Why Investing in Stocks is Good

Stocks offer investors the greatest potential for growth and positive returns over long periods of time. But stock prices move down as well as up. There’s no guarantee that the company whose stock you hold will grow and do well, so you can lose money you invest in stocks.

Even when companies aren’t in danger of failing, their stock price may fluctuate up or down. If you have to sell shares on a day when the stock price is below the price you paid for the shares, you will lose money on the sale.

Market fluctuations can be unnerving to some investors. A stock’s price can be affected by factors inside the company, such as a faulty product, or by events the company has no control over, such as political or market events.

Stocks can be a valuable part of your investment portfolio. Owning stocks in different companies can help you build your savings, protect your money from inflation and taxes, and maximize income from your investments. It's important to know that there are risks when investing in the stock market. 

Historically, the stock market has delivered generous returns to investors over time, but it also goes down, presenting investors with the possibility of both profits and loss, for risk and return.

Investing in the stock market can offer several benefits, including the potential to earn dividends or an average annualized return of 10%.

The stock market can be volatile, so returns are never guaranteed. You can decrease your investment risk by diversifying your portfolio based on your financial goals.

Investing in stocks means you're buying equity in a company. In other words, you're part owner, even if you only own a tiny fraction of the company. 

You can invest in stocks by purchasing whole or fractional shares in companies. You can also buy mutual funds or exchange-traded funds that invest in stocks.

How much can you make investing in stocks? No one can predict which way a stock will go, so there's a chance that you make money and a chance that you lose all of it. The more money you invest, the higher your potential gains or losses. 

common stock vs. preferred stocks

Blue-chip stocks

Blue-chip stocks are shares in large, well-known companies with a solid history of growth. They generally pay dividends.

Stocks can also be categorized by the size of the company, as shown in its market capitalization. There are large-cap, mid-cap, and small-cap stocks

Shares in very small companies are sometimes called “microcap” stocks. The very lowest priced stocks are known as “penny stocks.” 

These companies may have little or no earnings at all. Penny stocks do not usually pay dividends and are highly speculative.

Types of stocks 

There are two main types of stocks, common shares and preferred shares. Common shares entitles owners to vote at shareholder meetings and receive dividends. 

Preferred stockholders usually don’t have voting rights but they receive dividend payments before common stockholders do, and have priority over common stockholders if the company goes bankrupt and its assets are liquidated.

These stocks may fall into one or more of the following categories:

Growth stocks

Growth stocks rarely pay dividends and investors buy them in the hope of capital appreciation. A start-up technology company is likely to be a growth stock.

Income stocks

Income stocks pay dividends consistently and investors buy them for the income they generate. An established utility company is likely to be an income stock.

Value stocks

Value stocks have a low price-to-earnings (PE) ratio, and are cheaper to buy than stocks with a higher PE. Value stocks may be growth or income stocks, and their low PE ratio may be due to the fact that they have fallen out of favor with investors for some reason. 

Investors buy value stocks in the hope that the market has overreacted and that the stock’s price will rebound.

Benefits of Common Shares 

Common shares can offer investors the following benefits:

Capital growth. When the price of a stock goes up, shareholders can choose to sell their shares at a profit.

Dividend income. Many companies pay dividends to their shareholders, which can be a tax-efficient passive income for investors.

Voting privileges. Shareholders have some measure of control over who runs the company and how by having a vote.

Liquidity. Common shares can be bought and sold more quickly and easily than other investments, like real estate. Investors can buy or sell their investment for cash with relative ease.

common stock formula

Advantageous tax treatment. Dividend income and capital gains are taxed at a much lower rate than employment income and interest income from bonds.

preferred stock definition

Variety. Some preferred shares allow for unpaid dividends to accumulate, while others can be converted into common shares.

Benefits of Preferred Shares 

Preferred shares can offer investors the following benefits:

Reliable income stream. Preferred shares come with a fixed dividend that must be paid before any dividends are paid to common shareholders.

Higher income. Preferred shares tend to pay much higher dividends than common shares. The dividends also come with the same advantageous tax treatment as dividends on common shares.

Benefits of Dividends 

Dividends are a way for companies to distribute a portion of their profits to shareholders. They are often paid in cash on a quarterly basis. 

Not all companies pay dividends and some companies that are still growing may choose to reinvest profits back into the business to help grow it.

Dividends can offer investors advantages in areas such as:

Returns. Receiving dividend payments on your shares can increase the total return on your investment.

Volatility. Dividends can help lower volatility by supporting the stock price.

Income. Dividends can provide investors with investment income.

what are dividends?

Stability. Companies that manage their cash flow effectively tend to maintain consistent or growing dividend payments. 

Business stability and earnings growth leads to a much higher share price in the long-term.

Taxation. Dividends are taxed at a lower rate than interest income from bonds.

stock market investment tips

Why companies issue stock 

Companies issue stocks to get money for:

Why investors buy stocks 

Investors buy stocks for various reasons:

tips for beginner stock investors
basic rules of the stock market

Decide how you want to invest in the stock market

Choose the option that best represents how you want to invest, and how hands-on you'd like to be in picking and choosing the stocks you invest in. 

