What is Stock and How Can It Benefit My Portfolio?
If you are new to the world of investing, you may be overwhelmed by the almost unending variety of products and asset classes available to you. A good place to start is understanding the basics of what these investments are and how they can work for you. Whether you are considering stocks, bonds, mutual funds, annuities, or even options, you want to arm yourself with knowledge before getting started. This article will focus on the popular investment, stock.
Stocks, or equities as they are frequently called, represent ownership in a corporation. When a corporation needs to raise capital for expansion, one option they have is to sell stock to the public. If the company is "public", its shares will trade on one of the stock exchanges such as the New York Stock Exchange or NASDAQ.
There are two main types of stock, both with distinct differences to the investor. The two types of stock are "common" and "preferred". Lets take a look at common stock first.
Common stock is considered to be the riskier of the two assets in that common shareholders are the last to receive anything in the event a company is forced out of business and has to liquidate their assets. Common stock trading on an exchange can both increase and decrease in price during the trading day and at times can be fairly volatile. The laws of supply and demand essentially dictate stock prices. More people demanding, or buying will cause the price to increase, while more supply, or sellers, will cause the price to fall. News of a new product, better business prospects, or earnings reports can send the price of company's stock into the stratosphere. Negative news can have an equally damaging effect on the price of stock. Common stockholders may also receive dividends, which are a portion of a company's earnings that are shared with shareholders. Corporations do not have to pay dividends and some types of companies are more likely to pay dividends, such as utilities and mature companies with established and predictable cash flows. Another key feature of common stock is the right it gives its owner to vote for board of director members and other key issues facing the company.
Unlike bonds or some preferred stock, common stock does not have to be repurchased or redeemed by the issuing company. Common stock is generally bought and sold on exchanges. It can be bought and held onto for indefinite periods of time, from mere minutes if you are a day trader, to potentially decades and beyond for some "buy and hold" investors.
Preferred stock shareholders receive proceeds from a corporate liquidation before common shareholders, but only after the bondholders. An attractive feature of preferred stock is the fixed dividend that may be paid on a monthly or quarterly basis. This is beneficial to investors interested in a steady flow of income. Preferred shares also trade on exchanges, but are less volatile and do not generally participate in the ups and downs of the stock market, as do their common siblings. Because they pay income and also have a chance of increasing or decreasing in price, preferred stock is actually more closely related to bonds. A preferred’s price is more susceptible to moves in interest rates than other more “news-driven” events.
Some preferred shares have special features that the investor should be aware of. The first is if the stock is “callable”. This means that at some future date, the company can “call” or redeem, the stock from you at a predetermined price. A company will generally call an issue if they are able to issue new shares with a lower dividend thus costing them less money. The second feature that some preferred shares may have is called being “convertible”. Convertible preferred shares could be converted to shares of the issuing company’s common stock at a predetermined ratio. For example, you might be able to convert each one of your preferred shares for two shares of the common stock.
Individual equities can play an important part in any investor’s portfolio. Understanding the basics of individual asset classes you may be considering form the basis of a successful investment plan.