To get started with stock investment, first understand what stocks are?

What are stocks?

Stocks, also known as shares or equity, are a type of security that is proof of ownership of a company’s shares, which entitles the holder to participate in the distribution of the company’s assets and profits. Today, millions of Americans either own stocks in publicly traded companies or own mutual funds that invest in stocks.

The value of a stock depends on the willingness of its owners and other investors to buy or sell it. For example, if a company performs well or investors are confident about its future prospects, its stock price is likely to rise. The price and value of a stock are not necessarily consistent. Some stocks are undervalued because their prices are lower than analysts think they should be, while other stocks may be overvalued.

Advantages of investing in stocks

Investors can not only obtain capital gains when the price of the stocks they purchase increases, but also participate in the distribution of dividends when the company makes a profit.

Stocks vary widely in performance, but over the long term, their value grows with the economy. The S&P 500 (an index of the performance of the top 500 companies) showed that stocks rose in 16 of the 20 years ending in 1994. Stocks rose 35% in 1995, compared with a 30% drop the year before. In addition, investors receive an average of 4% of their stock’s value in dividends each year, depending on the market value. Over the past 20 years, the annual return on stock investments, including stock price increases and dividends, has been about 15%. In contrast, the consumer price index has risen 5% over the same period.

Risks of investing in stocks

The value of investment products is determined by their riskiness. For example, because savings accounts are protected, banks offer relatively low interest rates on savings accounts. Stocks are high-risk investments, and their potential return on investment is relatively high. Poor management, poor operating performance, or simply unpopularity with investors can cause a company’s share price to fall and lose market value. Some stocks are riskier than others. Before you buy a stock, check its fundamental value (a way to assess risk).

Buying Stocks

Investors usually buy stocks in the traditional way or through online brokers. These online brokers are also called brokers, which are registered stock investment companies with the U.S. Securities and Exchange Commission (SEC). Investors can also buy stocks directly from companies that issue stocks through dividend reinvestment plans (DRIPs).