Most 401(k)s offer a limited selection of stock mutual funds, but not access to individual stocks.

Set a budget for your stock market investment

The amount of money you need to buy an individual stock depends on how expensive the shares are. Share prices can range from just a few dollars to a few thousand dollars.

If you want mutual funds and have a small budget, an exchange-traded fund (ETF) may be your best option. 

Mutual funds often have minimums of $1,000 or more, but ETFs trade like a stock, which means you can purchase them for a share price.

Focus on investing for the long-term

The best thing to do after you start investing in stocks or mutual funds is to NOT look at them. 

Unless you’re trying to beat the odds and succeed at day trading, it’s good to avoid the habit of compulsively checking how your stocks are performing several times a day, every single day.

Manage your stock portfolio

There will of course be times when you’ll need to check in on your stocks. 

You’ll want to revisit your portfolio a few times a year to make sure it’s still in line with your investment goals.

If you’re approaching retirement, you may want to move some of your stock investments over to more conservative fixed-income investments. 

If your portfolio is too heavily weighted in one sector or industry, consider buying stocks or funds in a different sector to build more diversification.

Pay attention to geographic diversification, too. International stocks should make up as much as 40% of the stocks in your portfolio. You can buy international stock mutual funds to get this exposure.

How to invest in stocks 

Investing in stocks means buying shares of ownership in a public company. That means you could earn a profit if you decide to sell them. Investing in the stock market is a long game. 

A good rule of thumb is to have a diversified investment portfolio and stay invested, even when the market has ups and downs.

With many brokerage accounts, you can start investing for the price of a single share. Some brokers also offer paper trading, which lets you learn how to buy and sell with stock market simulators before you invest any real money.

Choose an investing account

This usually means a brokerage account. For those who would like a little help, opening an account through a robo-advisor is a sensible option. 

Both brokers and robo-advisors allow you to open an account with very little money.

An online brokerage account offers the quickest and least expensive path to buying stocks, funds and a variety of other investments. 

With a broker, you can open an individual retirement account, also known as an IRA, or you can open a taxable brokerage account if you’re already saving enough for retirement in an employer 401(k) or other plans.

A robo-advisor service provides complete investment management: These companies will ask you about your investing goals during the onboarding process and then build you a portfolio.

Most robo-advisors charge about 0.25% of your account balance. And you can also get an IRA at a robo-advisor if you so wish. Although robo-advisors are relatively inexpensive, read the fine print and choose your provider carefully. 

Some providers require a certain percentage of an account to be held in cash. The required cash allocation positions are sometimes more than 10%. 

The providers often pay very low interest on the cash position, and may create an allocation that is not ideal for the investor. 

Learn the difference between investing in stocks and funds

For most investors, stock market investing means choosing among these two investment types:

Stock mutual funds or exchange-traded funds. Mutual funds let you purchase small pieces of many different shares in a single transaction. 

Index funds and ETFs are a kind of mutual fund that tracks an index; for example, the S&P 500 fund replicates that index by buying the stock of the companies in it.

When you invest in a fund, you also own small pieces of each of those companies. You can put several funds together to build a diversified portfolio. 

Stock mutual funds are also sometimes called equity mutual funds. The upside of stock mutual funds is that they are inherently diversified, which lessens your risk. 

For those who are investing their retirement savings, a portfolio made up of mostly mutual funds is the best choice.

Individual stocks. You can buy a single share or a few shares as a way to start trading stocks. Building a diversified portfolio out of many individual stocks is possible, but it takes more investment and research. Remember that individual stocks will have ups and downs. 

The upside of individual stocks is that a good pick can pay off handsomely, but the odds that any individual stock will make you rich are exceedingly small.

Best stocks for beginners 

The process of picking stocks can be overwhelming for beginners. There are thousands of stocks listed on the major U.S. exchanges.

A low-cost S&P 500 index fund is the best investment most Americans can make. The S&P 500 is an index consisting of about 500 of the largest publicly traded companies in the U.S. 

Its average annual return over the last 50 years has been more or less the same as that of the market as a whole at about 10%. 

types of stocks

Choose individual stocks only if you believe in the company’s potential for long-term growth.

investing terms you should know

Make money in two ways. Most investors intend to buy low then sell high. They invest in fast-growing companies that appreciate in value. That's attractive to both day traders and buy-and-hold investors. 

Other investors prefer a regular stream of cash. They purchase stocks of companies that pay dividends. Those companies grow at a moderate rate.

Liquidity. The stock market allows you to sell your stock at any time. The term "liquid" means that you can turn your shares into cash quickly and with low transaction costs. 

This is important if you need your money urgently. Since stock prices are volatile, you run the risk of being forced to take a loss.

Benefits of Investing In Stocks 

Build. Long-term equity returns have been better than returns from cash or fixed-income investments such as bonds. 

Investors may want to consider a long-term perspective for their stock portfolio because stock-market fluctuations tend to smooth out over longer periods of time.

