The following post was originally published on Debt Free Guys
This posts kicks off our Investing 101 series. See the whole series here. 51 percent of Americans didn’t save for retirement in 2014 and, unfortunately, missed out on significant stock market gains. The most cited reason for not saving for retirement is lack of investment knowledge.
Over the next several weeks, we’ll discuss the most common investments types. With this information, you can build a foundation of investment knowledge. You’ll be able to make better decisions as to which investments are appropriate for you or give you enough information to ask more questions.
Because they are the most prolific investment, we’ll start with stocks. Stocks are the most common investments traded in the stock market because not only are investments made directly into stocks, but stocks are pooled together to create other investment types, such as mutual funds and exchange traded funds (ETFs).
1. What Is a Stock?
A stock represents fractional ownership in a company and proportional rights to dividends, voting rights and earnings growth. Dividends are profit distributions from the company that can be used to buy more stock or saved as cash.
In the hierarchy of corporate investments, stocks are at the bottom. This means if a company is dissolved or closed, investors in the company’s secured and unsecured debt, or “preferred stocks” and “bonds”, are compensated first. Stock holders receive compensation last, if any money is leftover.
The money you invest in the stock of a company is directly affected by that company’s overall performance. When the company performs well in the market place (i.e., Apple) and its accounting is clean, the company’s stock performs well. When a company doesn’t perform well in the market place, (i.e. Best Buy) or its accounting isn’t clean (i.e., Enron), the company’s stock performs poorly.
2. What Types of Stock Are There?
There are two primary types of stocks for retail or every day investors such as you and me, common stocks and preferred stocks.
Common stocks carry with them voting rights, along with dividend and growth benefits, but are subordinate to preferred stocks. If a company issues dividends or enters bankruptcy, common share holders are the last creditors paid. Common stocks, generally, have a greater chance of appreciation and are appropriate for investors seeking portfolio growth.
Preferred stocks do not carry with them voting rights, but do have seniority for dividend and bankruptcy claims over common stock share holders. Additionally, dividend payouts for preferred stocks are often consistent and somewhat predictable. This makes them appropriate for an investor seeking income.
When you hear or read stock price quotes, it is typically the common stock share price being quoted. Common and preferred stocks of the same company aren’t typically worth the same because of their differences.
3. What Are the Rewards and Risk of Owning a Stock?
The reward of owning a stock is that your money grows when a company performs well. For example, if you bought $10,000 of Microsoft (MSFT) common stock in December 2009, had all dividends reinvested and did nothing else, you would have over $18,000 today.
On the other hand, however, the risk is that you may lose when a company performs poorly. For example, if you bought $10,000 of JC Penny (JCP) common stock in December 2009, had all dividends reinvested and did nothing else, you would have less than $4,000 today.
There are other factors that play into the performance of a stock, such as the performance of the overall stock market, the economy in general, politics and international events. These can all be rewards and risks themselves.
There is a risk with putting all of your eggs in one basket, i.e., putting all of your investable money into one stock. There are always stories of those who made a fortune from one stock, but for everyone story you hear of someone who made millions with one investment there are hundreds of more stories of people who lost everything they had in one investment.
Quite often the best way to invest in stocks is with mutual funds and exchange traded funds (ETFs). We’ll discuss this more in later weeks, but essentially mutual funds and ETFs pool several different stocks into one investment. They offer the benefit of diversification, which reduces your risk of putting all your eggs in one basket.
That’s the basics of what you should know about stocks. Paying attention to individual stocks and the overall stock market is exciting. A great way to create interest in stocks is to pay attention to the stock of the companies you use, particularly the ones you like.
If you use and like Netflix or Comcast, shop at Target or Amazon or are fanatical about Google or Apple, you can follow their stocks, pay attention to their management and new products and watch how all these factors affect their stocks. If there is a particular company or collection of companies you like, these may be great initial investments for you to consider. This is a great way to start engaging with investing.