Investing in stocks is one of the most profitable ways to build wealth over the long-term. However, it's impossible to guarantee big returns - not even big investors like Warren Buffett can do that. Stocks are an investment that represents part ownership in a corporation and entitles you to part of that corporation's assets and earnings.
Today, share ownership is usually recorded electronically, and the shares are held in street name by your brokerage firm.
For most people, stock market investing means choosing among these two investment types:
Stock (also called equity) mutual funds or exchange-traded funds. These mutual funds let you purchase small pieces of many different stocks in a single transaction. Index funds and ETFs track an index; for example, a Standard & Poor’s 500 fund replicates that index by buying the stock of the companies in it. When you invest in a fund, you also own small pieces of those companies. You can put several funds together to build a diversified portfolio.ETFs trade throughout the trading day, like stocks, while mutual funds trade only at the end of the day at the net asset value (NAV) price.
Individual stocks If you’re after a specific company, you can buy a single share or a few shares as a way to dip your toe into the stock-trading waters. Building a diversified portfolio out of many individual stocks is possible, but it takes a significant investment.
Preferred Stock vs. Common Stock
Being a shareholder gives you certain rights and benefits; for example the right to vote on company matters at the Annual General Meeting and the potential benefit of receiving dividend payments.
Shareholders have a claim on the company’s assets in the event of liquidation, but do not own the assets.
Holders of common stock have voting rights at shareholders’ meetings. They also have right to receive dividends if they are declared. Holders of preferred stock don’t have voting rights, but do receive preference in terms of the payment of any dividends over common shareholders. Therefore, preferred stockholders receive a fixed dividend from the company, while common shareholders may or may not receive one, depending on the decisions of the board of directors.
Holders of preferred stock also have a higher claim on company assets than holders of common stock. Holders of preferred stock typically get paid more, and even have a priority claim in case something bad happens, like bankruptcy.
Preferred prices tend to be steadier than regular stocks, thanks to their big dividends. They’re also inconvenient to buy individually, so investors often turn to funds like ETFs and CEFs (closed-end funds) as ways to buy 5%+ paying baskets of preferred shares.
Ownership is determined by the number of shares a person owns relative to the number of outstanding shares.
Imagine you wanted to start a restaurant with your friends. You decide you need $800,000 to get the business off the ground so you incorporate a new company.
You divide the company into 1,000 shares of stock. You price each new share of stock at $800. If you can sell all of the shares to your friends, you should have the $800,000 you need (1,000 shares x $800 contributed capital per share = $800,000 cash raised for the company).
If the store earned $70,000 after taxes during its first year, each share of stock would be entitled to 1/1,000th of the profit. You'd take $70,000 and divide it by 1,000, resulting in $70 earnings per share (or EPS, as it is often called on Wall Street). You could also call a meeting of the company's Board of Directors and decide whether you should use that money to pay out dividends, expand the company by reinvesting in the retail store, or repurchase some stock.
For example, you may decide you want to sell your shares of the family retailer. At some point, if the company is large enough, you could have an IPO (initial public offering), allowing you to sell your stock on a stock exchange or the over-the-counter market.