If I had to choose one "fear factor" investment vehicle in the world of big risks and big rewards, my personal choice would be stocks.
Stocks—to me, at least—have always felt like such an "all or nothing" proposition.
It doesn't help that I often hear buying and selling stocks referred to as "playing the market,” which makes it sound more like a round of roulette than a sound investment strategy.
In light of this, learn why investment experts continue to assert that including stocks in your overall investment portfolio is, in fact, a wise choice!
Stocks: Defined and their classes
At its core, a "stock" is simply a share of ownership in the issuing entity (a company or corporation).
There are two main types of stock:
- Preferred: Preferred stockholders cannot vote at company meetings, but their shares earn higher dividends. And if the company goes belly-up—they’ll get paid before common stockholders.
- Common: Common stockholders have voting rights (which can influence how well stocks perform), but in exchange they receive lower dividends than preferred stockholders. And they receive their dividends after preferred stockholders get theirs (whether the company is in the black or in the red).
Classes of stock: From here, companies can designate different classes of stock (typically denoted by using letters—"A," "B," etc.). There is no standard for how a company can designate its own stock, so it’s important to read the fine print to discover what different classes of stock offer you in terms of voting rights, dividends and other stockholder perks!
Stockholders are partial owners
If you think of a "stock" as a "stake in the company," it soon becomes clear what you’re really doing when you’re buying stock—you’re buying a part of the company issuing the stock!
The more shares you own, the more of the company you own—so the bigger your stake in that company's future and success.
Example: A company issues 100 shares of stock. You buy 10 of those shares. You now own 10% of that company—win, lose or draw.
A word about risk
Once you understand that, as a stockholder, you become a part-owner of that company, it also instantly makes more sense why stocks are considered riskier investments than most other types of investment options.
- Unlike with a treasury bond, you have no insurance if the company goes under while you’re still holding shares.
- Unlike with a mutual fund, there is no diversification to limit the risk.
In essence, you are going “all in” based on your belief that the company will perform well during the time you hold your shares.
How to purchase shares of stock
The most common way to purchase stock is through a broker. There are two main types of brokers: full service and discount.
- Full service brokers are more expensive (in terms of fees), but you can get expert financial advice before you buy.
- Discount brokers are most commonly found online, and you can purchase the stocks of your choice for a very low fee (but without the expert advice that a full service broker will offer you).
Note: If you work for an employer who offers retirement benefits, you can often purchase stocks through your employer through a DRIP (dividend reinvestment plan) or a DIP (direct investment plan). Here, you pay a very minimal fee for both expert financial advice and the help of a broker to purchase your shares.
Choosing stocks to invest in
Experts offer the following tips for selecting the stocks you want to invest in.
- Choose a company you care about: If you’re passionate about a specific issue or cause, or you use a specific product a lot, consider investing into that company through buying stock.
- Research the "Price to Earnings Ratio" (P/E): To get the P/E, divide the company's share price by net income (you can often find the P/E on stock research sites as well). The P/E will tell you a lot about the stock—for instance, how fast the company is growing, how accurate the current stock price is given expected growth, and how that company's stock compares to competitors in the same market.
- Look for signs of financial stability and good health: If the company's income ("revenue") is growing consistently and expenses are stable or decreasing, this is a sign of a company with a business model that is working well (denoted by its "profit margin"—the difference between revenue and expenses).
- Check out dividend payments: Companies that pay regular dividends to stockholders, and especially companies that have been paying increasing dividends, are also good choices.
- Look for consistency over time: The stock market is volatile—always has been, always will be. So temporary dips and surges are not the best places from which to make a decision about which stock to buy (or not to buy). Rather, look for consistent, positive stability and growth over time to choose the best stocks for your portfolio.
4 Great stock research resources
These four great FREE resources can help you do the research you need to do to select the best stocks for your portfolio—even if this is the first time you have ever selected a stock!
- NASDAQ 12 Steps to Analyzing a Stock: http://www.nasdaq.com/investing/dozen/
- The Street: http://www.thestreet.com
- Investor Guide Stock Helper Tool: http://www.investorguide.com/stock-help/intro
- Investopedia (great for beginners!): http://www.investopedia.com