Stocks

Stocks represent ownership shares in publicly traded companies. When you buy a stock, you become a partial owner of that company, entitled to a share of its profits and assets.

What Are Stocks?

Ownership

Equity - Stocks are equity securities, meaning you own a piece of the company
Shares - Companies divide ownership into shares that can be bought and sold
Voting Rights - Common stockholders may vote on corporate matters
Residual Claim - Stockholders receive assets after creditors if company liquidates

How Stocks Generate Returns

Capital Appreciation

Stock price increases over time as company grows
Buy low, sell high
Long-term historical average: ~10% annually

Dividends

Regular cash payments to shareholders
Many companies pay quarterly dividends
Can be reinvested to compound returns

Types of Stocks

By Company Size

Large-Cap - Market value > $10 billion (established, stable)
Mid-Cap - Market value $2-10 billion (growing companies)
Small-Cap - Market value < $2 billion (higher risk, higher potential)

By Investment Style

Growth Stocks - Companies expected to grow faster than market average
Value Stocks - Companies trading below intrinsic value
Dividend Stocks - Companies with high dividend yields
Blue-Chip Stocks - Large, established, financially sound companies

By Sector

Technology, Healthcare, Financial, Consumer, Energy, Industrial, and more. Diversification across sectors reduces risk.

How to Invest in Stocks

Individual Stocks

Buy shares of specific companies
Requires research and stock selection
Higher risk (concentration in few companies)
Potential for higher returns if you pick winners

Stock Mutual Funds

Professionally managed portfolios of stocks
Diversification across many companies
Active management (fund manager picks stocks)
Higher fees than index funds

Stock Index Funds

Track market indices (S&P 500, Total Stock Market)
Low-cost, passive investing
Broad diversification
Historically outperform most active funds

Exchange-Traded Funds (ETFs)

Similar to index funds but trade like stocks
Can buy/sell throughout trading day
Low costs, tax-efficient
Easy to diversify

Stock Market Basics

Market Exchanges

NYSE - New York Stock Exchange (largest)
NASDAQ - Technology-focused exchange
Other Exchanges - Regional and international markets

Market Indices

S&P 500 - 500 large U.S. companies
Dow Jones - 30 large industrial companies
NASDAQ Composite - All NASDAQ-listed stocks
Total Stock Market - All publicly traded stocks

How Prices Are Determined

Supply and demand, company performance and prospects, economic conditions, and investor sentiment.

Risks of Stock Investing

Market Risk

Stock prices fluctuate daily
Markets can decline significantly (bear markets)
Short-term volatility is normal

Company-Specific Risk

Individual companies can fail
Industry disruptions
Management mistakes
Diversification reduces this risk

Economic Risk

Recessions impact stock prices
Interest rate changes affect valuations
Inflation erodes purchasing power

Stock Investment Strategies

Buy and Hold

Purchase quality stocks and hold long-term
Benefit from compound growth
Avoid frequent trading costs and taxes
Historically successful approach

Dollar-Cost Averaging

Invest fixed amounts regularly
Buy more shares when prices are low
Reduces impact of market timing
Takes emotion out of investing

Value Investing

Buy stocks trading below intrinsic value
Focus on company fundamentals
Long-term perspective
Popularized by Warren Buffett

Growth Investing

Focus on companies with high growth potential
Willing to pay premium for growth
Higher risk, higher potential reward
Common in technology sector

Stock Selection Criteria

Fundamental Analysis

Earnings - Company profitability
Revenue Growth - Increasing sales
Debt Levels - Financial health
Competitive Position - Market share and moats
Management Quality - Leadership track record

Financial Metrics

P/E Ratio - Price-to-earnings (valuation)
PEG Ratio - Price/earnings to growth
Dividend Yield - Annual dividend / stock price
ROE - Return on equity (profitability)

Tax Considerations

Capital Gains

Short-Term - <1 year holding, taxed as ordinary income
Long-Term - ≥1 year holding, preferential rates (0%, 15%, 20%)

Dividends

Qualified Dividends - Taxed at long-term capital gains rates
Ordinary Dividends - Taxed as ordinary income

Tax-Loss Harvesting

Sell losing positions to offset gains
Can deduct up to $3,000 in net losses annually
Maintain market exposure with similar investments

Building a Stock Portfolio

Diversification

Don't put all money in one stock
Spread across sectors and company sizes
Consider geographic diversification (international stocks)
Index funds provide instant diversification

Asset Allocation

Stocks should be portion of overall portfolio
Balance with bonds and other assets
Adjust based on age, risk tolerance, time horizon
Rebalance periodically

Starting Out

Emergency fund first - 3-6 months expenses
Employer retirement plan - Often includes stock funds
Low-cost index funds - Broad market exposure
Individual stocks - Only after building foundation

Common Stock Investing Mistakes

Trying to time the market - Usually fails
Over-trading - High costs and taxes
Lack of diversification - Too much concentration risk
Emotional decisions - Buying high, selling low
Ignoring fees - High costs reduce returns
Chasing hot stocks - Often buy at peaks
Not staying invested - Missing market recoveries

The Bottom Line

Stocks have historically been one of the best long-term wealth-building tools, with average annual returns around 10% over decades. While they carry risk and volatility, a well-diversified stock portfolio, held for the long term, is a cornerstone of most successful investment strategies.

For most investors, low-cost stock index funds provide the best balance of diversification, low costs, and long-term growth potential.

The Resource section of this website provides performance data on major market indices as well as several diversified ETFs that can be used to build a model investment portfolio.