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Types of Investments — Stocks

What they are

A stock is a share of ownership in a company, which entitles the owner, or shareholder, to own part of the company’s assets and earnings. They’re considered a relatively risky investment, because they can potentially lose all of their value. However, they can also potentially increase in value over time.


How they work

When you buy a share of stock, you’re entitled to a small fraction of the assets of that company — even dividends, if the company’s management chooses to pay them. The value of the stock is set by many people trading it in a free, open market, most often a stock exchange. The price of a stock fluctuates according to supply and demand, and many factors influence both.

Advantages and disadvantages

Stocks have their pros and cons, depending on what you’re looking for.

Advantages

  • Voting rights. Because you’re part owner, you often can vote on matters like corporate policy, or who serves on its board of directors.
  • Convenience. Stocks are often easy and inexpensive to trade.
  • Higher potential return. If a company meets or beats profit expectations, its stock may increase in price over time.
  • Potential income. Some stocks pay out quarterly dividends.

Disadvantages

  • Price swings. Stock markets can be volatile, and price swings can be frequent — which means your stocks could lose a substantial amount of value in a very short time.
  • Not guaranteed. Stocks are not guaranteed to return anything to an investor. So, while the possibility for high returns is greater, so is the possibility of losing money.

Types

Common stock and preferred stock

Common stock

Common stock, as you might guess, is the most common type of stock companies issue. It has the potential to increase in value through company growth and profits, and may pay out dividends to shareholders. This type of stock also may allow shareholders to vote on things such as a company’s board of directors.

Investing involves risk including the possible loss of principal. Stocks offer long-term growth potential, but may fluctuate more and provide less current income than other investments. An investment in the stock market should be made with an understanding of the risks associated with common stocks, including market fluctuations.  Dividends are not guaranteed and are subject to change or elimination.

Preferred stock

Preferred stocks offer investors other features. For example, if a company goes bankrupt or is dissolved, a shareholder will have dibs on assets before common stock shareholders. Preferred stocks typically pay out fixed, regular dividends, which also means there’s less chance you’ll make a large profit in your investment. They generally don’t allow shareholders to participate in voting.

Terms can vary greatly among preferred stock, so it’s important to understand the features before you invest.

There are special risks associated with investing in preferred securities. Preferred securities generally offer no voting rights with respect to the issuer. Preferred securities are generally subordinated to bonds or other debt instruments in an issuer’s capital structure, subjecting them to a greater risk of non-payment than more senior securities. In addition, the issue (or investment) may be callable, which may negatively impact the return of the security. Preferred dividends are not guaranteed and are subject to deferral or elimination.

Diversify to help manage risk

A typical investing mistake is to concentrate a large percentage of your money in one stock or one type of stock. To help reduce risk, many investors diversify — which means they spread their investment dollars strategically among different assets and asset categories. Here are 3 ways to diversify.

Diversification does not guarantee profit or protect against loss in declining markets.

How to invest

Assets

Assets are items of value owned by a company (e.g., cash, investments, equipment, real estate).

Earnings

A company’s earnings consist of its revenue minus business costs.

Dividends

A dividend is a sum of money paid regularly (often quarterly) by a company to its shareholders out of its profits (or reserves). Dividends are not guaranteed and are subject to change or elimination.

Stock exchange

A stock exchange is a market in which securities, such as stocks and bonds, are bought and sold.