Protect from Taxes and Inflation. Taxes and inflation can impact your wealth. Stock investments can give investors better tax treatment over the long term, which can help slow negative effects of taxes and inflation.

Historically, over the long term stocks have yielded a generous annualized return and is the best way to stay ahead of inflation

Maximize returns. Some companies pay shareholders dividends which can provide you with regular investment income and enhance your returns. As the economy grows, so do corporate earnings.

Easy to buy. You can purchase them through a broker or a financial planner, or online. Once you've set up an account, you can buy stocks in minutes.

Don't need a lot of money to start stock investing. Most retail brokers such as Charles Schwab, let you buy and sell stocks commission-free. 

Some brokers such as Fidelity also don't require account minimums. If the stock you want to buy is too expensive, you can also buy fractional shares if your broker allows for such investment.

Disadvantages of Investing in Stocks 

Risk: You could lose your entire investment. If a company does poorly, investors sell, sending the stock price plummeting. 

When you sell, you will lose your initial investment. If you can't afford to lose your initial investment, buy bonds.

Common stockholders paid last: Preferred stockholders and bondholders or creditors get paid first if a company goes bankrupt. A well-diversified portfolio should keep you safe if any company goes under.

Time: If you are buying stocks on your own, you must research each company to determine how profitable you think it will be before you buy the stock. 

Even the best company's price will fall in a market correction, a market crash, or bear market.

Taxes: If you sell your stock for a loss, you may be able to get a tax break. However, if you sell your stock for a profit, you'd be liable to pay capital gains taxes.

disadvantages of blue-chip stocks

Emotional roller coaster: Stock prices rise and fall. Some investors buy high out of greed, and sell low out of fear. 

The best thing to do is not constantly look at the price fluctuations of stocks, and just check in on a regular basis.

Professional competition: Institutional investors and professional traders have more time and knowledge to invest. 

They also have sophisticated trading tools, financial models, and computer systems at their disposal.

investment diversification

By location: Own companies located in the United States, Europe, Japan, and emerging markets. Diversification allows you to take advantage of growth without being vulnerable to any single geography.

Mutual funds and ETFs: Mutual funds or exchange-traded funds (ETFs) allows you to own hundreds of stocks selected by the fund manager. One easy way to diversify is through the use of index funds or index ETFs.

Ways you can diversify your stock investments 

By investment type: A well-diversified portfolio will provide most of the benefits and fewer disadvantages than stock ownership. 

Have a mix of stocks, bonds, and commodities. Over time, it's the best way to gain the highest return at the lowest risk.

By company size: There are large-cap, mid-cap, and small-cap companies. The term "cap" stands for "capitalization." 

It is the total stock price times the number of shares. It's good to own different-sized companies because they perform differently in each phase of the business cycle.

Large cap companies are considered more stable and less susceptible to share price volatility. Small cap companies might be riskier and prone to share price volatility but offer greater growth potential.

When to Buy and Sell a Stock 

When are you supposed to actually go in and buy shares so that you have a good chance of making money from those stocks?

When a stock goes on sale

Investors don't get as excited when stocks go on sale. In the stock market, a herd mentality takes over, and investors tend to avoid stocks when prices are low.

If stock prices are oversold, investors can decide whether they are "on sale" and likely to rise in the future. Establishing a range at which you would buy a stock is more reasonable.

Analyst reports and consensus price targets are a good starting point, which are averages of all analyst opinions. Without a price target range, investors would have trouble determining when to buy a stock.

When it is Undervalued

One of the best ways to determine the level of over or undervaluation is by estimating a company's future prospects for growth and profits.

A key valuation technique is a discounted cash flow (DCF) analysis, which takes a company's future projected cash flows and then discounts them back to the present using a reasonable risk factor. The sum of these discounted future cash flows is the theoretical price target. 

If the current stock price is below this value, then it is likely to be a good buy. Other valuation techniques include looking at a company's dividend growth and comparing a stock's price-to-earnings (P/E) multiple to that of competitors. 

Other metrics, including price to sales and price to cash flow, can also help an investor determine whether a stock looks cheap compared to its key rivals.

buy bull market sell bear market

When you have done your research

Relying on analysts' price targets or the advice of financial newsletters is a good starting point, but great investors do their own homework and due diligence on researching a stock.

The research can include reading a company's annual report, its most recent news releases and going online to check out some of its recent presentations to investors or at industry trade shows. 

When to patiently hold the stock

After you've done your research, properly identified a stock's price target, and estimated if it is undervalued, don't plan on seeing the stock price rise in value straight away after buying it. 

Be patient. It can take time for a stock to trade up to its true value. It can take years for a stock to appreciate close to a price target range. 

It would be even better to consider holding a stock for three to five years especially if you are confident in its ability to grow.

Warren Buffet long-term investing quote

By holding on to investments during rough market periods, you give the stocks the opportunity to recover to previous price levels and grow even more in value.

How does being a long-term investor build returns? 

A key to building high stock market returns is to let your portfolio weather periods of price drops due to economic events that are bound to happen over time. 

Although portfolio values can decrease, investors won't realize an actual loss during these periods unless they sell their investments.