What are stocks?
Shares of stock are a way for ordinary individuals to buy ownership interests in a company, and over the long run, investing in stocks can create significant wealth for patient investors. Perhaps that’s why Warren Buffett, investment expert and CEO of Berkshire Hathaway said, “The stock market is a place for transferring money from the impatient to the patient.”
In everyday conversation, we often refer to stocks interchangeably with the publicly traded companies that issue them. For instance, you might hear someone say that Apple was up 1%. What they really mean is that the shares issued by Apple, Inc. increased in price by 1%. Thus, the term “stock" here refers to the publicly traded shares of ownership in a company that investors can buy and sell on an exchange on a daily basis.
Investing in stock means you’re investing in a company
From the perspective of your investment portfolio, owning shares of stock are how you can benefit from a company's success and growth. You can think of shares as entitling you, as a shareholder, to a portion of the company's assets and earnings, often in the form of dividends (a sum of money paid regularly by a company to its shareholders out of its profits/reserves) or appreciation (increase) of the stock price.
For example, if you invested in $1,000 Apple in 2008, your investment would be worth more than $7,200 as of May 25, 2018. That’s seven times as much, including price appreciation and dividend gains reinvested. No wonder Warren Buffett also said, “When we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever.”
Of course, the other side of the coin is what happens when companies are not successful. If you buy a company’s stock, and the company starts doing poorly or goes out of business, the value of your stock is likely going down with it.
Common stock vs. preferred stock
There are two main types of stocks: common stock and preferred stock. When people talk about stocks, they are most likely referring to common stock, which is the majority of stock issued. Over the long term, common stock yields higher returns than almost every other investment, but investing in common stocks entails the most risk.
With preferred stock, investors are usually guaranteed a fixed dividend (a regular payout of a fixed amount), unlike with common stock, which has variable dividends that are never guaranteed. Some people consider preferred stock to be more like debt (a bond) than equity (a stock).
How to invest in stocks
By owning the shares of many different types of companies, you’re able to build a portfolio that benefits from the success of many different types of companies (and cushions against losses due to any underperforming companies). To own stocks, you can buy and sell individual stocks through a brokerage account or use mutual funds and ETFs to own entire baskets of stocks more quickly and easily.
Most investors prefer to own diversified portfolios of stocks, rather than individual ones, in order to benefit from diversification and the long-run growth in the market. Picking specific stocks within sectors and styles can be difficult, and managing them can feel like a full-time job. By holding a broadly diversified group of stocks across all sectors (technology, healthcare, utilities, etc.) and styles (growth, value, etc.), an investor can construct a balanced portfolio of stocks.
The verdict: Stocks help you generate long-term wealth
Regardless of how you do it, a properly diversified stock portfolio that is appropriate for your goals can be one of the best ways to help potentially generate long-term wealth.