you buy a high-quality stock, it can split into two shares. If this happens, your new lower-priced shares can grow even faster, giving you higher long-term returns.
- Stocks Outpace Inflation. Unlike bonds, stocks on the whole outpace inflation, meaning if you wait out selling your shares, you should find returns greater than any new inflation rate.
- They Make Great Retirement Plans. Again, when you invest in stocks, you have to think in the long-term. If you make investments in sound companies early on, decades later when you retire, you may just have some very impressive returns waiting for you.
- Bank Collateral. You can use your stock certificate as collateral at your bank.
- You Are Part-Owner of a Company! As a shareholder, you not only can expect returns, but also have a say in the direction of the company for which you are now part owner.
Of course, because of their risky nature, stocks also have disadvantages:
- They Have a Volatile Nature. As mentioned throughout this article, stocks have a volatile nature. Share prices are never very stable, so you don't have the guarantee of security that you have with some other forms of investment.
- Risky in the Short Term. Many investors hope to jump in the market, invest, get high returns, and sell. But it doesn't always work like this. Shares can fall and stay low for months at a time, so if you need your money back in six months, you may have to wait longer than you'd hoped to get it back with a profit.
- Retirement Can Be Tricky. While stocks can help you save for retirement, you don't want to run the risk of a crash making you lose your money so close to the end. So as you approach retirement, it's good to start moving your money to other sectors that aren't as volatile.
- Companies Go Out of Business. Sometimes the company you put your money in goes out of business. If this happens, your stock will be worthless.
- Brokerage Commissions. When you buy and sell, you have to pay brokerage commissions, which is why many experts suggest that you simply buy and hold.
- Lower Liquidity. Receiving your returns on stocks can depend on the brokerage, but sometimes forces you to wait longer than you'd expect.
Stock Market Risks
Stocks have been very popular trading options over the years despite the volatile trading environment. However, in 2008, the market dropped drastically, resulting in some companies going bankrupt and many investors losing their money. After this crash, many investors second-guessed the reliability of stocks, and instead turned to very safe investing options.
As mentioned in the disadvantages, there is always a risk involved in playing the stock market. As seen in the crash of 2008, some risks have nothing to do with you; they are essentially due to the economy. However, some risks have to do with the choices you or your broker makes regarding how risk-adverse or risk-seeking you or your broker may be. This is how we find ourselves in "bear" and "bull" markets where everyone is following the trends of others instead of watching company activity.
Are Stocks Good for Families?
Most experts would agree that stocks are probably not the best investment tools for those trying to create a stable income for the family. Because the market can be so volatile and unpredictable, you don't want to take your child's college savings and invest it in stocks in hopes of doubling your money. You could easily lose it all and have to start from scratch. This is why when it comes to families, safer routes like high-yield savings accounts, CDs, and bonds are recommended.
Now that you know more about stocks, you may want to keep a few things in mind before investing. If you want to work with a brokerage, it's good to check for commission fees that are fair and affordable. Also, it's good to make sure that the companies you're investing in are sound and not highly likely to go bankrupt. Since the stock market is volatile by nature, it's up to you to make wise choices throughout the years to provide you with the best returns in the long-term.
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