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If you are interested in using your money as a tool to generate more wealth, investing in stocks can be an effective method.
However, it’s important to note that investing in stocks also comes with a risk of financial loss. Before you attempt to make a profit on the stock market, it is vital that you learn about how stocks work, the varying types that are available and some of the advantages and disadvantages of this investment type.
Using this helpful information, you can learn how to build your financial portfolio.
To purchase a stock, a large percentage of investors handle their business through an investment firm or a mutual fund. Beginning investors are encouraged to set up a brokerage account with a firm so that they can start purchasing stocks.
All investors are encouraged to speak with their stockbroker and conduct research on any stocks they would like to purchase. Thorough research is essential for making a profit by investing in the stock market.
What are stocks and how do they work?
A stock is a popular type of investment where you essentially purchase ownership of a small share of a business or company. After purchasing stocks in a company, you become a co-owner, which entitles you to shareholder rights within the business.
For example, you could receive the authority to vote in a shareholder meeting in addition to receiving a portion of the company’s profits should you decide to sell your shares to other investors. Investing in the stock market can be a great way to use your money to earn more capital in the future, especially if you stay up-to-date on market trends.
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Often referred to as equities, stocks are distributed by companies who are attempting to raise money for their business operating needs in addition to funds for research and development, projects and expansions. Not all businesses offer their stocks to be purchased by investors in the general public, but the ones that do are referred to as “public” companies.
After an investor purchases a public stock, he or she can sell their share to other investors found on a public stock market exchange such as Nasdaq or the New York Stock Exchange.
What types of stocks can I invest in?
As an investor, there are two primary types of stocks that you can purchase from a company, common and preferred. It is essential to understand the difference between these two kinds of stocks before investing your money. The most frequently traded type of stock is appropriately named a common stock.
This type of stock typically entitles the investor to voting rights and the right to claim a portion of a company’s dividends or profits. Additionally, common stocks entitle investors to one vote for each share that they own during any shareholder meetings.
Common stocks are popular because they have the potential for a profitable yield and higher returns on investments through capital gains. Experienced investors tend to prefer common stocks for this reason.
It is vital for beginning investors to understand that common stocks also have a higher risk potential for financial loss, especially if the company goes bankrupt. Whenever a company goes out of business, assets are usually paid out to bondholders and preferred stockholders before common stockholders. This means that in the event of a bankruptcy, common stockholders may not receive any of their money back on their investment.
On the other hand, investors who opt for a preferred stock usually face less risk with their financial investment, but they will also have a lower potential for generating capital than with a common stock. Furthermore, preferred stockholders are not given voting rights in shareholder meetings.
The primary benefit of preferred stocks is that investors are guaranteed set, regular dividend payments for their shares. There may be some slight fluctuation in payments depending on the company’s earnings and losses, but there is generally less risk than a common stock. Additionally, if a company goes bankrupt and liquidates their assets, preferred shareholders typically get paid out first.
How are stocks different from bonds?
Stocks and bonds are both ways for consumers to invest in a company, but there are some important distinctions to consider between them. Although both stocks and bonds are commonly used by companies trying to raise capital, when a company sells a stock, they are also selling ownership.
A stock’s price can go up or down in value depending on how the business is performing. When a company has excess earnings, stockholders may receive a portion of these profits through a dividend check.
When a consumer invests in bonds for a company, they are essentially creating a type of loan. Basically, when an investor purchases a bond, they are giving a company or government entity money with the promise that they will be repaid on their investment with additional interest.
Generally, businesses will pay out a fixed-interest payment to bondholders until their bond matures. Once an investor’s bond has reached maturity, the company will pay them out for the full amount.
When being compared to stocks, bonds tend to carry less of a financial risk, but there is also a smaller opportunity for making capital returns. Most bonds are paid back in full in addition to interest payments, while stocks can drastically fluctuate in their price.
How can you make money with stocks?
Consumers who purchase stocks generally have two main methods of making a profit on their investment:
- Dividend income – When an investor is promised quarterly payments on their stocks, it is called dividend income. Dividends are seasonally paid out by the company that owns the stock you purchased. Dividend income is a fairly reliable source of income for investors. However, it is important to note that not every stock offers dividend payments.
- Capital appreciation – When you purchase a stock and the price of that stock goes up, it is called capital appreciation. While you do not receive any payments simply because the price of a stock appreciates, you can choose to trade your stock on the market in order to receive a higher price than you originally paid.
Questions to Ask Your Stockbroker Before You Invest
As stated previously, you might want to work with a stockbroker in researching and selecting stocks to invest in. In doing so, you can generally reduce your financial risk and maximize any potential gains that you will experience.
However, before investing, ask your broker the following questions:
- Why is this investment a good choice? When your stockbroker selects stocks for you to invest in, that broker is likely considering several factors that will influence whether or not a stock is a good choice for you. These factors could include your willingness to take risk, your ability to withstand loss, your age, your financial circumstances, your interests and your investment knowledge.
- What needs to occur for this investment to become profitable? A good investment is one that is likely to turn a profit. Therefore, brokers should be able to explain events that need to occur in order for an investor to be paid.
- What is the worst-case scenario for this investment opportunity? As you begin to invest, you will find that some investments will not pan out the way that you had hoped. However, a stockbroker that is experienced in investment will likely be able to tell you about the worst-case scenarios of an investment to help you fully understand the risk.