A share represents a portion of ownership in a company. Shares are also called stocks, which means that everyone who owns them has a stake in the company’s performance.
Stock market movements are always in the news, which can deter some people from investing in stocks. According to a 2023 Bankrate survey, 26 percent of Americans believe stocks are the best long-term investment, while 17 percent prefer cash. Although cash investments are less volatile than stocks, it is almost certain that cash will lose value over time as inflation erodes its value.
People buy stocks to earn a return on their investment, which allows them to grow their wealth and achieve financial goals such as retirement. Here’s what else you need to know.
What does it mean to own a stock?
Owning stock is a little different than if you owned 100 percent of a private company. Owning a share of stock gives you a partial ownership interest in the underlying company. Share prices are quoted throughout the trading day, meaning the market value of the company and your stake change regularly. If you owned a business alone or with a small number of partners, you wouldn’t receive a quote for the business every day or perhaps even every year.
Another major difference between owning stock and owning your own business is the control over decision-making within the company.
When you own stock, the company’s management team and all its employees work on behalf of the shareholders to build value. The company’s board of directors exists to represent the interests of shareholders and can make changes in management that it deems necessary. You would be much more involved in the day-to-day decision-making of a business that you owned alone or with partners.
While these differences exist, it can be helpful to remember that stock still represents a stake in an actual company. Sometimes people are fascinated by the changing prices on a screen and think they have to buy and sell shares regularly, but they would never behave that way if they owned the entire company.
How stocks work
When a company wants to grow, it needs money to help pay for expenses such as designing new products, hiring more people and expanding into new markets. They issue new shares to help raise that capital. Anyone who buys these stocks is poised to benefit if that growth materializes.
How do you make money with shares?
There are generally two ways:
- Price valuation. A company’s stock price will generally rise as profits and the future prospects of the company’s operations improve. Over the long term, earnings growth is a key driver of share prices, so it’s important to identify companies whose businesses are likely to do well.
- Dividends. Some companies also pay dividends, which is a way for them to share some of their profits with shareholders. These regular payments are typically made quarterly and can account for a large portion of investors’ returns over time. If a company pays an 18 cent dividend every quarter and you own 10 shares, you will receive $1.80 with each payment. Although rare, stock dividends can also exist, which reward shareholders with additional shares.
It is important to note that dividends are not guaranteed. Companies can cut their dividends. Not all companies pay them either. Younger, fast-growing companies often do not pay dividends. Instead, they reinvest all profits back into the company, hoping to grow further and generate more profits, which will ultimately lead to a higher share price.
What are the disadvantages of shares?
While stocks offer the potential to grow your money, the allure of these returns comes with some significant risks. If the company falls on hard times, posts losses or misses earnings expectations, the stock price could fall. Wherever the stock goes, your money follows.
There is also a chance that you will lose all your money. For example, if a company you invested in closes its doors, your investment is likely gone for good. Equity investors are last in line when it comes to claims on the assets. Employees, salespeople and bondholders all line up to get paid before shareholders.
How can you invest in shares?
The stock market is open to everyone and there are two ways to own shares.
Direct ownership
You can buy shares of individual companies through a securities account. As competition has increased in recent years, most online brokers no longer charge commission fees. So instead of paying to invest, you can put all your money into your investment. Some companies like Walmart, Coca-Cola, and Home Depot also offer direct investment plans, which allow you to purchase shares of their stock, bypassing the need to open a brokerage account altogether.
While direct investing can put you in the driver’s seat, it also creates a huge workload. Studies have shown that building a well-diversified portfolio of individual stocks requires holding about 30 different stocks. (Diversification refers to owning a range of assets versus holding just one or a small number of assets. This reduces the overall risk in your portfolio.) That’s 30 different companies to monitor, to track how their business is performing and whether they are on a positive trajectory. – quite a task that requires a lot of time and expertise.
Indirect ownership
Indirect investing is a much simpler approach and is a great way for beginners to buy stocks. Instead of reading annual reports, comparing performance data and manually selecting stocks, you can own shares through a mutual fund or an exchange-traded fund (ETF). These funds invest in hundreds – sometimes even thousands – of shares. Instead of tying your fortune to one company, you can benefit from exposure to a wide range of companies. Think of this as instant diversification from the first dollar you invest.
Should you buy one full share?
It’s important to note that owning stocks doesn’t mean you need a bunch of money. Fractional stock investing is available through many brokers, and it allows you to invest a small amount (as little as $5) into a company. An indirect investment will also spread that money across companies in smaller fractions. For example, if you buy one share of a fund, you can become an investor in Amazon, Alphabet, and a number of other high-profile companies.
Bonds vs. Stocks: What’s the Difference?
In addition to buying stocks, many investors also include bonds in their portfolios. To raise capital, companies can also issue bonds, but buying one does not make you an owner. Instead, you make a loan to the company and the bond has a maturity date.
The best-case scenario for owning a bond is that you get your money back on that date, with some extra interest paid out along the way.
Bonds have a higher repayment priority in the event of a company’s liquidation, meaning they’re safer than stocks – although you could still lose some or all of your money. It’s also worth noting that bond prices and interest rates generally move in opposite directions. So when interest rates rise, bond prices tend to fall.
In short
Stocks have an excellent track record of providing shareholders with stable returns over time. But past performance does not predict future results, so it is essential to understand the risks before you start investing. Index funds and ETFs are two ways to buy multiple stocks at once, providing instant diversification and reducing risk.
Please note: Bank interest Brian Baker also contributed to an update to this story.
